Question 1

If the inflation rate in the United States is greater than the inflation rate in Canada, other things held constant, the Canadian dollar will
A) Appreciate against the U.S. dollar.
B) Depreciate against the U.S. dollar.
C) Remain unchanged against the U.S. dollar.
D) Appreciate against other major currencies.
E) Appreciate against the U.S. dollar and other major currencies.

Accepted Answer

When the inflation rate in the United States is higher than in Canada, the value of the U.S. dollar tends to decrease relative to the Canadian dollar, leading to an appreciation of the Canadian dollar against the U.S. dollar. This is because higher inflation reduces the purchasing power of money, making goods and services in the country with higher inflation more expensive compared to those in the country with lower inflation.

Question 2

What is the common currency of the EMU?
A) U.S. dollar.
B) British pound.
C) Euro.
D) French franc.
E) German deutsche mark.

Accepted Answer

The common currency of the European Monetary Union (EMU) is the Euro.

Question 3

The need to use numerous national currencies in the conduct of global business operations is a fact of life for MNEs. For what purpose(s) do they use the foreign exchange markets?
A) Reducing the profit volatility that can arise from exchange rate fluctuations.
B) Providing credit to finance worldwide operations.
C) Conducting day-to-day operations.
D) All of the statements above are uses of the foreign exchange markets.
E) Only statements a and c are uses of the foreign exchange markets.

Accepted Answer

The foreign exchange markets are used by multinational enterprises (MNEs) for various purposes, including reducing profit volatility due to exchange rate fluctuations, providing credit for financing global operations, and conducting day-to-day operations. This makes all the statements correct, indicating that the foreign exchange markets serve multiple critical functions for MNEs in their global business activities.

Question 4

The balance of payments report is recorded using the rules of double-entry accounting and most closely resembles a(n) ______________.
A) Income statement.
B) Balance sheet.
C) Flow of funds statement.
D) Statement of retained earnings.
E) Bank statement.

Accepted Answer

The balance of payments report is a flow of funds statement as it records all economic transactions between residents of a country and the rest of the world over a period of time, similar to how a flow of funds statement tracks the movement of money.

Question 5

Which of the following balance of payment report groups would include purchases and sales of fixed assets?
A) Current account.
B) Capital account.
C) Financial account.
D) Net errors and omissions.
E) Reserves and related items.

Accepted Answer

The capital account in the balance of payments includes transactions involving the purchase and sale of fixed assets, such as real estate and other physical assets.

Question 6

Looking at patterns in price and volume data to predict exchange rate fluctuations is called a(n) ___________.
A) Technical analysis.
B) Asset market approach.
C) Current rate method.
D) Temporal method.
E) Purchasing power parity approach.

Accepted Answer

Technical analysis involves studying historical price and volume data to predict future market movements, including exchange rate fluctuations.

Question 7

A U.S. investor just received a foreign exchange rate quote for $0.7855/€. What kind of quote is this?
A) European term quotation.
B) American term quotation.
C) Forward rate quotation.
D) Indirect quotation.
E) Cross rate quotation.

Accepted Answer

The answer of A U.S. investor just received a foreign...

Question 8

Which of the following statements is most correct?
A) If one knows how many U.S. dollars it takes to buy one euro, and how many euros it takes to buy 100 Japanese yen, then it is easy to calculate the exchange rate between the dollar and the yen.
B) If the currency market is in equilibrium, and if you know how many dollars it takes to buy one euro, then it is easy to calculate the number of euros it takes to buy one dollar.
C) "European terms" means the number of units of any currency it takes to buy one U.S. dollar.
D) All of the statements above are correct.
E) Only statements a and b are correct.

Accepted Answer

All of the statements are correct.

Question 9

Which of the following statements about the balance of payments report is most correct?
A) The balance of payments report records all of a country's internal economic transactions.
B) Flows recorded in the current account are generally not reversible.
C) The net flow on the balance of payments report shows the effect of international transactions on the country's monetary reserves.
D) Both statements a and c are correct.
E) Both statements b and c are correct.

Accepted Answer

The current account records transactions that are generally not reversible, such as exports and imports of goods and services. The net flow on the balance of payments report reflects the impact of international transactions on a country's monetary reserves.

Question 10

Which of the following statements is most correct?
A) The section of the balance of payments (BOP) that records income flows into and out of a country is called the current account.
B) Transactions in the capital account are not usually reversible, but those in the financial account are reversible.
C) Current account transactions are usually made in anticipation of future profit.
D) All government transactions, including gifts, grants, loans, and changes in monetary reserves, are recorded in section E of the BOP.
E) Net errors and omissions are calculated using statistical sampling and the estimated amount is included in the BOP to make the overall balance more meaningful.

