Question 1

Hedging is the process of avoiding or covering a foreign exchange risk.

Accepted Answer

Hedging involves taking actions to reduce or eliminate the potential impact of currency fluctuations on investments, transactions or revenues. It is a common practice among companies engaged in international trade or investment to mitigate the risk of sudden changes in exchange rates that could negatively impact earnings or assets. Hedging can be achieved through a variety of financial instruments such as forward contracts, options, swaps, futures, or money market instruments.

Question 2

Futures contracts of the International Monetary Market have no set size,the contracts' dates of delivery are negotiable,and their costs are based on the bid-offer spread.

Accepted Answer

Futures contracts, including those traded on the International Monetary Market, have standardized contract sizes, predetermined delivery dates, and their prices are not solely based on the bid-offer spread but are determined by market supply and demand.

Question 3

Foreign exchange transactions are generally carried out by smaller banks located in smaller cities throughout the United States.

Accepted Answer

Foreign exchange transactions are not limited to smaller banks located in smaller cities. They can be carried out by larger banks as well as specialized foreign exchange companies.

Question 4

Trading in foreign currencies can be conducted in the futures market such as the International Monetary Market of the Chicago Mercantile Exchange

Accepted Answer

Trading in foreign currencies can indeed be conducted in the futures market, with examples including the International Monetary Market of the Chicago Mercantile Exchange as well as other exchanges like the Intercontinental Exchange (ICE) and the Eurex Exchange.

Question 5

When a foreign currency is worth more in the forward market than in the spot market,it is said to be at a discount in the forward market.

Accepted Answer

When a foreign currency is worth more in the forward market than in the spot market, it is said to be at a premium in the forward market, not at a discount.

Question 6

If the dollar cost of the U.K.pound is $1.50 and the dollar cost of the Swiss franc is $1,the cross exchange rate between pound and the franc is 0.67 francs per pound.

Accepted Answer

The cross exchange rate is calculated by dividing the dollar cost of the pound by the dollar cost of the franc, which is $1.50 / $1 = 1.50 francs per pound, not 0.67.

Question 7

Arbitrage tends to bring about an identical price for the same currency in different locations and thus results in one market.

Accepted Answer

Arbitrage involves buying and selling the same currency in different markets to take advantage of price differences. As a result, arbitrage tends to equalize prices and bring about a unified market for that currency.

Question 8

If British interest rates are lower than those of the United States,the pound shows a forward discount which means the forward rate is less than the spot rate.

Accepted Answer

The answer of If British interest rates are lower than...

Question 9

If the dollar's real exchange rate index increases,American products become more affordable to foreign buyers.

Accepted Answer

An increase in the dollar's real exchange rate index means the dollar has appreciated, making American products more expensive for foreign buyers.

Question 10

Concerning foreign currency trading,an option contract provides the holder the right to buy or sell a fixed amount of currency at a prearranged price within a few days or a couple of years.

Accepted Answer

An option contract is a type of derivative that gives the holder the right, but not the obligation, to buy or sell a fixed amount of currency at a prearranged price within a certain time period. This time period can be as short as a few days or as long as a couple of years.

Question 11

A foreign currency trader who works for a bank is assigned a position limit that stipulates the amount of buying and selling that can be conducted in a given currency.

Accepted Answer

This is correct. Position limits are put in place to manage the risk exposure of traders and ensure that they do not exceed the bank's risk tolerance levels. These limits specify the maximum amount of a particular currency that can be bought or sold by a trader within a given time period.

Question 12

The nominal exchange rate equals the real exchange rate adjusted for changes in the price level.

Accepted Answer

The real exchange rate is already adjusted for changes in the price level, so the statement is incorrect. The nominal exchange rate represents the actual exchange rate between two currencies without adjusting for changes in the price level.

Question 13

If the dollar/franc exchange rate is 1 franc = $1.20 in New York and 1 franc = 1.22 in Zurich,arbitragers would find it profitable to purchase francs in Zurich and immediately resell them in New York.

Accepted Answer

Arbitragers would find it profitable to purchase francs in New York at $1.20 and sell them in Zurich at $1.22, not the other way around.

Question 14

When a bank trades foreign currencies,its offer rate will be less than its bid rate.

Accepted Answer

In foreign currency trading by banks, the offer (or ask) rate is higher than the bid rate. The bid rate is the price at which the bank is willing to buy the currency, and the offer rate is the price at which the bank is willing to sell the currency.

Question 15

Suppose the selling price of one-month forward British pounds is $1.6036 per pound and the spot price of the pound is $1.6039.This means that there is an annual forward discount on the pound equal to 0.2 percent.

Accepted Answer

The forward price is lower than the spot price, indicating a forward discount, and the question specifies that this discount translates to an annualized rate of 0.2%.

Question 16

If interest rates in the U.K.are higher than those in the United States,the pound shows a forward discount which means the forward rate is less than the spot rate.

Accepted Answer

When interest rates are higher in the U.K. than in the United States, there is a greater demand for pounds in the forward market, which leads to a forward premium, not a forward discount.

Question 17

When conducting foreign exchange trading,commercial banks like Bank of America offer forward contracts.The size of these contracts can be tailored to the needs of an importer or importer and their date of delivery is negotiable.

Accepted Answer

This is true. Commercial banks like Bank of America do offer forward contracts in foreign exchange trading, and the size and delivery date can be customized to meet the needs of the importer or exporter.

Question 18

In 2013,Japanese automakers found that their vehicles were becoming more affordable to American consumers.Why? The exchange value of the yen was appreciating against the dollar.

Accepted Answer

The exchange value of the yen was actually declining against the dollar, which made Japanese vehicles more affordable to American consumers.

Question 19

Concerning the volume of foreign exchange market trading,forward transactions and foreign-exchange options are the two dominant instruments of foreign exchange.

Accepted Answer

While forward transactions and foreign exchange options are important instruments in the foreign exchange market, the most dominant instrument is spot trading, comprising approximately 1.5 trillion US dollars per day compared to the 400 billion US dollars of daily volume for options and 200 billion US dollars for forwards.

Question 20

Concerning the management of foreign exchange risk,some business firms do not hedge at all either because they cannot determine how much money will be coming in from abroad or because they have a deliberate strategy of allowing currencies to balance each other out around the world.

Accepted Answer

This statement is true. Some firms choose not to hedge their foreign exchange risk for the reasons given in the statement.

Quiz 11: Foreign Exchange