Deck 10: The Foreign Exchange Market

Question 1

Companies engage in currency speculation to get minimal but assured returns from idle cash.

Answer 1

False

Question 2

The foreign exchange market is a market for converting the currency of one country into that of another country.

Answer 2

True

Question 3

A common kind of currency swap is spot against forward.

Answer 3

True

Question 4

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 5

Assume that current dollar/yen spot exchange rate is $1 = ¥110.If the 30-day forward exchange is $1 = ¥105,we say the dollar is selling at a premium on the 30-day forward market.

Question 6

What happens in the foreign exchange market does not directly impact the sales,profits,and strategy of a multinational enterprise.

Question 7

Foreign exchange risk refers to the risk of not getting paid for a product that is exported from one country to another.

Question 8

When companies wish to convert currencies,they typically enter the foreign exchange market directly.

Question 9

The short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates is known as countertrade.

Question 10

The currency of Argonia falls sharply in value against the currency of Palladia.This exchange rate movement will boost Palladia's exports to Argonia.

Question 11

Carry trade is a kind of speculation whose success is based upon a belief that there will be no adverse movement in exchange rates.

Question 12

The integration of financial centers implies there can be no significant difference in exchange rates quoted in the foreign exchange trading centers.

Question 13

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

Question 14

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 15

For most major currencies,forward exchange rates are quoted for 30 days,90 days,and 180 days into the future.

Question 16

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

Question 17

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

Question 18

The forward exchange rate refers to the rate at which a foreign exchange dealer converts one currency into another currency on a particular day.

Question 19

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

Question 20

London has lost its leading position in the global foreign exchange market due to the diminishing importance of the British pound.

Question 21

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 22

When residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency,the phenomenon is generally referred to as capital flight.

Question 23

Since translation exposure,a category of foreign exchange risk,is concerned with the present measurement of past events,the resulting accounting gains or losses are said to be unrealized,and therefore unimportant.

Question 24

Transaction exposure,a category of foreign exchange risk,refers to the impact of currency exchange rate changes on the reported financial statements of a company.

Question 25

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

Question 26

If the law of one price were true for all goods and services,the purchasing power parity (PPP)exchange rate could be found from any individual set of prices.

Question 27

In countries where inflation is expected to be high,interest rates also will be high.

Question 28

Technical analysis,an approach to foreign exchange forecasting,does not rely on a consideration of economic fundamentals.

Question 29

Relative monetary growth,relative inflation rates,and nominal interest rate differentials are all moderately good predictors of long-run changes in exchange rates.

Question 30

Which of the following enables organizations to conduct international trade without having to resort to barter?

A) Foreign exchange market
B) Caribbean Single Market and Economy
C) Auction market
D) Countertrade
E) Balance-of-Trade Equilibrium

Question 31

_____ refers to the adverse consequences of unpredictable changes in exchange rates.

A) Countertrade
B) Foreign exchange risk
C) Currency speculation
D) Forward exchange
E) Floating exchange rate

Question 32

Economic exposure,a category of foreign exchange risk,is distinct from transaction exposure,which is concerned with the effect of exchange rate changes on individual transactions,most of which are short-term affairs that will be executed within a few weeks or months.

Question 33

The currency of Venadia,a country,falls sharply in value against the currency of Lutetia,a neighboring country.Which of the following is a consequence of this exchange rate movement?

A) Lutetia's products will achieve a competitive pricing in Venadia.
B) Venadia's exports to Lutetia will increase because Venadian goods will become cheaper in Lutetia.
C) Venadia's products will cost more in Lutetia.
D) There will be no difference in the volume or direction of trade.
E) Lutetia's exports to Venadia will increase because Lutetian goods will become cheaper in Venadia.

Question 34

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

Question 35

A(n)_____ refers to the rate at which one currency is converted into another.

A) economic exposure
B) arbitrage
C) exchange rate
D) tariff rate
E) currency swap

Question 36

Which of the following is a function of the foreign exchange market?

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

Question 37

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 38

Theoretically,a country in which price inflation is very high should expect to see its currency depreciate against that of countries in which inflation rates are lower.

Question 39

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

Question 40

In the context of The Economist's "Big Mac Index," assume that the average price of a Big Mac in South Korea is $2.98 at the prevailing won/dollar exchange rate.The average price of a Big Mac in the United States is $3.58.This suggests that the Korean won is overvalued against the U.S.dollar.

Question 41

Robben Inc.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.Which of the following 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 42

The speculative element of the carry trade is that its success is based upon a belief that:

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 43

How are spot exchange rates determined?

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

Question 44

Which of the following transactions is used to move out of one currency 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 45

Which of the following instances indicates that the dollar is selling at a premium on the 30-day forward market?