Accepted Answer

The current account indeed records income flows (such as earnings from exports and imports, services, primary income, and secondary income) into and out of a country, making it the correct statement among the options provided.

Question 11

Which of the following statements is most correct?
A) The term "parity conditions" refers to five economic theories that interact with each other to mutually define consistent values for interest rates in two countries and the exchange rates for their currencies.
B) If the real, risk-free interest rate is the same in the two countries, then nominal interest rates in the two countries and the exchange rate for the two currencies are driven by the rates of inflation in the two countries.
C) Because it is possible to measure expected inflation rates in the two countries quite accurately using an index such as the Consumer Price Index (CPI), the parity conditions usually hold quite closely and any deviations are usually small and short-lived.
D) All of the statements above are correct
E) Only statements a and b are correct.

Accepted Answer

Statements A and B are correct as they accurately describe the relationship between interest rates, exchange rates, and inflation in the context of international finance and the concept of parity conditions. Statement C is not entirely accurate because, while CPI is a tool for measuring inflation, predicting future inflation rates with high accuracy is challenging, and deviations in parity conditions can be significant and persistent.

Question 12

If the markets in two countries are in equilibrium, the parity conditions ensure which of the following?
A) The forecasted inflation rate differential between the two countries is exactly equal to the interest rate differential between those same countries.
B) The currency of the country with the higher inflation rate will sell at a discount to the other currency.
C) The forward discount will exactly cancel out the forecasted inflation differential.
D) If the information about future inflation is unbiased and the markets are in equilibrium, then the forward rate will be an unbiased predictor of the expected future spot rate.
E) All of the above conditions are ensured by the parity conditions.

Accepted Answer

Parity conditions, such as interest rate parity, purchasing power parity, and the international Fisher effect, collectively ensure that the forecasted inflation rate differential matches the interest rate differential (A), the currency of the higher inflation country will depreciate (B), the forward discount or premium adjusts for inflation differentials (C), and under efficient markets, the forward rate predicts the future spot rate if information is unbiased (D).

Question 13

Which of the following statements is not correct?
A) A quotation in American terms can be a direct quotation.
B) A quotation in American terms can be an indirect quotation.
C) Most interbank quotations are given in American terms.
D) One does not have to designate a "home" currency to know if a quotation is in American terms or European terms.
E) If quotations for two currencies are given in European terms, it is easier to calculate the cross rate than if they are given in American terms.

Accepted Answer

The answer of Which of the following statements is not...

Question 14

Which of the following statement is not correct?
A) A technique for forecasting future exchange rates that relies solely on the relationship between the prices of gold (a real asset) in the two currencies is called the asset market approach.
B) Technical analysis looks for repeating patterns in exchange rate movements in order to forecast what will happen in the future.
C) The asset market approach to exchange rate forecasting assumes that, in the short-run, exchange rate movements are probably driven by real and nominal interest rates, expectations for future growth and profitability in the economy, and investment opportunities for investment in the country.
D) The balance of payments approach to exchange rate forecasting is more useful for currencies subject to a fixed rate regime, but can still offer useful signals when a managed float is used.
E) Purchasing power parity is thought to hold reasonably well over the long run and interest rate parity is most useful to short-run predictions.

Accepted Answer

The asset market approach to forecasting exchange rates does not rely solely on the relationship between the prices of gold in two currencies. Instead, it considers a variety of financial assets and looks at factors such as interest rates, inflation rates, and economic indicators to predict exchange rate movements.

Question 15

Which of the following statements is most correct?
A) Most interbank foreign exchange quotations are given in American terms.
B) Transactions in the capital account (section B) of the balance of payments are usually not reversible.
C) If the real, risk-free interest rate is the same in two countries, then nominal interest rates in the two countries and the exchange rate for the two currencies are driven by the rate of inflation in the two countries.
D) Covered interest arbitrage is a technique for earning a riskless profit without having to commit one's own money when purchasing power parity does not hold.
E) All of the statements above are correct.

Accepted Answer

Statement C is correct because it reflects the International Fisher Effect, which posits that differences in nominal interest rates between countries are determined by expected inflation rates, assuming that real interest rates are equal across countries. This principle helps explain movements in exchange rates based on inflation differentials.

Question 16

Which of the following statements regarding foreign exchange markets is most correct?
A) Foreign exchange markets are "free" of government interferences.
B) Foreign exchange brokers act as agents in currency transactions and often take direct positions in transactions.
C) Anonymity is important for the parties of a brokered currency transaction because knowledge of the parties might affect the quote offered.
D) Currency speculation is not a major concern for central and commercial bank managers, and hence little of the bank's risk management program deals with currency risk.
E) None of the above statements correctly characterize foreign exchange markets.

