Chap 009

Chapter 09 - The Foreign Exchange Market
Chapter 09 The Foreign Exchange Market
True / False Questions 1. (p. 308) The international reserve market is a market for converting the currency of one country into that of another country. FALSE
AACSB: Analytic BT: Knowledge Difficulty: Easy Learning Objective: 9-1 Topic: The Functions of the Foreign Exchange Market
2. (p. 308) An exchange rate is simply the rate at which one currency is converted into another. TRUE
3. (p. 308-309) One function of the foreign exchange market is to provide some insurance against foreign exchange risk. TRUE
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4. (p. 309) In international trade, the risk of not getting paid for a product that is exported from one country to another is referred to as foreign exchange risk. FALSE
5. (p. 309) Tourists are major participants in the foreign exchange market. FALSE
AACSB: Analytic BT: Knowledge Difficulty: Medium Learning Objective: 9-1 Topic: The Functions of the Foreign Exchange Market
6. (p. 310) Currency speculation typically involves the long-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates. FALSE
7. (p. 310) One use of foreign exchange markets is that they can be used to pay a foreign company for its products or services in its country's currency. TRUE
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8. (p. 310) International businesses use foreign exchange markets when they are in dire need of cash and hence invest for long terms in money markets. FALSE
9. (p. 310) Hedging occurs when an investor places a speculative bet that the value of a financial asset will decline, and profits from that decline. FALSE
10. (p. 311) Spot exchange rates change continually as determined by the relative demand and supply for difference currencies. TRUE
11. (p. 312) When a U.S. tourist in Edinburgh goes to a bank to convert her dollars in pounds, the exchange rate is the forward exchange rate. FALSE
AACSB: Analytic BT: Comprehension Difficulty: Medium Learning Objective: 9-3 Topic: The Functions of the Foreign Exchange Market
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12. (p. 312) For most major currencies, forward exchange rates are quoted for 30 days, 90 days, and 180 days in the future. TRUE
13. (p. 312) When a firm enters into a forward exchange contract, it is taking out insurance against the possibility that future exchange rate movements will make a transaction unprofitable by the time that transaction has been executed. TRUE
14. (p. 312) By 2007, forward instruments accounted for 80 percent of all foreign exchange transactions, while spot exchange accounted for 20 percent. FALSE
15. (p. 313) A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for one single date. FALSE
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16. (p. 313) A common kind of currency swap is spot against forward. TRUE
17. (p. 314) When companies wish to convert currencies, they typically enter the market directly rather than go through their own banks. FALSE
AACSB: Analytic BT: Knowledge Difficulty: Easy Learning Objective: 9-3 Topic: The Nature of the Foreign Exchange Market
18. (p. 314) The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communication systems. TRUE
19. (p. 314) The most important trading center in the world is New York. FALSE
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20. (p. 314-315) Tokyo, London, and New York are all shut down for only eight hours out of every 24 hours. FALSE
21. (p. 315) Arbitrage is the process of buying a currency high and selling it low. FALSE
22. (p. 315) One feature of the foreign exchange market is the important role played by the U.S. dollar. TRUE
23. (p. 315) Although a foreign exchange transaction can involve any two currencies, most transactions involve Japanese yen on one side. FALSE
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24. (p. 315) The German mark has replaced the euro as the world's second most important vehicle currency. FALSE
25. (p. 315) At the most basic level, exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another. TRUE
AACSB: Analytic BT: Knowledge Difficulty: Easy Learning Objective: 9-4 Topic: Economic Theories of Exchange Rate Determination
26. (p. 316) The three factors that have an important impact on future exchange rate movements in a country's currency are price inflation, interest rates, and market psychology. TRUE
27. (p. 316) 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. TRUE
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28. (p. 317) Every year, The Economist publishes its own version of the PPP theorem, which it refers to as the "Big Mac Index." TRUE
29. (p. 317) PPP theory argues that changes in relative prices will result in a change in exchange rates. TRUE
30. (p. 321) An increase in a country's money supply, which increases the amount of currency available, changes the relative demand and supply conditions in the foreign exchange market. TRUE
31. (p. 321) Foreign exchange market determines whether the rate of growth in a country's money supply is greater than the rate of growth in output. FALSE
