Question 1

Which of the following has no impediments to the free flow of goods and services, such as trade barriers?

Accepted Answer

An efficient market has no impediments to the free flow of goods and services, such as trade barriers, and prices reflect all available public information. 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.

Question 2

What is meant by arbitrage?

Accepted Answer

Arbitrage is the purchase of securities in one market for immediate resale in another to profit from a price discrepancy. Because foreign exchange dealers are always watching their computer screens for arbitrage opportunities, the few that arise tend to be small, and they disappear in minutes.

Question 3

Which of the following transactions is used to move out of one currency and into another for a limited period without incurring foreign exchange risk?

Accepted Answer

A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. 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 4

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

Accepted Answer

The law of one price states that in competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency. Since one euro is equal to 1.2 dollars, the price of the camera should be €250 ($300/1.2).

Question 5

The law of one price states that:

Accepted Answer

An economic proposition known as the law of one price can help to understand how prices are related to exchange rate movements. The law of one price states that in competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.

Question 6

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. What does the purchasing power parity (PPP) theory predict to be the equivalent of the dollar/yen exchange rate, E_$/×?

Accepted Answer

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 PPP theory predicts that the dollar/yen exchange rate, E_$/×, should be equivalent to: E_$/× = P_$/P_×.

Question 7

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

Accepted Answer

When $1 buys more yen with a 30-day forward exchange than with a spot exchange, we say the dollar is selling at a premium on the 30-day forward market. This reflects the foreign exchange dealers' expectations that the dollar will appreciate against the yen over the next 30 days.

Question 8

Which of the following occurs when two parties agree to exchange currency and execute the deal at some specific date in the future?

Accepted Answer

To insure or hedge against a foreign exchange risk, a U.S. importer might want to engage in a forward exchange. A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future.

Question 9

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?

Accepted Answer

Changes in spot exchange rates can be problematic for an international business. Initially, the American importer had estimated a profit of $236 per computer ($1,600 - $1,364). However, at an exchange rate of $1 = ×90, the importer will have to pay $1,667 per computer (×150,000/90). The outcome will be a loss of $67 ($1,600 - $1,667).

Question 10

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 ×123,000,000 in New York and engages in arbitrage by selling it in London?

Accepted Answer

The purchase of securities in one market for immediate resale in another to profit from a price discrepancy is known as arbitrage. ×123 million could be sold for dollars in London to get $1,025,000 (×123 million ÷ 120). Net profit = $1,025,000 - $1,000,000 = $25,000.

Question 11

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

Accepted Answer

At the most basic level, exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another. However, it does not show under what conditions a currency is in demand or under what conditions it is not demanded.

Question 12

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

Accepted Answer

While differences in relative demand and supply explain the determination of exchange rates, they do so only in a superficial sense. This simple explanation does not reveal what factors underlie the demand for and supply of a currency. Nor does it tell us when the demand for dollars will exceed the supply (and vice versa) or when the supply of Japanese yen will exceed demand for them (and vice versa). Neither does it show under what conditions a currency is in demand or under what conditions it is not demanded.

Question 13

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?

Accepted Answer

Arbitrage is the purchase of securities in one market for immediate resale in another to profit from a price discrepancy. A dealer could buy yen in New York and resell it in London immediately.

Question 14

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?

Accepted Answer

When the dollar is selling at a premium on the 30-day forward market, it reflects the foreign exchange dealers' expectations that the dollar will appreciate against the euro over the next 30 days.

Question 15

If a basket of goods costs $100 in the United States and €120 in Europe, what would the purchasing power parity theory's prediction of the dollar/euro exchange rate be?

Accepted Answer

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. In this case, dollar/euro exchange rate should be $100/€120 or $0.833 per euro. In other words, $1 = €1.20.

Question 16

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

Accepted Answer

London's dominance in the foreign exchange market is due to both history and geography. As the capital of the world's first major industrial trading nation, London had become the world's largest center for international banking by the end of the nineteenth century, a position it has retained. Today, London's central position between Tokyo and Singapore to the east and New York to the west has made it the critical link between the East Asian and New York markets. Due to the particular differences in time zones, London opens soon after Tokyo closes for the night and is still open for the first few hours of trading in New York.

Question 17

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

Accepted Answer

The foreign exchange market has been growing at a rapid pace, reflecting a general growth in the volume of cross-border trade and investment. The most important trading centers are London (37 percent of activity), New York (18 percent of activity), and Zurich, Tokyo, and Singapore (all with around 5 to 6 percent of activity). Major secondary trading centers include Frankfurt, Paris, Hong Kong, and Sydney.

Question 18

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?

Accepted Answer

To insure or hedge against a foreign exchange risk, the U.S. importer might want to engage in a forward exchange. A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future. Initially, the importer had estimated a profit of $236 per computer ($1,600 - $1,364). With the forward contract in place, the importer will have to pay no more than $1,429 per computer (×150,000/105). The outcome will be a guaranteed profit of $171 ($1,600 - $1,429).

Question 19

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

Accepted Answer

When $1 buys more yen with a spot exchange than with a 30-day forward exchange, we say the dollar is selling at a discount on the 30-day forward market. It indicates that foreign exchange dealers expect the dollar to depreciate against the yen in the next 30 days.

Question 20

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

Accepted Answer

A feature of the foreign exchange market that is of particular note is that the market never sleeps. Tokyo, London, and New York are all shut for only 3 hours out of every 24. During these three hours, trading continues in a number of minor centers, particularly San Francisco and Sydney, Australia.

Quiz 10: The Foreign Exchange Market