Question 1

Suppose a Central Bank sells $30 billion in foreign reserves to the non-bank public in return for $30 billion in currency from the non-bank public to try to bolster up a country's FX rate, show the Balance Sheet accounts for the Central Bank's asset and liabilities how this would be carried out with a sterilized foreign exchange intervention, so there will be $0 change in the monetary base of the country.

Accepted Answer

$\mathbf {\text {Central Bank}}$
$\begin{array}{l}
\mathbf {\text { Assets: -} } \$ 30 \text { bil. Foreign Reserves} \quad \mathbf {\text {  Liabilities:} } \quad \text { - } \$ 30 \text { bil. Currency } \
\quad\quad\quad\quad+\$ 30 \text { bil. Securities } \quad\quad\quad\quad\quad\quad\quad\quad\quad+\$ 30 \text { bil. Currency } \
\quad\quad\quad\quad\text { Change in Monetary Base } \$ 0 \
\end{array}$
 This open market operation reduces the supply of international reserves in circulation, raising the value of foreign currency, and thus reducing the value of the currency for the domestic currency.
With the central bank selling foreign reserves to the non-bank public in return for currency, the currency in the country goes down by $30 billion. To offset this with a sterilized foreign intervention, the bank buys securities from the non-bank public putting $30 billion of currency back into circulation, resulting no change in the monetary base.

Question 2

What type of exchange rate regime is the U.S. under? Give an example of a country that has a fixed rate. What disadvantages does a fixed rate regime have?

Accepted Answer

The U.S. has a managed float system. An example of a fixed rate regime is the Bahamas, which has a fixed rate with the U.S. dollar. Advantages are U.S. tourists have an easy time visiting the Bahamas with a fixed rate with the U.S. dollar. Disadvantages are that the country depends on the U.S. dollar with their currency fluctuating in value with the U.S. dollar which is out of their control, and to keep the rate fixed the central bank has to buy or sell foreign reserves which can affect the currency in circulation for the country. If the central bank runs out of currency, it may have to engage in a devaluation, which results in a loss of confidence in the currency, which can contribute to an economic downturn.

Question 3

Under modern asset theory, what are five different factors that affect a country's exchange rate relative to another country?

Accepted Answer

Under modern asset theory, relative supply and demand factors determine the value of a currency relative to its trading partners.
Factors that affect a country's FX rate include:
(1) Relative inflation-higher inflation-more costly a country's goods-leading to a lower FX rate;
(2) Relative demand for a country's products & services-higher demand leads to more demand for a country's currency and a higher FX rate;
(3) Relative productivity-more efficient production, lower costs of goods and more demand for a country's currency and higher FX rate; and
(4) Tariffs and barriers keep out goods from other countries making lower demand for their currencies and a higher relative FX rate for a country.

Question 4

Based on the modern asset theory (which is similar to the loanable funds theory), using supply and demand factors, explain what would likely happen to the value of the U.S. dollar (holding other factors constant) under the following scenarios:
a. The European Central Bank engages in quantitative easing with a target of lower the country's real interest rate.
b. The U.S. increases trade barriers and tariffs for imported goods from other countries.
c. A trading partner of the U.S. offers desired products globally with technological breakthroughs offering these goods at an attractive price relative to the U.S.
d. The U.S. inflation rate goes up and is higher than its trading partner countries.

Accepted Answer

The answer of Based on the modern asset theory (which...

Question 5

In March, a U.S. Company is expecting to receive funds in Euros in June from its European customers of 500 million Euros, and wants to hedge against a fall in the value of the Euro relative to the U.S. dollar in December. At this time the spot exchange rate Euro is worth $1.109 USD. The CME Group currency future settle rate for a June Euro FX futures contacts is 1 Euro = $1.11875 USD, with each futures contract for 125,000 Euros per contract.
a. What position and how many contracts should the financial manager take to hedge against a fall in the Euro? Explain why. (Hint # contracts = Amount of Euros Hedging / 125,000 Euros per contract; always take a position that will give you a futures gain to offset your spot loss in the event of what you want to hedge.)
b. Suppose later in June, the spot rate for the Euro falls to $0.9981 USD and the futures settle rate has falls to $ 1.00688 USD. Calculate the spot opportunity loss or gain for the company and the futures gain or loss. What is the net hedging result?
c. What are the advantages and disadvantages of hedging with FX options on futures contracts instead?

Accepted Answer

The answer of In March, a U.S. Company is expecting...

Question 6

In October, a U.S. Company is expecting to pay funds in British Pounds in June to its British suppliers of 625 million British Pounds, and wants to hedge against a rise in the value of the British Pound relative to the U.S. dollar in December. At this time the spot exchange rate British Pound is worth $1.25 USD. The CME Group currency future settle rate for a December British Pound FX futures contacts is 1 British Pound = $1.2470 USD, with each futures contract for 62,500 British Pounds per contract.
a. What position and how many contracts should the financial manager take to hedge against a rise in the British Pound? Explain why. (Hint # contracts = Amount of British Pounds Hedged / 62,500 British Pounds per contract; always take a position that will give you a futures gain to offset your spot loss in the event of what you want to hedge.)
b. Suppose later in December the spot rate for the British Pound rises to $1.375 USD and the futures settle rate rises to $1.3717. Calculate the spot opportunity loss or gain for the company and the futures gain or loss. What is the net hedging result?

Accepted Answer

The answer of In October, a U.S. Company is expecting...

Question 7

Discuss the experience of the U.S. under a gold standard in the 1800's. What problems arose with this standard in terms of controlling the money supply when gold production rose or fell, and what problems were there for countries that are respectively net exporters and net importer countries?