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32. (p. 322) The PPP theory may not hold if many national markets are dominated by a handful of multinational enterprises that have sufficient market power to be able to exercise some influence over prices. TRUE
33. (p. 323) According to the International Fisher Effect, for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in the nominal interest rates between the two countries. TRUE
34. (p. 324) According to a number of studies, investor psychology and bandwagon effects play a minor role in determining short-run exchange rate movements. FALSE
35. (p. 326) An efficient market is one in which prices reflect all available public information. TRUE
AACSB: Analytic BT: Knowledge Difficulty: Easy Learning Objective: 9-5 Topic: Exchange Rate Forecasting
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36. (p. 327) Relative money supply growth rates, inflation rates, and interest rates are variables included in fundamental analysis. TRUE
37. (p. 328) Technical analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. FALSE
38. (p. 328) A currency is said to be externally convertible when only nonresidents may convert it into foreign currency without limitations. TRUE
AACSB: Analytic BT: Knowledge Difficulty: Medium Learning Objective: 9-5 Topic: Currency Convertibility
39. (p. 329) Capital flight is least likely to occur when the value of the domestic currency is depreciating rapidly. FALSE
AACSB: Analytic BT: Knowledge Difficulty: Easy Learning Objective: 9-5 Topic: Currency Convertibility
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40. (p. 330) Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. TRUE
AACSB: Analytic BT: Knowledge Difficulty: Easy Learning Objective: 9-6 Topic: Focus on Managerial Implications
Multiple Choice Questions 41. (p. 308) The _____ is a market for converting the currency of one country into that of another. A. foreign exchange market B. stock market C. financial barter market D. monetary replacement market
42. (p. 308) Without the _____ market, international trade and international investment on the scale that we see today would be impossible. A. foreign resale B. financial barter C. foreign exchange D. monetary replacement
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43. (p. 308) The _____ is the rate at which the market converts one currency into another. A. swap rate B. exchange rate C. fixed rate D. interest rate
44. (p. 308) Volkswagen uses the _____ market to convert the dollars it earns in the United States into euro. A. foreign exchange B. trade C. stock D. countertrade
45. (p. 309) The foreign exchange market serves two main functions. These are: A. collect duties on imported products and convert the currency of one country into the currency of another. B. insure companies against foreign exchange risk and set interest rates charged to foreign investors. C. collect duties on imported products and set interest rates charged to foreign investors. D. convert the currency of one country into the currency of another and provide some insurance against foreign exchange risk.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-1 Topic: The Functions of the Foreign Exchange Market
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46. (p. 309) Although the foreign exchange market offers some insurance against _____, it cannot provide complete insurance. A. capital flight B. currency swap C. speculation D. foreign exchange risk
47. (p. 309) Which of the following countries does NOT use the euro as its primary currency? A. France B. Germany C. Great Britain D. Italy
48. (p. 309) When a tourist exchanges one currency into another, he/she is participating in the: A. foreign barter market. B. foreign exchange market. C. foreign replacement market. D. foreign swap market.
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49. (p. 309) Which of the following correctly matches a country with its currency? A. South Korea - the pound B. France - the Deutschmark C. Japan - the yen D. Great Britain - the franc
50. (p. 309) You exchanged $1,000 to 104,000 yen for a trip to Japan. During your stay, you spent 10,000 yen. Also, during this period the dollar weakened against the yen to 99.5 to a dollar. On your return, you went to the bank to exchange 94,000 yen. How many dollars did you lose or gain due to the weakened dollars? A. Gain of $4.5 B. Gain of $45 C. Loss of $5 D. Gain of $41
AACSB: Reflective thinking BT: Application Difficulty: Hard Learning Objective: 9-1 Topic: The Nature of the Foreign Exchange Market
51. (p. 309) Which of the following is a major participant in the foreign exchange market? A. Central bank B. International businesses C. Governments D. Stockbrokers
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52. (p. 310) Which of the following is NOT one of the four main uses that international businesses have for the foreign exchange market? A. International businesses use foreign exchange markets to convert money they earn in foreign currencies to their home currencies. B. International businesses use foreign exchange markets in determining domestic wage rates. C. International businesses use foreign exchange markets when they have spare cash that they wish to invest for short terms in money markets. D. International businesses use foreign exchange markets for currency speculation.