Accepted Answer

Foreign exchange brokers facilitate transactions between parties while maintaining anonymity to ensure that the identity of the parties does not influence the transaction terms. This is crucial in maintaining fairness and competitiveness in the market.

Question 17

If the bid rate is given as $1.270293/€ and the offer rate is $1.270294/€, then which of the following statements is correct?
A) A person who wishes to buy euros for dollars will receive a rate of $1.270293/€.
B) A person who wishes to sell dollars for euros will receive a rate of $1.270293/€.
C) A person who wishes to sell euros for dollars will receive a rate of $1.270294/€.
D) A person who wishes to buy dollars for euros will receive a rate of $1.270293/€.
E) All of the statements above are correct.

Accepted Answer

The answer of If the bid rate is given as...

Question 18

Assume that a country is running a net credit balance on the balance of payments (BOP) and that the country is trying to maintain a fixed exchange rate against the currencies of its major trading partner. Under these conditions, which of the following statements is incorrect?
A) The country is required to intervene in the market to buy up the excess foreign currency.
B) The country is required to intervene in the market to supply foreign currencies from reserves.
C) The country will have to make changes in its domestic economy, most likely to lower interest rates, to increase demand for imports.
D) The country will have to make changes in its domestic economy, most likely to raise interest rates, to decrease demand for imports.
E) Statements b and d are incorrect.

Accepted Answer

A net credit balance on the BOP indicates that the country is exporting more than it is importing, leading to an inflow of foreign currency. To maintain a fixed exchange rate, the country would buy up the excess foreign currency (A), not supply more from its reserves (B). Lowering interest rates (C) could increase import demand, balancing the BOP, while raising interest rates (D) would decrease import demand and increase the credit balance, contrary to the goal of balancing the BOP. Therefore, statements B and D are incorrect.

Question 19

Covered interest arbitrage
A) Is a technique for earning a riskless profit without having to commit one's own money when purchasing power parity does not hold.
B) Involves borrowing one currency at that country's interest rate, converting the loan proceeds into another country's currency at the spot rate, and investing the proceeds at that country's interest rate. A forward contract is used to lock in the future exchange rate when one wants to reconvert the proceeds into the original currency for use in repaying the loan.
C) Requires that one have sufficient funds available from other sources to "cover" the amount of the transactions just in case the market turns around and exchange rates go against the arbitrageur before the position can be reversed.
D) All of the statements above are correct.
E) Only statements a and b are correct.

Accepted Answer

Covered interest arbitrage involves borrowing in one currency, converting it, investing in another currency, and using a forward contract to hedge against exchange rate risk.

Question 20

Which of the following statements is most correct?
A) The Fisher equation demonstrates that the ratio of prices on identical products in two countries determines the exchange rate between two currencies.
B) Most theorists agree that the Fisher effect is valid and that liquidity premia, and not inflation, drive interest rate determination.
C) If the forward currency premium or discount is equal in sign and magnitude to the interest rate differential, the spot and forward rates are said to be "at interest rate parity."
D) According to the unbiased predictor condition, the forward rate is the best estimate of the future spot rate, which is equally likely to be higher or lower than the forward rate.
E) For the parity conditions to hold, it is imperative that the real risk-free rate (r*) be determined by the market and be allowed to fluctuate freely.

Accepted Answer

The unbiased predictor condition suggests that the forward rate is an unbiased estimate of the future spot rate, meaning it is equally likely to be higher or lower than the forward rate.

Quiz 3: Exchange Rate Analysis

If the inflation rate in the United States is greater than the inflation rate in Canada, other things held constant, the Canadian dollar will

What is the common currency of the EMU?

The need to use numerous national currencies in the conduct of global business operations is a fact of life for MNEs. For what purpose(s) do they use the foreign exchange markets?

The balance of payments report is recorded using the rules of double-entry accounting and most closely resembles a(n) ______________.

Which of the following balance of payment report groups would include purchases and sales of fixed assets?

Looking at patterns in price and volume data to predict exchange rate fluctuations is called a(n) ___________.

A U.S. investor just received a foreign exchange rate quote for $0.7855/€. What kind of quote is this?

Which of the following statements is most correct?

Which of the following statements about the balance of payments report is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

If the markets in two countries are in equilibrium, the parity conditions ensure which of the following?

Which of the following statements is not correct?

Which of the following statement is not correct?

Which of the following statements is most correct?

Which of the following statements regarding foreign exchange markets is most correct?

If the bid rate is given as $1.270293/€ and the offer rate is $1.270294/€, then which of the following statements is correct?

Assume that a country is running a net credit balance on the balance of payments (BOP) and that the country is trying to maintain a fixed exchange rate against the currencies of its major trading partner. Under these conditions, which of the following statements is incorrect?

Covered interest arbitrage

Which of the following statements is most correct?