Question 1

The currency pair that is most commonly traded is U.S. dollar against Japanese yen (USD/JPY).

Accepted Answer

The currency pair that is most commonly traded is actually the euro against the U.S. dollar (EUR/USD). The USD/JPY is still a popular currency pair, but not the most commonly traded.

Question 2

As the currency swap market developed, the arbitrage opportunities for reduced funding costs that were available in the early days of the swap market became more common.

Accepted Answer

As the currency swap market developed and became more efficient, arbitrage opportunities for reduced funding costs that were available in the early days of the swap market became less common, not more. This is because increased competition and better information dissemination reduced the inefficiencies that initially allowed for such arbitrage opportunities.

Question 3

The foreign exchange market can best be described as an interbank over-the-counter market.

Accepted Answer

The foreign exchange market is primarily an interbank market where banks and financial institutions trade currencies with each other over-the-counter, rather than through a centralized exchange platform.

Question 4

Exchange rate quotations may be either direct or indirect. The difference depends on identifying one currency as a local currency and the other as a foreign currency.

Accepted Answer

Direct exchange rates quote the exchange rate of the local currency in terms of the foreign currency, while indirect exchange rates quote the exchange rate of the foreign currency in terms of the local currency. The choice of which currency is considered local and which is considered foreign depends on the perspective of the currency trader or market being analyzed.

Question 5

Prior to the establishment of the currency swap market, capitalizing on such arbitrage opportunities did not require use of the currency forward market.

Accepted Answer

Prior to the establishment of the currency swap market, capitalizing on such arbitrage opportunities did require use of the currency forward market. Currency swaps allow for a more efficient and flexible way to hedge currency risk and take advantage of arbitrage opportunities, but the forward market was still used before the swap market existed.

Question 6

On March 9, 2009, a U.S. investor is given a direct quote of 0.010113 U.S. dollars for one Japanese yen. That is, the price of a yen is $0.010113. The reciprocal of the direct quote is 98.88263, which would be the indirect quote for the U.S. investor; that is, one U.S. dollar can be exchanged for 98.88263 yens, which is the yen price of a U.S. dollar.

Accepted Answer

The reciprocal of the direct quote gives the indirect quote, which in this case would be 98.88263 yens per U.S. dollar.

Question 7

Dealers in the foreign exchange market realize revenue from commissions charged on foreign exchange transactions.

Accepted Answer

Dealers in the foreign exchange market typically earn revenue through commissions charged on foreign exchange transactions. They usually charge a small percentage of the transaction value as a commission to the customers for converting currencies.

Question 8

Members of the EMU are said to be part of "Euroland" or the "euro zone" because the euro became the only legal currency.

Accepted Answer

Members of the EMU (European Monetary Union) adopted the euro as their legal currency, making them part of the "Euroland" or "euro zone".

Question 9

Both European and U.S. investment banks play insignificant roles in the primary issuance of corporate debt denominated in euros.

Accepted Answer

European and U.S. investment banks both play significant roles in the primary issuance of corporate debt denominated in euros, with many U.S. banks having strong presences in European markets and participating actively in euro-denominated transactions.

Question 10

How do we mathematically express interest rate parity? In your answer describe all relevant variables.

Accepted Answer

The answer of How do we mathematically express interest rate...

Question 11

The market for long-dated forward exchange rate contracts is thin, which decreases the cost of eliminating foreign-exchange risk.

Accepted Answer

A thin market for long-dated forward exchange rate contracts means that there are few buyers and sellers, which often leads to wider bid-ask spreads and higher costs for hedging foreign-exchange risk.

Question 12

What is a key factor affecting the expectation of changes in a country's exchange rate with another currency? Explain in terms of the purchasing power parity relationship?

Accepted Answer

The answer of What is a key factor affecting the...

Question 13

In a world with market imperfections, it may be possible for an issuer to reduce its borrowing cost by borrowing funds denominated in a foreign currency and hedging the associated exchange rate risk, also known as an arbitrage opportunity.

Accepted Answer

It is possible for an issuer to benefit from borrowing in a foreign currency if there are market imperfections that lead to a cost advantage. By hedging the associated exchange rate risk, the issuer can further lower its borrowing cost and potentially create an arbitrage opportunity. However, this strategy also carries risks and may not always be profitable.

Question 14

The development of the swap market reduced arbitrage opportunities.

Accepted Answer

The swap market allows for efficient hedging of risks and price discovery, which reduces the chances of profitable arbitrage opportunities.

Question 15

Exchange rate quotations may be either direct or indirect. Distinguish between a direct and an indirect quote.

Accepted Answer

The answer of Exchange rate quotations may be either direct...

Question 16

From the perspective of a U.S. investor, the cash flows of assets denominated in a foreign currency offer the investor to certainty as to the actual level of the cash flow measured in U.S. dollars.

Accepted Answer

The cash flows of assets denominated in a foreign currency are subject to currency exchange rate fluctuations, which can affect the level of cash flow measured in U.S. dollars. Therefore, there is no certainty as to the actual level of cash flow measured in U.S. dollars.

Question 17

To qualify as a participating country in the EMU requires that a country satisfy certain economic standards. Describe these standards. Have they been achieved?

Accepted Answer

The answer of To qualify as a participating country in...

Question 18

The birth of the euro was smooth and uneventful in terms of both market volatility and operations.

Accepted Answer

The answer of The birth of the euro was smooth...

Question 19

What is the spot (or cash) exchange rate market? Are exchange rates free to float?

Accepted Answer

The answer of What is the spot (or cash) exchange...

Question 20

Dealers in the foreign exchange market realize revenue from the bid-ask spread but not from trading profits.

Accepted Answer

Dealers in the foreign exchange market can realize revenue both from the bid-ask spread, which is the difference between the prices at which they buy and sell currencies, and from trading profits, which arise from changes in exchange rates.

Quiz 32: The Market for Foreign Exchange and Risk Control Instruments