Deck 9: The Foreign Exchange Market

Question 1

Although the foreign exchange market offers some insurance against foreign exchange risk,it cannot provide complete insurance.

Answer 1

True
Explanation: Although the foreign exchange market offers some insurance against foreign exchange risk,it cannot provide complete insurance.It is not unusual for international businesses to suffer losses because of unpredicted changes in exchange rates.

Question 2

Assume that the currency of Country A falls sharply in value against the currency of Country B. This exchange rate movement will boost Country B's exports to Country A.

Answer 2

False

Question 3

Assume that current dollar/yen spot exchange rate is $1 = $\times$ 110.If the 30-day forward exchange rate for converting dollars into yen is $1 = $\times$ 105,we say the dollar is selling at a discount on the 30-day forward market.

Answer 3

True

Question 4

A common kind of swap is spot against forward.

Question 5

If the euro gains against the dollar,we say that the euro is strengthening,from a dollar perspective.However,the reverse observation that the dollar is weakening against the euro need not be true from a euro perspective.

Question 6

The British pound used to be second in importance to the dollar as a vehicle currency,but its importance has diminished in recent years.This has resulted in London losing its leading position in the global foreign exchange market.

Question 7

Even though the foreign exchange market is critical to an economy as a whole,it does not have a direct impact on the sales,profits,and strategy of a multinational enterprise.

Question 8

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 €30.

Question 9

When a German tourist in Seoul goes to a bank to convert her euros into Korean wons,the exchange rate used is the spot exchange rate for that day.

Question 10

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

Question 11

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

Question 12

Carry trade has a speculative element attached to it.

Question 13

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

Question 14

By 2007,forward instruments accounted for 85 percent of all foreign exchange transactions,while spot exchanges accounted for 15 percent.

Question 15

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

Question 16

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

Question 17

Foreign exchange transactions that occur when a dealer wants to sell a nondollar currency and buy another rarely involve dollars.

Question 18

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

Question 19

Tourists are the major participants in the foreign exchange market.

Question 20

For most major currencies,forward exchange rates are usually quoted for 1 year,2 years,and 3 years into the future.

Question 21

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

Question 22

If the expected rate of inflation in Germany is greater than that in Australia,German nominal interest rates will be greater than Australian nominal interest rates.

Question 23

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 24

Identify a main function of the foreign exchange market.

A)Provide some insurance against foreign exchange risk.
B)Prevent one-way movement of a currency with respect to another.
C)Ensure that currencies are not volatile.
D)Eliminate foreign exchange risk for companies involved in international trade.

Question 25

The _____ is the rate at which one currency is converted into another.

A)LIBOR
B)reference rate
C)exchange rate
D)par value

Question 26

Technical analysis does not rely on a consideration of economic fundamentals.

Question 27

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

Question 28

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

Question 29

When the growth in a country's money supply is faster than the growth in its output,price inflation is fueled.

Question 30

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 31

Capital flight is most likely to occur when the value of the domestic currency depreciates because of deflation.

Question 32

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

Question 33

Which of the following will organizations have to resort to in order to conduct international trade in the absence of the foreign exchange market?

A)Barter system
B)Spot market
C)Silver standard
D)Stock market

Question 34

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

A)Systemic risk
B)Foreign exchange risk
C)Exchange control
D)Liquidity risk

Question 35

The efficient market school argues that companies should spend additional money trying to forecast short-run exchange rate movements.

Question 36

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 37

Borrowing or lending of funds in foreign currencies involves transaction exposure.

Question 38

Assume that the currency of Country A falls sharply in value against the currency of Country

A)Country B's products will become more competitive
B)Country A's exports to Country B will increase
C)Country B's products will become less expensive in Country A
D)There will be no difference in the volume or direction of trade

Question 39

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

Question 40

Economic exposure 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 41

How are spot exchange rates in the foreign exchange markets determined?

A)By using historical average prices
B)By the relative demand and supply for different currencies
C)By taking the average of a basket of currencies
D)By government decree

Question 42

A currency carry trade takes advantage of:

A)temporary undervaluation of one currency vis-à-vis another.
B)mispricing of stocks trading in two exchanges.
C)high volatility in currency exchange rates.
D)differences in interest rates between countries.

Question 43

Which of the following involves borrowing in one currency where interest rates are low,and then using the proceeds to invest in another currency where interest rates are high?

