Question 1

The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values is known as:

Accepted Answer

Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. It includes obligations for the purchase or sale of goods and services at previously agreed prices and the borrowing or lending of funds in foreign currencies.

Question 2

Which of the following would a follower of the inefficient market school of thought agree with?

Accepted Answer

The inefficient market school argues that companies can improve the foreign exchange market's estimate of future exchange rates (as contained in the forward rate) by investing in forecasting services.

Question 3

_____ is most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation or when a country's economic prospects are shaky in other respects.

Accepted Answer

Governments typically impose convertibility restrictions on their currency when they fear that free convertibility will lead to a run on their foreign exchange reserves. This occurs when residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency-a phenomenon generally referred to as capital flight.

Question 4

_____ is the impact of short-run currency exchange rates changes on the reported financial statements of a company.

Accepted Answer

Translation exposure is concerned with the present measurement of past events.

Question 5

The _____ states that a country's "nominal" interest rate is the sum of the required "real" rate of interest and the expected rate of inflation over the period for which the funds are to be lent.

Accepted Answer

The Fisher Effect states that a country's "nominal" interest rate (i) is the sum of the required "real" rate of interest (r) and the expected rate of inflation over the period for which the funds are to be lent (I).

Question 6

Which of the following occurs when traders start moving as a herd in the same direction at the same time?

Accepted Answer

The bandwagon effect occurs when traders start moving as a herd in the same direction at the same time.

Question 7

A currency is said to be freely convertible when:

Accepted Answer

A country's currency is said to be freely convertible when the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it.

Question 8

Which of the following occurs when the quantity of money in circulation in a country rises faster than the country's stock of goods and services?

Accepted Answer

Inflation occurs when the quantity of money in circulation rises faster than the stock of goods and services, that is, when the money supply increases faster than output increases.

Question 9

It follows from the Fisher Effect that if the real interest rate is the same worldwide; any difference in interest rates between countries reflects differing expectations about ______.

Accepted Answer

It follows from the Fisher Effect that if the real interest rate is the same worldwide; any difference in interest rates between countries reflects differing expectations about inflation rates.

Question 10

Assume that the law of one price holds.A shirt that retails for $120 in New York sells for £60 in London.The exchange rate between the British pound and the dollar is £1 = $1.50.Assuming away transportation costs and trade barriers,this creates a profit-making opportunity called _____.

Accepted Answer

Arbitrage involves the purchase and sale of a commodity at the same time to take advantage of pricing differentials in two markets.

Question 11

_____ uses price and volume data to determine past trends,which are expected to continue into the future.

Accepted Answer

Technical analysis is based on the premise that there are analyzable market trends and waves and that previous trends and waves can be used to predict future trends and waves.

Question 12

According to the law of one price,if the exchange rate between the British pound and the dollar is £1 = $1.50,a shirt that retails for $120 in New York should sell for _____ in London.

Accepted Answer

The short will sell for £80 (120 ÷1.5). The law of one price states that in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.

Question 13

_____ refers to a range of barter-like agreements by which goods and services can be traded for other goods and services.

Accepted Answer

Countertrade refers to a range of barter-like agreements by which goods and services can be traded for other goods and services. Companies can deal with the nonconvertibility problem by engaging in countertrade.

Question 14

The _____ suggests that given relatively efficient markets,the price of a "basket of goods" should be roughly equivalent in each country.

Accepted Answer

If the law of one price were true for all goods and services, the PPP exchange rate could be found from any individual set of prices. 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 15

A(n)_____ involves attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate.

Accepted Answer

Leading involves accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries.

Question 16

Which of the following is referred to as the purchasing power parity puzzle?

Accepted Answer

The failure to find a strong link between relative inflation rates and exchange rate movements has been referred to as the purchasing power parity puzzle.

Question 17

The _____ school of thought argues that forward exchange rates do the best possible job of forecasting future spot rates and therefore investing in forecasting services would be a waste of money.

Accepted Answer

The efficient market school argues that forward exchange rates do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of money.

Question 18

Identify the incorrect statement about the PPP theory.

Accepted Answer

While PPP theory seems to yield relatively accurate predictions in the long run, it does not appear to be a strong predictor of short-run movements in exchange rates covering time spans of five years or less.

Question 19

Suppose the price of a Big Mac in New York is $3.00 and the price of a Big Mac in Paris is equivalent to $3.75 at the prevailing euro/dollar exchange rate.Using the concept of purchasing power parity,the euro is:

Accepted Answer

According to the PPP theory, the prices in the two countries should be the same. If they are not, it implies that the currency is either overvalued against the dollar or undervalued.

Question 20

The _____ states that for any two countries,the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two countries.

Accepted Answer

The International Fisher Effect states that for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two countries.

Quiz 10: The Foreign Exchange Market