Deck 12: The Foreign Exchange Market

Question 1

If you know that the price of Canadian dollars in China is 8 yuan, then you also know that in Canada one yuan costs:

A) CAN$.80
B) CAN$.125
C) CAN$1.25
D) CAN$.08

Answer 1

CAN$.125

Question 2

The foreign exchange rate:

A) must always be stated as the foreign currency price of the domestic money.
B) is always stated as the domestic currency price of foreign money.
C) can be stated as either the foreign currency price of the domestic money or as the domestic currency price of foreign money.
D) is always given in terms of U.S. dollars.

Answer 2

can be stated as either the foreign currency price of the domestic money or as the domestic currency price of foreign money.

Question 3

The foreign exchange markets are operated mostly by:

A) government agencies.
B) central banks.
C) specially chartered firms located at airports and principal tourist centers.
D) All of the above.
E) None of the above.

Answer 3

None of the above.

Question 4

If you know that the price of a Canadian dollar in France is €2, then you also know that in Canada a British pound costs CAN$2.00, then under perfect triangular arbitrage the pound cost of a euro must be:

A) €.20
B) €4.00
C) €$0.40
D) None of the above.

Question 5

If the Chilean escudo is valued at four Mexican pesos, what is the escudo price of a peso?

A) 4.00 escudos
B) 0.25 escudos
C) 0.04 escudos
D) 2.00 escudos

Question 6

The markets where different currencies are bought and sold are known collectively as the:

A) international market.
B) foreign exchange market.
C) money market.
D) All of the above.
E) b and c only.

Question 7

The earliest foreign exchange markets arose:

A) about 200 years ago.
B) in India 1,000 years ago.
C) in ancient times, over 2,000 years ago.
D) in Medieval Europe at trade fairs.

Question 8

The earliest foreign exchange markets were operated by:

A) Italian bankers over 500 years ago who issued various types of bills.
B) central banks who issued paper money.
C) Venetian merchants during the Renaissance who traded with China, India, and North Africa.
D) money changers in ancient times, over 2,000 years ago.

Question 9

Seignorage:

A) is the difference between the cost of producing money and the purchasing power of the money.
B) only occurs with fiat money, not coins made with precious metals.
C) does not occur with fiat money.
D) is no longer a source of revenue for governments, although it produced revenue for ancient rulers.

Question 10

Fiat money:

A) is currency that is tender by law but is not redeemable into gold or silver.
B) makes the job of the money changer easier.
C) means that future purchasing power of national moneys no longer matters for the exchange rate.
D) All of the above.

Question 11

Arbitrage:

A) is the simultaneous purchase and sale of goods or assets in two distinct markets with different prices.
B) permits the arbitrageur to profit from a difference in prices for a certain commodity or asset across different market segments.
C) tends to eliminate price differences across different market segments.
D) All of the above.

Question 12

Exchange rates:

A) are always stated in domestic terms.
B) can be stated in either domestic terms or foreign terms.
C) are always stated in foreign terms.
D) must be stated in third-country terms in order to avoid conflict.

Question 13

The presence of perfect triangular arbitrage means that:

A) a government need only manipulate supply and demand in the n?1 foreign exchange markets where its currency trades to keep its exchange rates fixed.
B) the exchange rate between any two currencies will be the same in markets around the world.
C) if any one exchange rate changes, other exchange rates will remain unchanged.
D) it is not difficult for policy makers to keep exchange rates fixed.

Question 14

In general, for n different currencies, there are:

A) n different exchange rates.
B) [n(n - 1)]/2 different foreign exchange rates.
C) n + 1 different exchange rates.
D) just two different exchange rates, e and its reciprocal 1/e.

Question 15

If there are 20 countries in the world, each with its own currency, then there are:

A) 400 different foreign exchange markets.
B) 19 different foreign exchange markets.
C) 380 different foreign exchange markets.
D) 190 different foreign exchange markets.

Question 16

Among the forms of arbitrage that are characteristic of unrestricted foreign exchange markets are:

A) reverse arbitrage.
B) market arbitrage.
C) geographic arbitrage.
D) All of the above.
E) None of the above.

Question 17

If the U.S. dollar is valued at 12.5 Mexican pesos, what is the U.S. dollar price of a peso?

A) $12.00
B) $.08
C) $.125
D) $1.25

Question 18

An effective exchange rate is:

A) an exchange rate at which currencies are actually exchanged in the foreign exchange market.
B) a weighted average of a whole set of foreign exchange rates.
C) an exchange rate that is adjusted purchasing power in the two countries whose currencies are compared by the exchange rate.
D) an exchange rate that remains unchanged for at least five years.

Question 19

Foreign exchange market intervention is carried out:

A) by foreign exchange dealers who seek to profit from expected exchange rate changes.
B) by a nation's authorities when they suspect fraudulent behavior or insider trading.
C) by a country's central bank to influence the exchange rate.
D) by the International Monetary Fund to provide liquidity to the foreign exchange market.