53. (p. 310) _____ typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates. A. Capital venturing B. Currency speculation C. Hedging D. Investment contemplation
54. (p. 310) In its Malaysian companies, Dell pays its workers in Malaysian currency. This demonstrates that international businesses use foreign exchange markets: A. to pay for exports. B. when they wish to undergo currency speculation. C. when they have spare cash that they wish to invest for short terms in money markets. D. when they must pay a foreign company for its products and services in its country's currency.
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55. (p. 310) When two parties agree to exchange currency and execute the deal immediately, the transaction is referred to as a: A. currency speculation. B. temporal exchange. C. spot exchange. D. forward exchange.
56. (p. 311) _____ are reported on a real-time basis on many financial Web sites. A. Real time rates B. Spot exchange rates C. Sanctioned rates D. Statutory exchange rates
57. (p. 311) The value of a currency is determined by: A. the interaction between the demand and supply of that currency relative to the demand and supply of other currencies. B. a consortium of international currency traders. C. the World Trade Organization. D. negotiations between the central banks of the leading five industrial powers of the world.
AACSB: Analytic BT: Knowledge Difficulty: Medium Learning Objective: 9-2 Topic: The Nature of the Foreign Exchange Market
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58. (p. 311) An exchange rate can be quoted in two ways: as the amount of foreign currency one U.S. dollar will buy, and: A. as the PPP of a foreign currency. B. as the price of a basket of goods in foreign currency. C. as the value of a dollar for one unit of foreign currency. D. as the price of an adjacent country's currency.
59. (p. 311) If the U.S. dollar is in short supply, and the British pound is in plentiful supply, the _____ exchange rate is likely to change. A. fixed B. spot C. relative D. hedging
60. (p. 311) Which of the following would cause depreciation of U.S. dollars against the Japanese yen? A. Demand for U.S. dollars is low compared to yen. B. Inflation rate in the U.S. is lower than that of Japan. C. Prices in the U.S. are lower than prices in Japan. D. Unemployment rate is higher in the U.S. than Japan.
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61. (p. 312) A _____ exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future. A. reverse B. spot C. hedge D. forward
62. (p. 312) Rates for currency exchange quoted for 30, 90, or 180 days into the future are referred to as: A. forward exchange rates. B. countertrade rates. C. united trade rates. D. spot exchange rates.
63. (p. 312) We say the dollar is selling at a _____ when the dollar buys more francs on the spot market than the 30-day forward market. Conversely, when the dollar buys fewer francs on the spot market than the 30-day forward market, we say the dollar is selling at a: A. premium; discount. B. bandwagon; bonus. C. profit; loss. D. subsidy; parity.
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64. (p. 312) In 2007, _____ accounted for some 69 percent of all foreign exchange transactions, while _____ accounted for 31 percent. A. currency swaps; arbitrage exchange B. reverse exchange; speculation exchange C. forward exchange; spot exchange D. efficient market; countertrade
65. (p. 313) The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates is called a: A. spot exchange. B. currency swap. C. forward exchange. D. reverse exchange.
66. (p. 314) The foreign exchange market: A. is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. B. is located in New York City. C. is a business unit governed by the major industrial organizations of the five most powerful nations connected to each other through wireless networks. D. is located in London.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-3 Topic: The Nature of the Foreign Exchange Market
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67. (p. 314) Which of the following are the most important trading centers for the foreign exchange market? A. London, New York, and Tokyo B. San Paulo, Beijing, and Paris C. San Francisco, Frankfurt, and Singapore D. Mumbai, Hong Kong, and Sydney
68. (p. 314) The largest trading center in the foreign exchange market is: A. Hong Kong. B. London. C. San Paulo. D. Paris.
69. (p. 314) London is dominant in the foreign exchange market because: A. it is located closer to New York. B. of its historical connection to the U.S. C. of the particular differences in time zones. D. of the pound's central role in so many foreign exchange deals.
AACSB: Reflective thinking BT: Knowledge Difficulty: Medium Learning Objective: 9-3 Topic: The Nature of the Foreign Exchange Market
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70. (p. 314) Which of the following is a feature of the foreign exchange market? A. The market never sleeps. B. The market has not yet created a global link. C. There are multiple markets due to high speed linkages. D. The British pound plays the most important role in the foreign exchange market.
