Deck 10: The Foreign Exchange Market

Question 1

The foreign exchange market is the primary vehicle used to minimize monopolies within a marketplace.

Answer 1

False

Question 2

The spot exchange rate is the rate at which the foreign exchange dealer will convert one currency into another on a particular day.

Answer 2

True

Question 3

Carry trade occurs when borrowing is done in one currency where interest rates are low and using the proceeds to invest in another country where interest rates are high.

Answer 3

True

Question 4

A common kind of currency swap is spot against forward.

Question 5

Unlike the purchasing power parity theory, the international Fisher effect is a good predictor of short-run changes in spot exchange rates.

Question 6

Assume that the euro/dollar exchange rate is €1 = $1.20. If it costs $36 to buy a European product, the stated price of the product would be €36.

Question 7

In economic terms, interest rate levels reflect future inflation rates.

Question 8

In terms of exchange rate forecasting, the efficient market school argues that companies should spend additional money trying to forecast short-run exchange rate movements.

Question 9

Investor psychology has an effect on short-run exchange rate movements.

Question 10

Supply and demand of one currency relative to another helps determine exchange rates.

Question 11

Inflation occurs when the money supply in a country increases faster than output increases.

Question 12

The foreign exchange market offers complete insurance against foreign exchange risk.

Question 13

When a firm enters into a spot exchange contract, it is taking out insurance against adverse future exchange rate movements.

Question 14

A fundamental approach to exchange rate forecasting would focus on relative money supply growth rates, inflation rates, and interest rates.

Question 15

An efficient market exists when countries enact tariff barriers to minimize imports.

Question 16

Although a foreign exchange transaction can involve any two currencies, most transactions involve U.S. dollars on one side.

Question 17

For price discrimination to work, arbitrage opportunities must be unlimited.

Question 18

When companies wish to convert currencies, they typically do so through a bank.

Question 19

Currency swaps are transacted between international businesses and their banks, between banks, and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange risk.

Question 20

Spot exchange rates and the 30-day forward rates are the same.

Question 21

A(n) ________ occurs when two parties agree to exchange currency and execute the deal at some specific date in the future.

A) forward exchange
B) spot exchange
C) carry trade
D) currency swap
E) arbitrage

Question 22

The U.S. dollar is selling at a discount on the 30-day forward market when what is taking place?

A) The spot exchange rate is $1 = ¥120 currently and $1 = ¥130 after 30 days.
B) The spot exchange rate is $1 = ¥120 currently and $1 = ¥100 after 30 days.
C) The current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 = ¥110 after 30 days.
D) The current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 = ¥130 after 30 days.
E) The current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 = ¥120 after 30 days.

Question 23

Countertrade is a logical choice when a country's currency is freely convertible.

Question 24

How are spot exchange rates determined?

A) using historical average prices of different currencies
B) the interaction between demand and supply of a currency relative to other currencies
C) taking the average of a basket of currencies
D) by government decree
E) predicting future currency movements in nonmember countries

Question 25

Rhonda tells Kevin that he will receive 0.86 euro for every U.S. dollar he wants to convert. Rhonda is referring to

A) the exchange rate.
B) arbitration.
C) a forward exchange.
D) countertrade.
E) a balance-of-trade equilibrium.

Question 26

World Auto Group, based in California, buys component parts from Indonesia. The Indonesian company must be paid in rupiah. World Auto Group will rely on ________ to convert dollars to rupiah.

A) local content regulations
B) the foreign exchange market
C) a greenfield investment
D) an acquisition agreement
E) arbitration

Question 27

Currency speculation takes place when

A) there is short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.
B) the exchange rate at which a foreign exchange dealer will convert one currency differs on a particular day.
C) there is a simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
D) the purchase of securities in one market are immediately resold in another to profit from a price discrepancy.
E) the growth in a country's money supply exceeds the growth in its output, leading to price inflation.

Question 28

When Lila was planning her visit to Japan, she learned that the 30-day forward exchange rate was $1 = ¥130, which meant that $1 would buy more yen with a forward exchange than a spot exchange. In other words, the dollar was selling at a ________ on the 30-day forward market.

