Deck 14: Foreign Exchange Risk

Question 1

14-10 U.S.pension funds invest approximately one percent (1%)of their portfolios in foreign securities.

Answer 1

False

Question 2

14-1 An FI can eliminate its currency risk exposure by matching its foreign currency assets to its foreign currency liabilities.

Answer 2

False

Question 3

14-14 The underlying cause of foreign exchange volatility reflects fluctuations in the demand and supply of a country's currency.

Answer 3

True

Question 4

14-4 As the U.S.dollar appreciates against the Japanese yen,Japanese goods sold in the U.S.become less expensive to the U.S.consumer.

Question 5

14-11 U.S.life insurance companies generally hold less than ten percent (10%)of their portfolios in foreign securities.

Question 6

14-16 A positive net exposure position in FX implies the FI is net short in a currency.

Question 7

14-12 State regulation of the U.S.insurance industry has an effect on the ability of insurance companies to invest in foreign securities.

Question 8

14-18 Most profits or losses on foreign trading come from taking an open position in currencies.

Question 9

14-3 As the U.S.dollar appreciates against the Japanese yen,U.S.goods become less expensive to Japanese consumers.

Question 10

14-2 To a U.S.trader of foreign currencies,a direct quote indicates U.S.dollars received for each one unit of the foreign currency.

Question 11

14-5 The exposure to foreign exchange risk by U.S.FIs has decreased with the growth of the various derivative markets.

Question 12

14-8 Forward contracts in FX are typically written for periods exceeding 6 months.

Question 13

14-7 The market in which foreign currency is traded for future delivery is the forward foreign exchange market.

Question 14

14-15 A positive net exposure position in FX implies an FI has purchased more foreign currency than it has sold.

Question 15

14-9 The greater the volatility of foreign exchange rates given any net exposure position,the greater the fluctuations in value of the foreign exchange portfolio.

Question 16

14-13 Most nonbank FIs have foreign exchange risk exposure that is smaller than the exposure of the large U.S.money-center banks.

Question 17

14-19 The FX markets of the world have become one of the largest of all financial markets.

Question 18

14-17 As of March 2009,U.S.banks were net short British pounds.

Question 19

14-20 Average daily turnover in the FX market has recently been as high as $4 trillion.

Question 20

14-6 The spot foreign exchange market is where forward and futures contracts and swap agreements are transacted.

Question 21

14-23 The reason an FI receives a fee when purchasing foreign currencies to allow customers to complete international transactions is because the FI assumes some FX risk.

Question 22

14-28 On-balance-sheet hedging involves making changes in the on-balance-sheet assets and liabilities to protect FI profits from FX risk without the use of derivative securities.

Question 23

14-37 The FI is acting as a FX market agent for its customers when it

A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in a currency.
E)advises customers on their international business.

Question 24

14-35 Which of the following is NOT a source of foreign exchange risk?

A)Trading foreign currencies.
B)Making domestic-currency loans to foreign corporations.
C)Buying foreign-issued securities.
D)Issuing foreign currency-denominated debt.
E)Making foreign currency loans.

Question 25

14-22 FX trading income is derived only from profit (or loss)on the FI's speculative currency positions.

Question 26

14-24 Profits in foreign exchange trading have grown despite the decreased volatility in FX rates in European countries.

Question 27

14-27 Off-balance-sheet hedging involves taking a position in FX forward or other derivative securities even though no FX assets or liabilities are on the balance sheet.

Question 28

14-21 FX trading risk exposure continues into the night until all FI operations are closed.

Question 29

14-33 Long-term violations of the interest rate parity relationship may occur if imperfections in the international financial markets are allowed to exist.

Question 30

14-29 Directly matching foreign asset and liability books in the same FX currency will allow an FI to hedge or lock in a profit spread regardless of future changes in exchange rates.

Question 31

14-31 Interest rate parity implies that the discounted spread between interest rates in two currencies should equal the percentage spread between forward and spot exchange rates.

Question 32

14-40 The reasons nonbank FIs have less FX risk than major money center banks include

A)Smaller asset sizes.
B)Prudent person concerns.
C)Regulations.
D)All of the above.
E)Answers A and C only.

Question 33

14-30 The use of an exchange rate forward contract assures the FI of the opportunity to buy (or sell)the foreign currency at a future time at a known price.