71. (p. 315) The process of buying a currency low and selling it high is called: A. forward exchange. B. skimming. C. profiteering. D. arbitrage.
72. (p. 315) Although a foreign exchange transaction can involve any two currencies, in 2007, some 86 percent of transactions involved: A. Japanese yen. B. British pounds. C. U.S. dollars. D. French francs.
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73. (p. 315) At the most basic level, exchange rates are determined by the demand and supply of one currency relative to the: A. permanent value of another. B. 30-day average of another. C. 90-day average of another. D. demand and supply of another.
74. (p. 315) If the demand for dollars outstrips the supply of them and if the supply of Japanese yen is greater than the demand for them, the dollar will: A. appreciate against the yen. B. sell in discount against the yen. C. inflate against the yen. D. will follow the law of one price.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-4 Topic: Economic Theories of Exchange Rate Determination
75. (p. 316) The three factors that have the most important impact on future exchange rate movement include the country's price inflation, its market philosophy, and: A. law of one price. B. unionization of businesses. C. interest rate. D. participation in the World Trade Organization.
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76. (p. 316) The _____ 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. A. law of one price B. principle of consistent pricing C. model of fair pricing D. principle of equitable pricing
77. (p. 316) The law of one price and the PPP theory help explain how _____ are related to exchange rate movements. A. interest rates B. migration rates C. costs D. prices
78. (p. 316) A(n) _____ has no impediments to the free flow of goods and services. A. classical market B. efficient market C. traditional market D. stock market
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79. (p. 316) If the law of one price were true for all goods and services, the _____ exchange rate could be found from any individual set of prices. A. stability power similarity (SPS) B. purchasing ability adeptness (PAA) C. buying prowess equality (BPE) D. purchasing power parity (PPP)
80. (p. 316) A(n) _____ is a market in which few impediments to international trade and investment exist. A. relatively efficient market B. stock market C. trade market D. commodity market
81. (p. 316) By comparing the prices of _____ products in different countries, it would be possible to determine the PPP exchange rate that would exist if markets were efficient. A. substitute B. complementary C. identical D. industrial
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82. (p. 317) The newsmagazine The Economist has selected the _____ as a proxy for a "basket of goods" because it is produced according to the same recipe in about 120 countries. A. Burger King Whopper B. Krispy Kreme Donut C. Taco Bell Tacos D. McDonald's Big Mac
83. (p. 317) In essence, PPP theory predicts that changes in relative prices will result in a change in: A. interest rates. B. banking fees. C. exchange rates. D. tax rates.
84. (p. 319) According to the text, when the growth in a country's money supply is faster than the growth in its output, _____ is fueled. A. economic growth B. unemployment C. inflation D. per capita savings
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85. (p. 319) If everyone in the country suddenly acquired $10,000 from the government, the result would be: A. high unemployment. B. price inflation. C. price discrimination. D. appreciation in dollars.
86. (p. 319) When does inflation occur? A. When the money supply is higher than the growth of goods and services. B. When the credit interest rates from banks are higher than the price of goods. C. When the prices of goods and services is very low. D. When the country's currency exchange rate is higher than other countries.
87. (p. 320) The PPP theory tells us that a country with a high inflation rate will see: A. a depreciation in its currency exchange rate. B. a depreciation in prices of goods and commodities. C. a reduction in credit interest rates from the government. D. an increase in the country's money supply.
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88. (p. 320) The _____ theory tells us that a country with a high inflation rate will see deprecation in its currency exchange rate. A. law of one price B. monetary system C. PPP D. efficient market
89. (p. 321) _____ determines whether the rate of growth in a country's money supply is greater than the rate of growth in output. A. The international monetary authority B. A market mechanism C. The private sector D. Government policy
90. (p. 321) If the U.S. money supply is growing more rapidly than U.S. output, the dollar will _____ on the foreign exchange market against the currencies of countries with slower monetary growth. A. be bought in bandwagon B. become nonconvertible C. sell in premium D. depreciate
AACSB: Analytic BT: Knowledge Difficulty: Medium Learning Objective: 9-4 Topic: Economic Theories of Exchange Rate Determination
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91. (p. 321) The inevitable result of excessive growth in money supply is called: A. interest rate. B. price inflation. C. economic growth. D. per capita savings.