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

Question 46

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 47

Assume that the dollar is selling at a premium on the 30-day dollar/euro forward market.Which of the following 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 48

An American company imports laptop computers from Japan.The company knows that after a shipment arrives,it must pay in yen to the Japanese supplier within 30 days.In a particular exchange,the American company must pay the Japanese supplier ¥150,000 for each computer at the current dollar/yen spot exchange rate of $1 = ¥110.The company intends to resell the computers the day they arrive for $1,600 each but it does not have the funds to pay the Japanese supplier until the computers have been sold.Which of the following will happen if the exchange rate after 30 days is $1 = ¥90?

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

Question 49

When a firm insures itself against foreign exchange risk,it is said to be engaging in _____.

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

Question 50

Which of the following caused a decline in the dollar-yen carry trade during 2008-09?

A) Increase in risk appetite making the carry trade less attractive
B) Decrease in interest rate differentials as the U.S. rates came down
C) Increase in interest rate differentials as Japanese interest rates came down
D) Decrease in interest rate differentials as the U.S. interest rates went up
E) Decrease in interest rate differentials as the Japanese rates went up

Question 51

Which of the following refers to carry trade?

A) Providing insurance or hedging against the risks that arise from volatile changes in exchange rates
B) A transaction between two parties that involves exchanging currency and executing a deal at some specific date in the future
C) Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
D) The purchase of securities in one market for immediate resale in another to profit from a price discrepancy
E) Borrowing in one currency where interest rates are low and then using the proceeds to invest in another currency where interest rates are high

Question 52

Carry trade,a kind of speculation,takes advantage of the:

A) temporary undervaluation of one currency vis-à-vis another.
B) disparity between spot exchange rates and forward exchange rates.
C) the collapse of the gold standard.
D) differences in interest rates between countries.
E) the rise of the fixed exchange rate system.

Question 53

Which of the following indicates that the dollar is selling at a discount on the 30-day forward market?

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

Question 54

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.Considering a current exchange rate of $1=¥100,how many dollars did Steven spend on the trip?

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

Question 55

When two parties agree to exchange currency and execute the deal immediately,the transaction is referred to as _____.

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

Question 56

Which of the following refers to currency speculation?

A) The 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 into another that particular day
C) Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
D) The purchase of securities in one market for immediate resale in another to profit from a price discrepancy
E) The growth in a country's money supply exceeding the growth in its output, leading to price inflation

Question 57

_____ refers to the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

A) Carry trade
B) Forward exchange
C) Spot exchange
D) Currency swap
E) Arbitrage

Question 58

The interest rate on borrowings in Rhodia is 2 percent and the interest rate on bank deposits in Maritia is 7.5 percent.In this scenario,a carry trade would be to:

A) borrow money in Maritian currency, convert it into Rhodian currency, and deposit it in a Rhodian bank.
B) borrow money in Rhodian currency and invest in stocks with good growth potential in Rhodia.
C) borrow money in Rhodian currency, convert it into Maritian currency, and deposit it in a Maritian bank.
D) invest in bank deposits of Maritia and reinvest the earnings in Rhodia.
E) invest in bank deposits of Rhodia and reinvest the earnings in Maritia.

Question 59

A French company wants to invest 20 million euros for three months.The company found that investing in a Thai money market account will give it a higher interest rate than domestic investments.Which of the following is true about this investment?

A) The investment is risk-free because money market investments are considered to be equivalent to bank deposits.
B) The investment is not risk-free because foreign currency movements in the intervening period can affect the profitability of the firm.
C) The investment is risk-free because such investments also lock foreign exchange rates for the duration of the investment.
D) The investment is not risk-free because money market instruments are considered to be the most speculative of all investments.
E) The investment is risk-free because the Thai money market is considered to be more stable and secure than other markets.

Question 60

A U.S.company that imports laptop computers from Japan knows that in 30 days it must pay in yen to a Japanese supplier when a shipment arrives.The company will pay the Japanese supplier ¥150,000 for each computer,and the current dollar/yen spot exchange rate is $1 = ¥110.The importer can sell the computers the day they arrive for $1,600 each.However,the importer will not have the funds to pay the Japanese supplier until the computers have been sold.The importer enters into a 30-day forward exchange transaction with a foreign exchange dealer at $1 = ¥105.Which of the following will happen if the exchange rate after 30 days is $1 = ¥90?

A) The importer will earn a profit of approximately $236 per computer.
B) The importer will earn a profit of approximately $171 per computer.
C) The importer will earn a profit of approximately $65 per computer.
D) The importer will incur a loss of approximately $67 per computer.
E) The importer will incur a loss of approximately $105 per computer.

Question 61

Which of the following is a reason for London's dominance in the foreign exchange market?