Question 20

Suppose that the exchange rate, defined in domestic terms, begins to rise. The domestic central bank can prevent the rise in the exchange rate by:

A) buying its own currency in the foreign exchange market.
B) buying foreign currency in the foreign exchange market.
C) selling its own currency in the foreign exchange market.
D) decreasing domestic interest rates.

Question 21

If the dollar is valued at four Swiss francs, what is the dollar price of Swiss francs?

A) $4.00
B) $0.25
C) $0.04
D) $2.00

Question 22

If the U.S. dollar is valued at five Chilean pesos, what is the U.S. dollar price of a peso?

A) $5.00
B) $0.20
C) $0.05
D) $0.50

Question 23

Some possible consequences of the expansion of direct on-line computer trading of foreign exchange include:

A) substantial job losses in the foreign exchange departments of commercial banks and dealers.
B) spreads between buy and sell quotes will widen.
C) transaction costs for exporters, importers, and international investors will increase.
D) All of the above.
E) None of the above.

Question 24

Triangular arbitrage suggests that:

A) a government need only manipulate supply and demand in the n?1 foreign exchange markets where its currency trades to keep all of its currency's exchange rates fixed.
B) the exchange rate between any two currencies will be the same in markets around the world.
C) if any one exchange rate changes, other exchange rates will remain unchanged.
D) it is not difficult for policy makers to keep exchange rates fixed.

Question 25

The foreign exchange market consists of:

A) exclusively spot transactions.
B) both a forward and spot markets.
C) only a forward market, with spot transactions handled directly by money changers.
D) a network of central banks that buy and sell currencies to the public in the spot market.

Question 26

The forward foreign exchange markets:

A) are operated by the same dealers who operate the spot markets.
B) are operated by small banks located in off-shore banking centers such as Panama, Grand Cayman, and the Bahamas.
C) are necessary for carrying out triangular arbitrage.
D) are useless for hedging against foreign exchange risk.

Question 27

Denoting the forward exchange rate as f_t^t+1, the spot exchange rate as e_t, r as the domestic rate of return on assets, and r* as the foreign rate of return on assets, then the covered interest parity condition is:

A) e_t = [(1 + r*)/(1 + r)](f_t^t+1)
B) e_t = [(1 + r)/(1 + r*)](f_t^t+1)
C) e_t = [(1 + r)/(1 + r*)] + (f_t^t+1)
D) (f_t^t+1) = [(1 + r*)/(1 + r)]e_t

Question 28

Denoting the forward exchange rate as f_t^t+1, the expected future exchange rate as Ee_t+1 the spot exchange rate as e_t, r as the domestic rate of return on assets, and r* as the foreign rate of return on assets, the equations (1) e_t = [(1 + r*/(1 + r)](Ee_t+1) and (2) e_t = [(1 + r*)/(1 + r)](f_t^t+1):

A) represent the (1) covered and (2) uncovered interest parity conditions, respectively.
B) are equivalent in all respects.
C) represent the (1) uncovered and (2) covered interest parity conditions, respectively.
D) represent the (1) spot and (2) forward exchange markets, respectively.

Question 29

The interest parity condition tells us that if corporations, entities, and people are free to store their wealth where they want:

A) the spot exchange rate depends on expectations about the future exchange rate.
B) the relative rates of return on assets at home and abroad do not affect the spot exchange rate.
C) current economic conditions fully explain the spot exchange rate.
D) the spot exchange rate depends only on current rates of return of domestic assets.

Question 30

You are an established speculator with an excellent reputation, but you do not have any liquid funds at the moment. You are sure that the dollar is going to appreciate in the near future, even though the forward exchange rate implies dollar depreciation. How can you set yourself up to profit from the appreciation of the dollar that you expect but the forward market does not expect to occur?

A) Borrow dollars and sell them on the spot market.
B) Buy foreign currency forward.
C) Sell foreign currency forward.
D) Do nothing; anything you do will result in a loss because you have to borrow.

Question 31

An effective exchange rate is:

A) an exchange rate that the government mandates for a specific set of international transactions.
B) a weighted average of a set of different foreign exchange rates.
C) an exchange rate that is adjusted for inflation in the two countries whose currencies are compared by the exchange rate.
D) an exchange rate that more "effectively" reduces exchange rate volatility.

Question 32

Rational expectations implies that people set their expectations:

A) using the best available economic models.
B) using all available information.
C) using their available information in an unbiased fashion.
D) All of the above.
E) None of the above.

Question 33

When expectations are rationally set and the interest parity condition holds (international investment is not restricted), future changes in the spot exchange rate:

A) are unpredictable.
B) follow a predictable path.
C) are predictable only if people use their full information set.
D) are predictable if government policy makers do not interfere with the foreign exchange market.

Question 34

Foreign exchange markets have existed:

A) for several thousand years.
B) since the nineteenth century.
C) since the financial liberalization in the 1990s.
D) since fiat money replaced gold as the medium of exchange.

Question 35

The term finance refers to:

A) purchases and sales of bonds and stocks, but not bank loans or savings accounts.
B) all inter-temporal exchanges.
C) exotic forms of instruments such as derivatives and off-shore accounts.
D) All of the above.
E) None of the above.