92. (p. 321) PPP theory predicts that changes in _____ will result in a change in exchange rates. A. relative prices B. interest rates C. unemployment rates D. statutory prices
93. (p. 321) How does a government policy increase money supply? A. By increasing credit interest rates in banking. B. By telling the central bank to issue more money. C. By increasing the reserve requirements by banks. D. By increasing tax to fund public expenditure.
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94. (p. 321) According to the PPP theory, exchange rates are determined by _____, and changes in them will result in a change in exchange rates. A. interest rates B. relative prices C. government policy D. consumer demand
95. (p. 321) According to the text, the PPP theory seems to be a particularly good predictor of: A. exchange rate changes between the currencies of advanced industrialized nations. B. exchange rates movement for time spans of five years or less. C. exchange rate changes for countries with high rates of inflation. D. exchange rate movement in the short run.
96. (p. 321) The failure to find a strong link between relative inflation rates and exchange rate movements has been referred to as: A. the purchasing power parity puzzle. B. the Leontief paradox. C. the capital flight. D. the Fisher Effect conundrum.
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97. (p. 322) Why did the PPP theory fail to predict exchange rates more accurately? A. PPP takes into consideration transportation costs and trade barriers. B. It takes into consideration government intervention, which weakens the link between relative prices and exchange rates. C. Government intervenes in foreign exchange markets to influence the value of their currencies. D. National markets are dominated by a handful of multinational enterprises.
98. (p. 322) Setting different prices in different markets to reflect varying demand conditions is referred to as: A. market inefficiency. B. countertrade. C. currency spiking. D. price discrimination.
99. (p. 322) Arbitrage must be limited for _____ to work. A. countertrade B. inflation C. price discrimination D. capital flight
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100. (p. 322) Even though the Chinese version of Microsoft Office may be less expensive than the U.S. version, the use of _____ to equalize prices may be limited because few Americans would want a version that was based on Chinese characters. A. speculation B. arbitrage C. hedging D. bandwagon effects
101. (p. 322) How does limited arbitrage increase price discrimination? A. The enterprises cannot control distribution channels. B. Limiting resale allows enterprises to set different prices for otherwise identical products in different markets. C. Competition between large numbers of multinationals allows them to exercise a degree of pricing power. D. By allowing unauthorized resale of products purchased in another national market, enterprises can set different prices.
102. (p. 322) _____ tells us that interest rates reflect expectations about likely future inflation rates. A. Economic theory B. Fisher Effect C. International Fisher Effect D. PPP theory
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103. (p. 323) 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. A. PPP theory B. efficient market theory C. Sora Effect D. Fisher Effect
104. (p. 323) 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 the nominal interest rates between the two countries. A. international free trade theory B. Big Mac index C. International Fisher Effect D. law of one price
105. (p. 323) According to the Fisher Effect, if the real rate of interest in a country is 8 percent and the annual inflation is expected to be 11.49 percent, the nominal interest rate will be: A. 5.49 percent. B. 3.49 percent. C. 19.49 percent. D. 21 percent.
AACSB: Reflective thinking BT: Application Difficulty: Medium Learning Objective: 9-4 Topic: Economic Theories of Exchange Rate Determination
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106. (p. 323) When investors are free to transfer capital between countries, according to the Fisher Effect: A. inflation will rise in the country with lower rates. B. arbitrage will give rise to price discrimination. C. interest rates will be the same in every country. D. prices of goods and services will rise in the country with higher rates.
107. (p. 323) How does the Fisher Effect apply to countries? A. Exchange rates are determined by relative prices, and changes in relative prices will result in a change in exchange rates. B. Any difference in interest rates between countries reflects differing expectations about inflation rates. C. It predicts a strong link between relative inflation rates and exchange rate movements. D. It states that identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.
108. (p. 323) Empirical evidence suggests that neither the PPP theory nor the International Fisher Effect are particularly good at: A. predicting exchange rate changes for countries with high rates of inflation. B. regulating money supply to curtail inflation. C. predicting short-term movements in exchange rates. D. predicting transportation costs and trade barriers.
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109. (p. 323) If the interest rate in Japan is 12 percent and in the United States it is 9 percent, according to the International Fisher Effect, we would expect the value of the dollar to: A. appreciate by 3 percent against the yen. B. sell in discount by 6 percent against the yen. C. become nonconvertible against the yen. D. arbitrage would raise it by 21 percent against the yen.