A)Reinvestment
B)Refinancing
C)Contrarian trade
D)Carry trade

Question 44

When a firm insures itself against foreign exchange risk,we say that it is engaging in:

A)speculating.
B)timing the market.
C)hedging.
D)market making.

Question 45

A French company has 20 million euros that it wants to invest for three months.Investing in a Thai money market account gives the company a higher return than domestic investments.Is this investment risk-free? Why or why not?

A)Yes,because money market investments are considered to be equivalent to bank deposits.
B)No,because foreign currency movements in the intervening period can affect the profitability.
C)Yes,because such investments also lock foreign exchange rates for the duration of the investments.
D)No,because money market instruments are considered to be the most speculative of all investments.

Question 46

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

A)The dollar will depreciate against the euro.
B)The dealers are undecided about the direction of movement.
C)The dollar will appreciate against the euro.
D)The dollar/euro exchange rate will be steady.

Question 47

_____ typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.

A)Venture capital
B)Hedging
C)Currency speculation
D)Exchange rate manipulation

Question 48

Robben Inc.converted 1 million dollars into euros when the exchange rate was $1 = €0.75.The company converts this back into dollars after three months when the exchange rate is $1 = €0.80.Which of the following is true of the outcome of this transaction?

A)Loss of $62,500
B)Loss of $66,667
C)Gain of $50,000
D)Gain of $62,500

Question 49

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

A)currency barter
B)currency exercise
C)currency option
D)currency swap

Question 50

When two parties agree to exchange currency and execute the deal immediately,the transaction is referred to as a(n):

A)futures transaction.
B)call option exercise.
C)arbitrage transaction.
D)spot exchange.

Question 51

Why do spot exchange rates and forward rates differ?

A)Because forward rates reflect the expectations of the foreign exchange market about future currency movements
B)Because of the imbalance between demand and supply for the currency in the spot exchange market
C)Because of the volatility inherent in foreign exchange markets
D)Because forward rates,by definition,should sell either at a premium or a discount

Question 52

Which is the most important foreign exchange trading center in terms of percentage of activity?

A)Zurich
B)London
C)New York
D)Singapore

Question 53

Identify one of the major reasons behind the decline in the dollar-yen carry trade during 2008-09.

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

Question 54

You exchanged $1,000 to $\times$ 105,000 for a trip to Japan.During your stay,you spent $\times$ 50,000.Also,during this period the dollar weakened against the yen to 100 to a dollar.On your return,you went to the bank to exchange the remaining yen.How many dollars did you spend on the trip?

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

Question 55

Which of the following is transacted when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange risk?

A)Swap
B)Delivery
C)Commercial paper
D)Straddle

Question 56

A U.S.company that imports laptop computers from Japan knows that in 30 days it must pay yen to a Japanese supplier when a shipment arrives.The company will pay the Japanese supplier $\times$ 150,000 for each computer,and the current dollar/yen spot exchange rate is $1 = $\times$ 110.The importer knows she 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.Which of the following will happen if the exchange rate after 30 days is $1 = $\times$ 90?

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

Question 57

A U.S.company that imports laptop computers from Japan knows that in 30 days it must pay yen to a Japanese supplier when a shipment arrives.The company will pay the Japanese supplier $\times$ 150,000 for each computer,and the current dollar/yen spot exchange rate is $1 = $\times$ 110.The importer knows she 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 = $\times$ 105.Which of the following will happen if the exchange rate after 30 days is $1 = $\times$ 90?

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

Question 58

Assume that the interest rate on borrowings in Country A is 2 percent and that on bank deposits in Country B is 7.5 percent.A carry trade in this scenario would be to:

A)borrow in Country B's currency, then convert the money into Country A's currency and deposit it in a bank in Country A.
B)borrow in Country A's currency, and invest in stocks with good growth potential in Country A.
C)borrow in Country A's currency, then convert the money into Country B's currency and deposit it in a bank in Country B.
D)invest in bank deposits of Country B and reinvest the earnings in Country A.

Question 59

A _____ 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)contrarian trade

Question 60

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.
B)liquidity is the key factor in determining interest rates.
C)borrowing costs increase when demand for funds increases.
D)foreign exchange rates are highly volatile.

Question 61

Assume that the yen/dollar exchange rate quoted in London at 3 p.m.is $\times$ 120 = $1,and that the New York yen/dollar exchange rate at the same time is $\times$ 123 = $1.Which profit making situation exists here?