A) discount
B) constant
C) command
D) premium
E) deficit

Question 29

Jasper Corp. converts $1,000,000 into euros when the exchange rate is $1 = €0.75. After three months, the company converts this back into dollars when the exchange rate is $1 = €0.80. What is the outcome of this transaction?

A) A loss of $62,500
B) A loss of $66,667
C) A gain of $50,000
D) A gain of $62,500
E) A loss of $50,000

Question 30

One function of the foreign exchange market is to

A) provide some insurance against foreign exchange risk.
B) protect short-term cash flow from adverse changes in exchange rates.
C) eliminate volatile changes in exchange rates.
D) reduce the economic exposure of a firm.
E) enable companies to engage in capital flight when countertrade is not possible.

Question 31

Assume that the interest rate on borrowings in Japan is 3 percent while the interest rate on bank deposits in a U.S. bank is 5 percent. Laura, an active currency trader, borrows in Japanese yen, converts the money into U.S. dollars and deposits it in a U.S. bank. Laura is engaging in

A) countertrading.
B) hedging.
C) currency swap.
D) arbitrage.
E) carry trade.

Question 32

FutureForm, a U.S. company, imports microprocessors from Japan. The company must pay in yen to the Japanese supplier within 30 days. In a particular exchange, the company must pay the Japanese supplier ¥150,000 for each microprocessor at the current dollar/yen spot exchange rate of $1 = ¥110. FutureForm intends to resell the microprocessors the day they arrive for $1,600 each but it does not have the funds to pay the Japanese supplier until these have been sold. What will happen if the exchange rate after 30 days is $1 = ¥90?

A) The importer will earn a profit of approximately $236 per microprocessor.
B) The importer will earn a profit of approximately $67 per microprocessor.
C) The importer will incur a loss of approximately $236 per microprocessor.
D) The importer will incur a loss of approximately $67 per microprocessor.
E) The importer will incur a loss of approximately $90 per microprocessor.

Question 33

When only non-residents of a country may convert currency into a foreign currency without any limitations it is called freely convertible.

Question 34

Jin-Lo is investing money for his company. He notices that the interest rate on borrowing in Jakarta is 2 percent and the interest rate on bank deposits in Warsaw is 7.5 percent. In this situation, a carry trade would occur when Jin-Lo

A) borrows money in Warsaw currency, converts it into Jakarta currency, and deposits it in a Jakarta bank.
B) borrows money in Jakarta currency and invests in stocks with good growth potential in Jakarta.
C) borrows money in Jakarta currency, converts it into Warsaw currency, and deposits it in a Warsaw bank.
D) invests in bank deposits of Warsaw and reinvests the earnings in Jakarta.
E) invests in bank deposits of Jakarta and reinvests the earnings in Warsaw.

Question 35

Last week, Saturn Tide a U.S.-based energy firm, entered into an agreement with another party to exchange currency and execute the deal in eighteen months. What is Saturn Tide using to insure itself against foreign exchange risk?

A) currency speculation
B) carry trade
C) hedging
D) currency swap
E) arbitrage

Question 36

Steven converted $1,000 to ¥105,000 for a trip to Japan. However, he spent only ¥50,000. During this period, the value of the dollar weakened against the yen. Using a current exchange rate of $1 = ¥100, how many dollars does Steven have left?

A) $550
B) $523
C) $450
D) $600
E) $500

Question 37

Economic exposure is concerned with long-run effects on future prices, sales, and costs caused by changes in exchange rates.

Question 38

Assume that the dollar is selling at a premium on the 30-day dollar/euro forward market. What is true of the foreign exchange dealers' market's expectations about the dollar over the next 30 days?

A) The dollar will depreciate against the euro.
B) The market is undecided about the direction of currency movement.
C) The dollar will appreciate against the euro.
D) The dollar/euro exchange rate will be steady.
E) The dollar will buy more euros with a spot exchange than with a 30-day forward exchange.

Question 39

Assume that the interest rate on borrowings in India is 1 percent while the interest rate on bank deposits in a U.S. bank is 4 percent. Carlos, an active currency trader, borrows in Indian rupees, converts the money into U.S. dollars and deposits it in a U.S. bank. What is the speculative element of this carry trade?