Accepted Answer

The answer of Discuss the experience of the U.S. under...

Question 8

Discuss the Bretton Woods Agreement and the establishment of a fixed exchange rate in gold for the U.S. dollar. Explain what happened in the 1970s with the end of the fixed rate gold standard FX exchange rate system, the Bretton Woods system. What system was put in its place and what are popular reserve currencies?

Accepted Answer

The answer of Discuss the Bretton Woods Agreement and the...

Question 9

What are the IMF's special drawing rights (SDR) and what does the SDR consist of? How has the IMF helped to respond to balance of payment problems for poorer countries, and what reforms have been made?

Accepted Answer

The answer of What are the IMF's special drawing rights...

Question 10

Suppose a central bank purchases $30 billion in foreign reserves from the non-bank public in return for $30 billion in deposits for the non-bank public to try to reduce its country's FX rate. Show the Balance Sheet accounts for the central bank's asset and liabilities and how this would be carried out with a sterilized foreign exchange intervention, so there will be $0 change in the monetary base of the country.

Accepted Answer

The answer of Suppose a central bank purchases $30 billion...

Question 11

Give a brief overview of the Group of Five (G5) and the Group of Seven (G7) and the Group of 20.

Accepted Answer

The answer of Give a brief overview of the Group...

Question 12

An international bank in Paris has loans maturing in a year of 500 million Euros with a 10% annual interest rate financed by U.S. certificates of deposit maturing in a year of $400 million with a 5% rate.
What is the expected interest rate spread in Euros for the bank if $1 U.S. is worth 0.70 Euros, and what is the expected interest rate spread in Euros if the dollar rises to be worth 1 Euro?

Accepted Answer

Expected Interest Rate spread in Euros = Interest Revenues - Interest Expenses = 
(500 mil. Euros x .10) - (400 mil. U.S. dollars x .70 Euro x .05) 
= 50 million Euros - 14 million Euros = 36 million Euros 
Expected Interest Rate Spread if the U.S. dollar rises to be worth 1 Euro 
= (500 mil. Euros x .10) - (400 mil. U.S. dollars x 1 Euro x .05) =
 50 million Euros - 20 million Euros = 30 million Euros 
(I.e. a decline in the Net Interest Spread by 6 million Euros)

Question 13

If the value of $1 U.S. dollars is worth 1.34 Canadian dollars, what is the value of the Canadian dollar in U.S. dollars?

Accepted Answer

To find the value of the Canadian dollar in U.S. dollars, we need to take the reciprocal of the exchange rate. $1/1.34 = 0.7463$, so the value of the Canadian dollar in U.S. dollars is $0.7463. Therefore, the answer is B, $0.7463.

Question 14

Crazy Boris Export Company plans to receive 200,000 British pounds in six months from now. Suppose at this time, 1 U.S. dollar = 0.81 British pounds. In U.S. dollars, what amount does in U.S. dollars does Boris expect to receive?

Accepted Answer

To convert British pounds to U.S. dollars, divide the amount in pounds by the exchange rate: 200,000 pounds / 0.81 = $246,914.

Question 15

Under the Modern Asset Theory for FX rates, if a country has significant inflation in its nominal prices for goods and services relative to other countries, which of the following statements is true under exchange rate theory for the country's currency exchange rate relative to the currency of other countries?

Accepted Answer

According to the Modern Asset Theory, higher inflation in a country will lead to a decline in the demand for its currency as investors would prefer to hold currencies of countries with relatively lower inflation rates. This will result in a fall in the exchange rate of the country's currency relative to the currency of other countries. Therefore, option A is the correct answer. Option B is incorrect as it is opposite to the theory. Option C is also incorrect as inflation rates are considered relevant in exchange rate determination under the Modern Asset Theory. Option D is incorrect as only option A is correct.

Question 16

The theory of purchase power parity states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries. Purchase power parity focuses on how FX rates are determined in the long run.

Accepted Answer

Purchase power parity theory is based on the long-run determination of exchange rates. It suggests that FX rates between two countries will adjust to reflect changes in the countries' price levels. Therefore, A is the correct answer.

Question 17

Under the Modern Asset Theory for FX rates, based on supply and demand factors for a foreign currency, which of the following factors affect foreign exchange rates between two different countries?

Accepted Answer

The answer of Under the Modern Asset Theory for FX...

Question 18

Suppose hypothetically that the inflation rate in Britain was 6%, and the inflation rate in the U.S. was 4%, under the theory of purchase power parity, what should happen to the value of the British pound in U.S. dollars?

Accepted Answer

According to the theory of purchasing power parity, the exchange rates between two countries should adjust to match the inflation rates in each country. So in this case, the British pound should depreciate relative to the US dollar by the difference in their inflation rates, which is 2%. Therefore, the correct answer is option D, the pound should fall by 2%.

Question 19

Suppose hypothetically that the interest rate on Euro Deposits was 7% and the interest rate on U.S. Dollar Deposits was 5%, and the value of the dollar relative to the Euro is expected to appreciate by 4% in the future. Which of the following statements is correct?

Accepted Answer

4 percent appreciation in the U.S. dollar implies a 4% depreciation in the Euro, so the expected return on Euro Deposits will be 7% - 4% = 3%.

Question 20

A fall in the domestic money supply of a country should result in which of the following for the value (FX rate) of the domestic currency, holding other factors constant?

Accepted Answer

A decrease in the domestic money supply, all else being equal, typically leads to an appreciation of the domestic currency in the short run. This is because a reduced supply of money increases its value, making the currency stronger compared to foreign currencies.

Quiz 7: International Financial Markets, Fx Risks, and Hedging Fx Risks