Question 34

14-39 A negative net exposure position in FX implies that the FI is

A)net long in a currency and exposed to depreciation of the foreign currency.
B)net short in a currency and exposed to depreciation of the foreign currency.
C)net long in a currency and exposed to appreciation of the foreign currency.
D)net short in a currency and exposed to appreciation of the foreign currency.
E)neither long nor short in a currency.

Question 35

14-25 The total FX risk for a domestic bank that is making a one-year loan in a foreign currency is that the interest income expected on the loan is exposed to a depreciation of the foreign currency.

Question 36

14-34 The real interest rate reflects the underlying real sector demand and supply for funds in denominated in the domestic currency.

Question 37

14-26 An FI can control its FX risk exposure by on-balance-sheet and off-balance-sheet hedging.

Question 38

14-36 The market in which foreign currency is traded for immediate delivery is the

A)spot market.
B)forward market.
C)futures market.
D)currency swap market.
E)London capital market.

Question 39

14-38 A positive net exposure position in FX implies that the FI is

A)net long in a currency and exposed to depreciation of the foreign currency.
B)net short in a currency and exposed to depreciation of the foreign currency.
C)net long in a currency and exposed to appreciation of the foreign currency.
D)net short in a currency and exposed to appreciation of the foreign currency.
E)neither long nor short in a currency.

Question 40

14-32 Violation of the interest rate parity theorem would allow arbitrage profits.

Question 41

14-47 The decrease in European FX volatility during the last decade has occurred because of

A)the stabilizing force of the euro.
B)reduction in inflation rates in European countries.
C)the reduced volatility in many emerging-market countries.
D)the greater volatilities of Asian currencies.
E)Answers A and B only.

Question 42

14-50 Which of the following FX trading activities is used to hedge FX risk?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)None of the above.

Question 43

14-42 The FI is acting as a hedger when it

A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in a currency.
E)advises customers on their international business.

Question 44

14-59 What is the FI's net exposure in British pounds?

A)?45,400.
B)?150,600.
C)?196,000.
D)+105,200.
E)+196,000.

Question 45

14-56 The nominal interest rate is equal to the

A)real interest rate minus the inflation premium.
B)real interest rate minus the trailing inflation rate.
C)real interest rate plus the expected interest rate increase.
D)real interest rate plus the expected inflation rate.
E)real interest rate plus the interest rate volatility.

Question 46

14-55 Deviations from the international currency parity relationships may occur because of

A)free capital movements across national boundaries.
B)barriers to cross-border financial flows.
C)perfect rationality of market participants.
D)differences in each country's productive capacity.
E)Basel capital regulations.

Question 47

14-51 Which of the following FX trading activities is used for purposes of speculation?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)None of the above.

Question 48

14-53 As of 2009,which of the following FX "markets" is the largest?

A)London.
B)New York.
C)Tokyo.
D)Hong Kong.
E)Zurich.

Question 49

14-45 Which of the following factors help explain the decline in FX trading in the early years of this century?

A)Introduction of the euro.
B)Consolidation in the banking industry.
C)Growth of electronic brokering.
D)Mergers in the corporate sector.
E)All of the above.

Question 50

14-48 The decline in European FX volatility during the last decade has been offset in part by

A)the greater volatilities of Asian currencies.
B)a reduction in inflation rates in European countries.
C)the fixing of exchange rates among European countries.
D)the replacement of domestic currencies with the euro.
E)None of the above.

Question 51

14-46 The FI is acting as a speculator when it

A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in a currency.
E)advises customers on their international business.

Question 52

14-44 When purchasing and selling foreign currencies to allow customers to take positions in foreign real and financial investments,the FI

A)acts defensively as a hedger.
B)acts aggressively as a speculator.
C)assumes the FX risk itself.
D)acts as an agent.
E)acts as a market maker.

Question 53

14-52 In which of the following FX trading activities does the FI not assume FX risk?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)Answers B and D only.

Question 54

14-43 FX risk exposure of an FI essentially relates to this type of activity.

A)Purchase and sale of foreign currencies to allow customers to participate in and complete international commercial trade transactions.
B)Purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
C)Purchase and sale of foreign currencies for hedging purposes to offset customer exposure in any given currency.
D)Purchase and sale of foreign currencies for speculative purposes through forecasting or anticipating future movements in FX rates.
E)None of the above.

Question 55

14-57 Which of the following is an example of interest rate parity?