A) There will be no adverse movement in exchange rates or interest rates.
B) Liquidity is the key factor in determining interest rates.
C) Increasing money supply will not drive inflation.
D) Spot exchange rates are more favorable than forward exchange rates.
E) Hedging insures a company against foreign exchange risks.

Question 40

Leading and lagging strategies involve accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries.

Question 41

Assume that the yen/dollar exchange rate quoted in London at 3:00 p.m. is ¥115 = $1. Rinaldo finds out that the rate quoted in New York at 10:00 a.m. (3:00 p.m. London time) is ¥135 = $1. Rinaldo decides to buy yen in New York and sell it in London. Rinaldo is engaging in

A) currency swapping.
B) currency speculation.
C) carry trade.
D) arbitrage.
E) hedging.

Question 42

According to purchasing power parity (PPP) theory, the price of a "basket of goods" should be

A) the sum of the required "real" rate of interest.
B) unchangeable based on the forward exchange rate.
C) roughly equivalent in each country in relatively efficient markets.
D) discounted to reflect trade barriers.
E) focused strictly on consumer and not industrial goods.

Question 43

To jumpstart its slow economy, Greece increased the money supply. What is a likely consequence of this action?

A) It results in an overall decrease in credit.
B) It makes it difficult for individuals and companies to borrow from banks.
C) It makes it easier for banks to borrow from the government.
D) It causes a decrease in demand for goods and services.
E) It causes price deflation as the money supply exceeds goods and services output.

Question 44

In theory, if inflation is at an all-time high in the United States, then its currency will

A) increase in value when trading with countries in a political union.
B) appreciate against that of other countries where inflation is lower.
C) not be affected.
D) depreciate against that of other countries where inflation is lower.
E) increase faster than the money supply.

Question 45

Assume that the yen/dollar exchange rate quoted in Tokyo at 5 p.m. is ¥120 = $1, and the New York yen/dollar exchange rate at the same time (noon New York time) is ¥123 = $1. What action should a broker take to yield immediate profit?

A) forward exchange
B) carry trade
C) currency swap
D) arbitrage
E) currency speculation

Question 46

Kristin was shopping in New York last week and saw a Coach purse for $210. When she returned to London, she saw that same purse for £105. She knew that the exchange rate was one pound for every two dollars. Her shopping experience demonstrates

A) hedging.
B) arbitrage.
C) currency swap.
D) exchange rate risk.
E) the law of one price.

Question 47

The purchasing power parity (PPP) theory tells us that a country with a high inflation rate will see

A) appreciation in its currency exchange rate.
B) a decrease in interest rates.
C) the collapse of the gold standard.
D) depreciation in its currency exchange rate.
E) no change in its exchange rates.

Question 48

If a basket of goods costs $100 in the United States and €120 in Europe, what would the purchasing power parity theory's prediction of the dollar/euro exchange rate be?

A) $1 = €1.20
B) $1 = €1
C) $1 = €0.80
D) $1 = €0.90
E) $1 = €1.10

Question 49

The law of one price states that

A) by comparing the prices of identical products in different currencies, it would be possible to determine the "real" or PPP exchange rate that would exist if markets were efficient.
B) a country's "nominal" interest rate (i) is the sum of the required "real" rate of interest (r) and the expected rate of inflation over the period for which the funds are to be lent (I).
C) a country in which price inflation is running wild should expect to see its currency depreciate against that of countries in which inflation rates are lower.
D) when the growth in a country's money supply is faster than the growth in its output, price inflation is fueled.
E) in competitive markets free of transportation costs and trade barriers, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.

Question 50

Suppose that the government of Venezuela decided to give everyone in the country the equivalent of $20,000. Upon receipt of the money, people raced to the stores to buy furniture, electronics, and new clothes. There was such high demand for goods that producers raised prices. What is this an example of?

A) isolationism
B) inflation
C) spot exchange
D) recession
E) a planned economy

Question 51

The foreign exchange trading center in ________ has the highest percentage of activity.

A) Frankfurt
B) London
C) Paris
D) Hong Kong
E) Sydney

Question 52

A(n) ________ has no impediments to the free flow of goods and services, such as trade barriers.

A) economic union
B) currency board
C) efficient market
D) carry trade
E) European Monetary System

Question 53

A(n) ________ is used to move out of one currency and into another for a limited period without incurring foreign exchange risk.