A)Option
B)Straddle
C)Swap
D)Arbitrage

Question 62

Which of the following refers to the purchase of securities in one market for immediate resale in another to profit from a price discrepancy?

A)Exercise
B)Straddle
C)Arbitrage
D)Swap

Question 63

Assume that the yen/dollar exchange rate quoted in London at 3 p.m.is $\times$ 120 = $1,and that the New York yen/dollar exchange rate at the same time is $\times$ 123 = $1.What will be the net profit if a dealer takes one million dollars to purchase $\times$ 123 million in New York and engages in an arbitrage trade?

A)$34,000
B)$24,390
C)$25,000
D)$46,666

Question 64

Let P$ be the U.S.dollar price of a basket of particular goods and P $\times$ be the price of the same basket of goods in Japanese yen.The PPP theory predicts that the dollar/yen exchange rate,E_{$/ $\times$} ,should be equivalent to:

A)(1+P $\times$ )/P$.
B)(1 + P$)/P $\times$ .
C)P $\times$ /P$.
D)P$/P $\times$ .

Question 65

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,making the pound an important vehicle currency
B)The preeminence of Financial Times Stock Exchange (FTSE)index as an economic health indicator
C)London's geographical position making it the link between the East Asian and New York markets
D)London being the preferred headquarters location for major multinational corporations

Question 66

The theory of purchasing power parity (PPP)links changes in the exchange rate between two countries' currencies to:

A)changes in the countries' price levels.
B)changes in the countries' population.
C)changes in the countries' political structure.
D)changes in the countries' productivity levels.

Question 67

If a basket of goods costs $100 in the United States and €120 in Europe,PPP theory predicts that the dollar/euro exchange rate should be:

A)$1 = €1.20.
B)$1 = €1.
C)$1 = €0.87.
D)$1 = €0.83.

Question 68

Which is the world's most important vehicle currency?

A)Euro
B)U.S.dollar
C)British pound
D)Japanese yen

Question 69

Why has the newsmagazine The Economist selected McDonald's Big Mac as a proxy for a "basket of goods" in publishing its own version of the PPP theorem?

A)Because McDonald's holds the title rights for the index till 2015
B)Because Big Mac is produced according to the same recipe in about 120 countries
C)Because Big Mac is the most popular hamburger in the world
D)Because no other product is available in all countries of the world

Question 70

Assume that the exchange rate between the euro and the dollar is €1 = $1.20.A camera that retails for $300 in New York sells for €200 in Berlin.Ignoring any transaction costs or barriers,this represents an initial arbitrage profit potential of:

A)$60.
B)$80.
C)$20.
D)$100.

Question 71

Every year,the newsmagazine The Economist publishes its own version of the PPP theorem,which it refers to as the:

A)"Commodity Index."
B)"Big Mac Index."
C)"Unilever Index."
D)"Walmart Index."

Question 72

A dealer wishes to sell Thai baht for Brazilian real.Which "third" currency is most likely to appear in this transaction?

A)Euro
B)Japanese yen
C)British pound
D)U.S.dollar

Question 73

Assume that the exchange rate between the euro and the dollar 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

Question 74

Most economic theories of exchange rate movements agree that three factors have an important impact on future exchange rate movements in a country's currency.Which of the following is NOT one of these factors?

A)The country's price inflation
B)The country's interest rate
C)Market psychology
D)The country's population

Question 75

Which of the following states that in competitive markets free of transportation costs and barriers to trade,identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency?

A)Law of money supply
B)Law of one price
C)Theory of competitive advantage
D)Theory of purchasing power parity

Question 76

Which currency did the euro replace as the world's second most important vehicle currency?

A)Japanese yen
B)Swiss franc
C)German mark
D)Russian ruble

Question 77

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

A)They usually tend to be large.
B)They tend to disappear in minutes.
C)They tend to occur very frequently.
D)They are one of the riskiest trades.

Question 78

Which is the world's second most important vehicle currency?

A)Euro
B)Japanese yen
C)British pound
D)Saudi riyal

Question 79

A(n)_____ has no impediments to the free flow of goods and services,such as trade barriers,and prices reflect all available public information.

A)structured market
B)regional market
C)efficient market
D)mixed economy

Question 80

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

A)The market never sleeps.
B)The market is located in London.
C)The market is characterized by high transaction costs.
D)The market is shut for only two hours.