A)The Japanese yen trades at the same exchange rate as the Swiss franc.
B)U.S.dollar rates on one year U.S.Treasury securities equal 1 year Japanese government bond rates.
C)U.S.dollar rates on one year U.S.Treasury securities equal 1 year Japanese government bond rates,restated in dollars.
D)British pound 2 year forward rates equal 2 year Swiss franc forward rates.
E)All currency exchange rates and interest rates move in unison.

Question 56

14-54 Most profits or losses on foreign trading for FIs come from

A)open positions or speculation.
B)market making.
C)acting as agents for retail customers.
D)acting as agents for wholesale customers.
E)hedging activities.

Question 57

14-41 U.S.pension funds hold approximately _______ of their assets in foreign securities,while British pension funds have traditionally invested approximately _______ of their funds in foreign assets.

A)20 percent; 5 percent
B)5 percent; 20 percent
C)0 percent; 30 percent
D)30 percent; 10 percent
E)20 percent; 20 percent

Question 58

14-60 What is the FI's net exposure in the Japanese yen?

A)+30,000.
B)+40,600.
C)-19,400.
D)?40,600.
E)+20,600.

Question 59

14-58 According to PPP,foreign currency exchange rates between two countries adjust to reflect changes in each country's

A)unemployment rates.
B)export competitiveness.
C)inflation rates.
D)foreign exchange reserves.
E)reserve requirements.

Question 60

14-49 If foreign currency exchange rates are highly positively correlated,how can a FI reduce its exchange rate risk exposure?

A)By taking net long positions in all currencies.
B)By taking net short positions in all currencies.
C)By taking opposing net short and net long positions in different currencies.
D)By maximizing net FX exposure in each currency,independently.
E)By minimizing net FX exposure in each currency,independently.

Question 61

14-66 How would you characterize the FI's risk exposure to fluctuations in the Euro to dollar exchange rate?

A)The FI is net short in the Euro and therefore faces the risk that the Euro will rise in value against the U.S.dollar.
B)The FI is net short in the Euro and therefore faces the risk that the Euro will fall in value against the U.S.dollar.
C)The FI is net long in the Euro and therefore faces the risk that the Euro will fall in value against the U.S.dollar.
D)The FI is net long in the Euro and therefore faces the risk that the Euro will rise in value against the U.S.dollar.
E)The FI has a balanced position in the Euro.

Question 62

14-73 If the exchange rate had fallen from $1.60/£1 at the beginning of the year to $1.50/£1 at the end of the year when the FI needed to repatriate the principal and interest on the loan.What would be the dollar loan revenues at the end of the year?

A)$6.25 million.
B)$11.6 million.
C)$7.25 million.
D)$6.625 million.
E)$10.875 million.

Question 63

14-61 What is the FI's net exposure in the Swiss franc?

A)+2,400.
B)+400.
C)?2,800.
D)?2,400.
E)+3,200.

Question 64

14-65 What is the FI's total FX investment?

A)US$671,500.
B)US$1,236,700.
C)?US$671,500.
D)?US$1,236,700.
E)0

Question 65

14-79 If in one year there is no change to either interest rates or exchange rates,what is the end-of-year profit or loss for the bank? (Hint: Annual interest is paid on both the Canadian bonds and the CD on the date of liquidation in exactly one year.)

A)Profit of US$ 20,000.
B)Loss of C$ 224,000.
C)Profit of US$ 50,000.
D)Profit of C$ 63,700.
E)Profit of US$313,000.

Question 66

14-69 What is the portfolio weight of the Japanese yen in this FI's portfolio of foreign currency?

A)+0.18 percent.
B)?36.62 percent.
C)+75.20 percent.
D)?5.47 percent.
E)+66.70 percent .

Question 67

14-67 What is the portfolio weight of the Euro in this FI's portfolio of foreign currency?

A)+0.18 percent.
B)?36.62 percent.
C)+75.20 percent.
D)?5.47 percent.
E)+66.70 percent.

Question 68

14-62 How would you characterize the FI's risk exposure to fluctuations in the British pound to dollar exchange rate?

A)The FI is net short in the British pound and therefore faces the risk that the British pound will rise in value against the U.S.dollar.
B)The FI is net short in the British pound and therefore faces the risk that the British pound will fall in value against the U.S.dollar.
C)The FI is net long in the British pound and therefore faces the risk that the British pound will fall in value against the U.S.dollar.
D)The FI is net long in the British pound and therefore faces the risk that the British pound will rise in value against the U.S.dollar.
E)The FI has a balanced position in the British pound.