A) currency swap
B) currency speculation
C) carry trade
D) spot exchange
E) arbitrage

Question 54

The yen/dollar exchange rate is ¥120 = $1 in London and ¥123 = $1 in New York at the same time. What is the net profit if a dealer takes $1,000,000 to purchase ¥123,000,000 in New York and engages in arbitrage by selling it in London?

A) $34,000
B) $20,390
C) $25,000
D) $46,666
E) $39,454

Question 55

The euro/dollar exchange rate is €1 = $1.20. According to the law of one price, how much would a camera that retails for $300 in New York sell for in Germany?

A) €320
B) €300
C) €250
D) €360
E) €150

Question 56

Shantal saw a Hermes scarf at the Amsterdam airport when she was catching a flight back home to New York. She noticed that the scarf sold for 100 euros. Assume that the euro/dollar exchange rate is €1 = $1.20. According to the law of one price, at what price would it make sense to buy the scarf in New York?

A) $150
B) $140
C) $120
D) $105
E) $100

Question 57

To express the PPP theory in symbols, let P$ be the U.S. dollar price of a basket of particular goods and P¥ be the price of the same basket of goods in Japanese yen. What does the purchasing power parity (PPP) theory predict to be the equivalent of the dollar/yen exchange rate, E$/¥?

A) E$/¥ = (1 + P¥) ÷ P$
B) E$/¥ = (1 + P$) ÷ P¥
C) E$/¥ = P¥ ÷ P$
D) E$/¥ = P$ ÷ P¥
E) E$/¥ = (1 + P$) ÷ (1 + P¥)

Question 58

London is able to dominate in the foreign exchange market because of its

A) conversion to the euro.
B) government.
C) location.
D) class system.
E) free trade policy.

Question 59

A base model Schwinn bike costs $100 in the United States and €125 in Europe. What would the purchasing power parity theory's prediction of the dollar/euro exchange rate be based on this example?

A) $1 = €1.25
B) $1 = €1
C) $1 = €0.80
D) $1 = €0.90
E) $1 = €1.10

Question 60

Assume that a Big Mac costs $4.93 in the United States and that the Brazilian real is undervalued by 23 percent. According to the Big Mac Index published by The Economist, a Big Mac would

A) cost a bit more in Brazil than in the United States.
B) cost less in Brazil than in the United States.
C) cost the same in both countries.
D) would cost twice as much in Brazil.
E) would cost less than half of the United States price in Brazil.

Question 61

________ draw(s) on economic theory to construct sophisticated econometric models for predicting exchange rate movements.

A) Technical analysis
B) Purchasing power parity
C) The Sullivan principles
D) Fundamental analysis
E) The Treaty of Lisbon

Question 62

The Fisher effect is used to demonstrate a strong correlation between inflation rates and

A) interest rates.
B) competition.
C) entrepreneurial activity.
D) spot exchange rates.
E) forward rates.

Question 63

What happens to the value of money when hyperinflation exists?

A) Money loses value very rapidly.
B) Foreign currency is valued against the U.S. dollar.
C) The value of all currency increases faster than gross national income.
D) There are more goods to purchase and it costs less to buy them.
E) All currency continues to be valued at the same amount across trade channels.

Question 64

The Brazilian government decided to analyze price and volume data to determine past trends in exchange rate movements for the country. What approach does this represent?

A) technical analysis
B) PPP index
C) efficient market
D) fundamental analysis
E) inefficient market

Question 65

One reason for the failure of purchasing power parity theory and international Fisher effect in predicting short-term movements in exchange rates is due to the

A) impact of investor psychology on short-run exchange rate movements.
B) strong relationship between inflation rates and interest rates.
C) impact of interest rates and short-term exchange rate movements.
D) strong relationship between interest rate differentials and subsequent changes in spot exchange rates.
E) government intervention in cross-border trade that violates the assumption of efficient markets.

Question 66

The nominal interest rate is 9 percent in Brazil and 6 percent in Japan. Applying the international Fisher effect, the Brazilian real should

A) appreciate by 3 percent against the Japanese yen.
B) depreciate by 3 percent against the Japanese yen.
C) appreciate by 1.5 percent against the Japanese yen.
D) depreciate by 1.5 percent against the Japanese yen.
E) appreciate by 15 percent against the Japanese yen.