A) Great Britain's decision to retain the British pound instead of using the euro
B) The preeminence of Financial Times Stock Exchange (FTSE) index as an economic health indicator
C) London's location making it the link between the East Asian and New York markets
D) London being the preferred headquarters destination for major multinational corporations
E) London's trading centers opening soon after Tokyo's and New York's trading centers closing for the night

Question 62

Which of the following is true of the determination of exchange rates?

A) Differences in relative demand and supply do not explain the determination of exchange rates.
B) Differences in relative demand and supply explain the factors underlying the phenomenon behind the demand for and supply of a currency.
C) The differences in relative demand and supply alone provide a high level understanding of behind determination of exchange rates.
D) While the differences in relative demand and supply they provide an accurate explanation for appreciation of currencies, they fail to explain depreciation.
E) The differences in relative demand and supply cannot explain or predict the conditions under which a particular currency will be in demand or not.

Question 63

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.The (purchasing power parity)PPP theory predicts that the dollar/yen exchange rate,E_$/¥,should be equivalent to _____.

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 64

Which of the following is true of the differences in relative demand and supply of currencies?

A) They cannot be used to explain the determination of exchange rates.
B) While they provide an understanding of the major factors underlying exchange rates, they exclude minor factors.
C) They provide a high level understanding of exchange rates.
D) While they provide an accurate explanation for appreciation of currencies, they fail to explain depreciation.
E) They cannot explain or predict when the demand of a particular currency would exceed its supply and vice versa.

Question 65

Which of the following is true of arbitrage opportunities in foreign exchange markets?

A) They cause long-term bandwagon effects.
B) They tend to be small and they disappear in minutes.
C) They tend to occur very frequently.
D) They are only valid for dollar transactions.
E) They provide insurance against foreign exchange risk.

Question 66

What is meant by arbitrage?

A) To provide insurance or hedge against the risks that arise from volatile changes in exchange rates
B) A transaction between two parties that involves exchanging currency and executing a deal at some specific date in the future
C) Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
D) The purchase of securities in one market for immediate resale in another to profit from a price discrepancy
E) To borrow in one currency where interest rates are low and use the proceeds to invest in another currency where interest rates are high

Question 67

Which of the following 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 68

Which of the following is true of the purchasing power parity (PPP)theory?

A) 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).
B) The exchange rate will not change if relative prices change.
C) The price of a "basket of goods" should be roughly equivalent in each country in relatively efficient markets.
D) In competitive markets free of transportation costs and trade barriers, identical products sold in different countries must sell for the same price.
E) If the law of one price were true for all goods and services, the PPP exchange rate could not be found from any individual set of prices.

Question 69

The euro/dollar exchange rate is €1 = $1.20.If a trader buys a camera that retails for $300 in New York and sells it for €200 in Berlin (ignoring transaction costs,transportation costs,or trade barriers),this represents a potential profit (arbitrage)of _____.

A) $60
B) $80
C) $20
D) $100
E) $40

Question 70

A dealer wishes to sell Thai baht for Argentine peso.Which of the following currencies is most likely to act as a vehicle currency in this transaction?

A) Malaysian ringgit
B) Japanese yen
C) British pound
D) U.S. dollar
E) South African rand

Question 71

Assume that the yen/dollar exchange rate quoted in London at 3 p.m.is ¥120 = $1,and the New York yen/dollar exchange rate at the same time (10 a.m.New York time)is ¥123 = $1.Which of the following transactions would yield immediate profit?

A) Forward exchange
B) Carry trade
C) Currency swap
D) Arbitrage
E) Currency speculation

Question 72

Which of the following is illustrated by the Big Mac Index published by The Economist?

A) The law of one price
B) The purchasing power parity theory
C) The Fisher effect
D) Flow of FDI
E) The bandwagon effect

Question 73

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 ¥1,23,000,000 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 74

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

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

Question 75

Which of the following is a key feature of the foreign exchange market?

A) The foreign exchange market never sleeps.
B) The foreign exchange market is located in London.
C) The foreign exchange market is characterized by high transaction costs.
D) The foreign exchange market is shut for two hours every day.
E) The foreign exchange market is poorly interconnected giving rise to ample arbitrage opportunities.

Question 76

Which of the following is a vehicle currency due to its central role in foreign exchange deals?

A) South African rand
B) U.S. dollar
C) British pound
D) Japanese yen
E) Chinese renminbi

Question 77

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 in the same currency.

Question 78

If a basket of goods costs $100 in the United States and €120 in Europe,purchasing power parity theory predicts that the dollar/euro exchange rate should be _____.

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

Question 79

Which of the following foreign exchange trading centers has the highest percentage of activity?

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

Question 80

In terms of foreign exchange transactions,the _____ has replaced the German mark as the world's second most important vehicle currency.

A) euro
B) yen
C) pound
D) riyal
E) mark