Question 1

A currency is said to be freely convertible when:

Accepted Answer

Freely convertible currency means that both residents and non-residents can convert the currency into a foreign currency without any restrictions or limitations. Option D is the only option that fits this definition. Options A and B describe restricted currency regimes, while option C describes a non-convertible currency.

Question 2

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

Accepted Answer

The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values is known as transaction exposure. Economic exposure refers to the impact of exchange rate changes on a firm's overall future cash flows, while financial exposure refers to the impact of exchange rate changes on a firm's financial structure (e.g. debt obligations). Translation exposure refers to the impact of exchange rate changes on a firm's financial statements when they are translated into a different currency.

Question 3

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

Accepted Answer

Technical analysis is a method of analyzing stocks and financial markets by examining historical price and volume data to identify future trends. This approach assumes that market trends, including price movements and trading volumes, can provide insights into the behavior of investors and traders. Technical analysts use tools such as charts and graphs to identify patterns and trends in market data, with the goal of predicting future market movements. Fundamental analysis, on the other hand, involves examining a company's financial statements and other economic indicators to determine its intrinsic value. Efficient market theory suggests that market prices already reflect all available information about a security, and therefore it is impossible to consistently achieve returns that exceed the market average. Value investing involves seeking out undervalued companies based on their financial metrics and other factors.

Question 4

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 of thought suggests that forward exchange rates accurately predict future spot rates, meaning that forecasting services would not provide any additional value.

Question 5

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

The Fisher Effect states that nominal interest rates will adjust to accommodate expected changes in inflation rates. Therefore, if the real interest rate is the same worldwide, any difference in interest rates between countries reflects differing expectations about inflation rates.

Question 6

Identify the incorrect statement about the PPP theory.

Accepted Answer

PPP theory is based on the idea that the same basket of goods should have the same price in different countries, taking into account exchange rates. However, in the short-run, exchange rates are influenced by many factors other than relative prices, such as speculation, government policies, and market sentiment. Therefore, PPP theory does not yield accurate predictions of short-run movements in exchange rates.

Question 7

_____ 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

Capital flight is the most likely to occur when the value of the domestic currency is depreciating rapidly due to hyperinflation or when a country's economic prospects are uncertain. Capital flight refers to the large-scale and sudden outflow of capital from a country, often in response to economic instability, political unrest, or other factors that make investors wary of keeping their money in that country.

Question 8

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

The lead strategy 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. This helps to mitigate the risk of exchange rate changes and ensure that the company is able to secure the most favorable exchange rates possible.

Question 9

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 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. The purchasing power parity theory relates to the theory that exchange rates should adjust to equalize the prices of identical goods between different countries. The efficient market theory relates to the idea that prices in financial markets reflect all available information at any point in time. The law of one price states that identical goods will have the same price in different markets when prices are expressed in the same currency.

Question 10

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

When the quantity of money in circulation in a country rises faster than the country's stock of goods and services, it creates an excess of money chasing a limited supply of goods and services, causing prices to increase, leading to inflation.

Question 11

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. This can result in market bubbles or crashes, as individuals buy or sell assets based on the actions of others, rather than fundamental factors. The Fisher effect relates to nominal and real interest rates, arbitrage is the practice of exploiting price differences in different markets, and decoupling of markets refers to the phenomenon where two or more previously correlated markets diverge in their movements.

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 shirt 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

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

Accepted Answer

The purchasing power parity puzzle refers to the failure to find a strong link between relative inflation rates and exchange rate movements. Option A refers to the quantity theory of money, option B explains the relationship between depreciation and inflation, and option C refers to the law of one price.

Question 14

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

The law of one price states that identical goods in different markets should sell for the same price, assuming no trade barriers or transportation costs. In this scenario, the shirt is selling for $120 in New York and £60 in London, which translates to $90 at the exchange rate of £1=$1.50. Since the prices are not equal, there is an opportunity for arbitrage, which means buying the shirt in London for £60 ($90) and selling it in New York for $120, making a profit of $30 per shirt.

Question 15

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

Purchasing power parity (PPP) states that the exchange rates between two currencies should equalize the prices of a basket of goods and services in both countries. In this case, the price of a Big Mac in Paris is $3.75, which is 25% higher than the price in New York ($3.00). According to PPP, the exchange rate should adjust so that the cost of a Big Mac in Paris is the same as in New York. Since the euro price is higher than the equivalent dollar price, this implies that the euro is overvalued by 25% relative to the dollar. Therefore, the answer is B, overvalued by 25% against the dollar.

Question 16

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

Accepted Answer

Translation exposure refers to the impact of short-run currency exchange rates changes on the reported financial statements of a company. This type of exposure arises when a company has operations in foreign countries and needs to translate the financial statements of those operations into the home currency for reporting purposes. This can result in gains and losses due to the fluctuation of exchange rates. Economic exposure refers to the impact of long-term currency exchange rate changes on a company's cash flows and profitability, while financial exposure refers to the impact of currency exchange rate changes on a company's financial position and ability to meet financial obligations. Transaction exposure refers to the risk of loss from changes in currency exchange rates in a specific transaction.

Question 17

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

Accepted Answer

The theory of purchasing power parity suggests that in efficient markets, the price of a basket of goods should be roughly equivalent in each country once exchange rates are taken into account. This theory is based on the premise that currencies will adjust to offset any differences in inflation rates between countries.

Question 18

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 the nominal interest rate is equal to the real interest rate plus the expected inflation rate.

Question 19

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

Accepted Answer

Countertrade is a type of trading where goods and services are exchanged for other goods and services, circumventing the exchange of currency. It includes barter, offset, buyback, and switch trading.

Question 20

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.

Quiz 10: The Foreign Exchange Market