Question 67

Traders at a stock exchange notice that five traders on the floor seem to be selling more yen and purchasing more euros because of an expected decline in the yen. As a result, all other traders started to do the same. This is an example of the ________ that creates a self-fulfilling prophecy when the yen does decline in value.

A) spot exchange rate
B) arbitration process
C) bandwagon effect
D) difference principle
E) tragedy of the commons

Question 68

According to the Fisher effect, if the "real" rate of interest in a country is 3 percent and the expected annual inflation is 8 percent, what would the "nominal" interest rate be?

A) 5.5 percent
B) 11 percent
C) 9 percent
D) 24 percent
E) 2.25 percent

Question 69

A country that relies on technical analysis for forecasting exchange rate movements would know that

A) price and volume data cannot be used to determine past trends.
B) econometric models drawn from economic theory are best suited to predict exchange rate movements.
C) the foreign exchange market is efficient and forward exchange rates are the best predictors of future spot exchange rates.
D) previous market trends and waves can be used to predict future market trends and waves.
E) since forward exchange rates are the best predictors of future spot rates, it makes no sense to invest in forecasting.

Question 70

In countries where inflation is expected to be high, interest rates also will be high, because investors want compensation for the decline in the value of their money. This relationship is referred to as the

A) purchasing power parity puzzle.
B) lead strategy.
C) Fisher effect.
D) bandwagon effect.
E) international Fisher effect.

Question 71

The purchasing power parity puzzle represents the failure to find a strong link between relative inflation rates and

A) trade agreements.
B) entrepreneurial activity.
C) exchange rate movements.
D) the bandwagon effect.
E) monopolistic competition.

Question 72

One reason for the failure of the purchasing power parity (PPP) theory to predict exchange rates accurately is because it

A) assumes away transportation costs and trade barriers.
B) does not take into account the law of one price.
C) does not take into account arbitration.
D) assumes that the markets are not efficient.
E) does not consider government influence on a nation's money supply.

Question 73

The purchasing power parity (PPP) theory best predicts exchange rate changes for countries with

A) low rates of inflation.
B) stable currencies.
C) underdeveloped capital markets.
D) small differentials in inflation rates.
E) industrialized economies.

Question 74

According to the efficient market school, ________ do the best job at predicting future spot exchange rates.

A) forecasting services
B) government institutions
C) inflationary trends
D) forward exchange rates
E) arbitration results

Question 75

When discussing exchange rate forecasting, the inefficient market school of thought would agree that

A) forward exchange rates are the best possible predictors of future spot exchange rates.
B) forward exchange rates represent market participants' collective predictions of likely spot exchange rates.
C) companies cannot beat the markets because forward rates reflect all available information about likely future changes in exchange rates.
D) investing in forecasting services can improve the foreign exchange market's estimate of future exchange rates.
E) the foreign exchange market is efficient at setting forward rates, which are unbiased predictors of future spot rates.

Question 76

The ________ states that for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two countries.

A) bandwagon effect
B) law of one price
C) international Fisher effect
D) Helms-Burton Act
E) purchasing power parity (PPP) theory

Question 77

What is one way an enterprise with some market power might limit arbitrage so that their price discrimination policy works?

A) price its products identically despite huge differences in demand across different markets
B) differentiate otherwise identical products among nations along some line, such as design or packaging
C) adopt a pricing strategy that matches what competitors charge in each of the different national markets
D) limit sales of its products to only a few nations
E) sell its products at higher prices than normal to break even by selling fewer units

Question 78

The ________ is a variable used in exchange rate forecasting models based on fundamental analysis.

A) PPP index
B) moving average
C) inflation rate
D) business cycle
E) regression rate

Question 79

Gold Brands is the industry leader in golf equipment and not only has a degree of pricing power amongst its competition but also sets different prices in different markets based on demand conditions. Gold Brands is practicing

A) price discrimination.
B) premium pricing.
C) psychological pricing.
D) price skimming.
E) price leadership.

Question 80

Many economists compare the process of ________ to fortune-telling because there is no rationale for the assumption of predictability.

A) the efficient market school
B) fundamental analysis
C) a planned economy
D) the inefficient market school
E) technical analysis