AACSB: Reflective thinking BT: Application Difficulty: Hard Learning Objective: 9-4 Topic: Economic Theories of Exchange Rate Determination
110. (p. 323-324) Neither the PPP theory nor the International Fisher Effect are good at explaining short-term movement in exchange rates. One reason may be the impact of: A. investor psychology. B. capital flight. C. speculation. D. governments.
111. (p. 324) Investor psychology is influenced by all of the following EXCEPT: A. political factors. B. cultural factors. C. microeconomic effects. D. bandwagon effects.
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112. (p. 324) Which of the following is NOT a moderately good predictor of long-run changes in exchange rates? A. Relative money growth B. Relative inflation rates C. Bandwagon effects D. Nominal interest rate differentials
113. (p. 324) Which of the following is a predictor of long-term exchange rates? A. Psychological factors B. Investor expectations C. Bandwagon effects D. Inflation rates
114. (p. 326) The efficient market school argues that: A. forward exchange rates do the best possible job of forecasting future spot exchange rates. B. companies should invest their money on forecasting services. C. professional exchange rate forecasts provide better predictions of future spot rates. D. inaccuracies will be consistently above or below future spot rates.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-5 Topic: Exchange Rate Forecasting
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115. (p. 326) In an efficient market: A. prices reflect all available public information. B. inflation is lower than other countries. C. forward exchange rates accurately predict future spot rates. D. interest rates will be lower than the inflation rates.
116. (p. 326) Many economists believe the foreign exchange market is _____ at setting forward rates. A. poor B. efficient C. inaccurate D. inappropriate
117. (p. 326) The _____ market school argues that companies can improve the foreign exchange market's estimate of future exchange rates by investing in forecasting services. A. stock B. closed C. inefficient D. free
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118. (p. 327) A(n) _____ market is one in which prices do not reflect all available information. A. stock B. inefficient C. free D. closed
119. (p. 327) Which school of thought does not believe that foreign exchange rates are the best possible predictors of future spot exchange rates? A. Countertrade market B. Closed market C. Planned market D. Inefficient market
AACSB: Reflective thinking BT: Comprehension Difficulty: Easy Learning Objective: 9-5 Topic: Exchange Rate Forecasting
120. (p. 327) According to the _____ school, it may be worthwhile for international businesses to invest in forecasting services. A. inefficient market B. countertrade market C. free market D. perfect market
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121. (p. 327) _____ draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. A. Principal investigation B. Fundamental analysis C. Primary evaluation D. Technical analysis
122. (p. 327) Running a deficit on a balance-of-payments current account creates pressures that result in: A. capital flight. B. trade speculation. C. inflation of the country's currency. D. depreciation of the country's currency.
AACSB: Analytic BT: Knowledge Difficulty: Medium Learning Objective: 9-5 Topic: Exchange Rate Forecasting
123. (p. 328) _____ uses price and volume data to determine past trends, which are expected to continue into the future. A. Principal investigation B. Primary evaluation C. Fundamental analysis D. Technical analysis
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124. (p. 328) _____ is based on the premise that analyzable market trends and waves can be used to predict future trends and waves. A. Technical analysis B. Fundamental analysis C. Basic analysis D. Central analysis
125. (p. 328) A country's currency is said to be _____ when the country's government allows both residents and nonresidents to purchase unlimited amounts of foreign currency with it. A. countertradeable B. freely convertible C. externally convertible D. nonconvertible
126. (p. 328) A currency is said to be _____ when only nonresidents may convert it into a foreign currency without any limitations. A. externally convertible B. freely convertible C. countertradeable D. nonconvertible
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127. (p. 328) A currency is _____ when neither residents nor nonresidents are allowed to convert it into a foreign currency. A. freely convertible B. nonconvertible C. externally convertible D. technically convertible
128. (p. 328) Restricting domestic businesses' ability to take foreign currency out of the country is an example of: A. free convertibility. B. bartering. C. nonconvertibility. D. external convertibility.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-5 Topic: Currency Convertibility
129. (p. 329) A government restricts the convertibility of its currency to protect the country's: A. membership in the World Trade Organization. B. foreign exchange reserves. C. political stature. D. national sovereignty.