Question 69

14-80 What is the end-of-year profit or loss to the bank if in one year the exchange rate falls to US$0.765 per Canadian dollar? (Assume that there is no change in interest rates.)

A)Loss of US$75,000.
B)Profit of C$274,000.
C)Loss of US$7,000.
D)Profit of C$9,000.
E)Loss of US$5,000.

Question 70

14-70 If the exchange rate remains constant at $1.60 to £1 throughout the year,sterling revenue from U.K.loans will be

A)£6.25 million.
B)£7.875 million.
C)£7.25 million.
D)£6.625 million.
E)£11.26 million.

Question 71

14-71 If the spot foreign exchange rate remains constant at $1.60 to £1 throughout the year,the return from the U.K.investment will be

A)15%.
B)12%.
C)16%.
D)13%.
E)7%.

Question 72

14-78 If you wanted to hedge your bank's risk exposure,what hedge position would you take?

A)A short interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar.
B)A short interest rate hedge to protect against interest rate increases and a short currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S.dollar.
C)A long interest rate hedge to protect against interest rate increases and a long currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S.dollar.
D)A long interest rate hedge to protect against interest rate declines and a long currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar.
E)A long interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar.

Question 73

14-72 The weighted return on the bank's portfolio of investments would be

A)15%.
B)12%.
C)16%.
D)13%.
E)7%.

Question 74

14-68 How would you characterize the FI's risk exposure to fluctuations in the yen/dollar exchange rate?

A)The FI is net short in the yen and therefore faces the risk that the yen will rise in value against the U.S.dollar.
B)The FI is net short in the yen and therefore faces the risk that the yen will fall in value against the U.S.dollar.
C)The FI is net long in the yen and therefore faces the risk that the yen will fall in value against the U.S.dollar.
D)The FI is net long in the yen and therefore faces the risk that the yen will rise in value against the U.S.dollar.
E)The FI has a balanced position in the Japanese yen.

Question 75

14-76 If the exchange rate had fallen from $1.60/£1 at the beginning of the year to $1.50/£1 at the end of the year,the net interest margin for the FI on its balance sheet investments is

A)3.29%.
B)-3.29%.
C)4%.
D)8.75%.
E)0.38%.

Question 76

14-63 How would you characterize the FI's risk exposure to fluctuations in the yen/dollar exchange rate?

A)The FI is net short in the yen and therefore faces the risk that the yen will rise in value against the U.S.dollar.
B)The FI is net short in the yen and therefore faces the risk that the yen will fall in value against the U.S.dollar.
C)The FI is net long in the yen and therefore faces the risk that the yen will fall in value against the U.S.dollar.
D)The FI is net long in the yen and therefore faces the risk that the yen will rise in value against the U.S.dollar.
E)The FI has a balanced position in the Japanese yen.

Question 77

14-74 If the exchange rate had fallen from $1.60/£1 at the beginning of the year to $1.50/£1 at the end of the year when the FI needed to repatriate the principal and interest on the loan.What would the dollar loan revenues at the end of the year be as a return on the original dollar investment?

A)13%.
B)12.55%.
C)16%.
D)8.75%.
E)7.25%.

Question 78

14-64 How would you characterize the FI's risk exposure to fluctuations in the Swiss franc/dollar exchange rate?

A)The FI is net short in the franc and therefore faces the risk that the franc will rise in value against the U.S.dollar.
B)The FI is net short in the franc and therefore faces the risk that the franc will fall in value against the U.S.dollar.
C)The FI is net long in the franc and therefore faces the risk that the franc will fall in value against the U.S.dollar.
D)The FI is net long in the franc and therefore faces the risk that the franc will rise in value against the U.S.dollar.
E)The FI has a balanced position in the Swiss franc.

Question 79

14-75 If the exchange rate had fallen from $1.60/£1 at the beginning of the year to $1.50/£1 at the end of the year,the weighted return on the FI's asset portfolio would be

A)13.29%.
B)12.56%.
C)16%.
D)8.75%.
E)9.38%.

Question 80

14-77 Your position is exposed to

A)interest rate risk only.
B)credit risk only.
C)exchange rate risk only.
D)interest rate and exchange rate risk only.
E)interest rate risk,exchange rate risk,and credit risk.