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130. (p. 329) When residents of a country convert domestic currency into foreign currency in swarms, what is occurring? A. Countertrade B. Reciprocal trade C. Capital flight D. Hedging
131. (p. 329) _____ is most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation. A. Countertrade B. Foreign investment C. Reciprocal trade D. Capital flight
132. (p. 329) _____ refers to a range of barter-like agreements by which goods and services can be traded for other goods and services. A. Capital flight B. Foreign investment C. Countertrade D. Hedging
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133. (p. 330) _____ is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. A. Translation exposure B. Economic exposure C. Fluctuation exposure D. Transaction exposure
134. (p. 330) Which of the following is included in transaction exposure? A. Present measurement of past events. B. Long-run effect of changes in exchange rates on future prices. C. Collect foreign currency receivables early. D. Purchasing goods and services at previously agreed prices.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-6 Topic: Focus on Managerial Implications
135. (p. 330) _____ is the extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange values A. Translation exposure B. Economic exposure C. Fluctuation exposure D. Transaction exposure
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136. (p. 331) Economic exposure is: A. the extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange values. B. the extent to which a firm's future international earning power is affected by changes in exchange rates. C. the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. D. the impact of currency exchange rate changes on the reported financial statements of a company.
137. (p. 331) Economic exposure is concerned with: A. obligations for the purchase or sale of goods and services at previously agreed prices. B. borrowing or lending of funds in foreign currencies. C. the long-run effect of changes in exchange rates on future prices, sales, and costs. D. collecting foreign currency early before it depreciates.
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138. (p. 331) Lead strategy is: A. delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if that currency is expected to depreciate. B. converting holdings of domestic currency into a foreign currency, usually taking place when domestic currency is depreciating rapidly or a country is facing dim economic prospects. C. allowing neither residents nor nonresidents to convert its currency into a foreign currency. D. 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.
139. (p. 331) _____ involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payable if the currency is expected to depreciate. A. Advance strategy B. Lag strategy C. Swap strategy D. Lead strategy
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140. (p. 332) What could firms do to manage foreign exchange risk? A. Firms should distinguish between, on one hand, transaction and translation exposure and, on the other, economic exposure. B. Firms should invest with professional forecasters because professional exchange rate forecasts might provide better predictions of future spot rates than forward exchange rates do. C. On the basis of the information it receives from exchange rate forecasts and its own regular reporting systems, the firm should produce monthly foreign exchange exposure reports. D. A decentralized control of exposure is needed to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies.
Essay Questions 141. (p. 308-310) What are the functions of the foreign exchange market?
The foreign exchange market is a market for converting the currency of one country into that of another. The two main functions of the foreign exchange market are currency conversion and insuring against foreign exchange risk. In terms of currency conversion, international businesses have four uses of the market: (1) converting payments a company receives in foreign currencies into the currency of its home country; (2) converting the currency of a company's home country into another currency when they must pay a foreign company for its products and services in their currency; (3) international businesses may use foreign exchange markets when they have spare cash that they wish to invest for short terms in money markets (of another country); and (4) currency speculation. The second function of the foreign exchange market is to provide insurance to protect against the possible adverse consequences of unpredictable changes in exchange rates. This can be accomplished through the use of a forward exchange.
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142. (p. 310-312) Explain the difference between spot exchange rates and forward exchange rates. Briefly explain how the forward exchange market works.
When two parties agree to exchange currency and execute the deal immediately, the transaction is referred to as a spot exchange. The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day. Thus, when a Japanese tourist in Orlando goes to a bank to convert yen into dollars, the exchange rate is the spot rate for that day. Spot exchange rates change daily, based on the relative supply and demand for different currencies. Exchange rates governing such future transactions are referred to as forward exchange rates. Forward exchange rates are rates for currencies quoted for 30, 90, or 180 days into the future (in some cases, it is possible to get forward exchange rates for several years into the future). Forward exchange rates are available because of the volatile and problematic nature of the spot exchange market. Let us assume the 30-day forward exchange rate for converting dollars into yen is $1 = 110. The importer enters into a 30-day forward exchange transaction with a foreign exchange dealer at this rate and is guaranteed that she will have to pay no more than $1,818 for each computer (1,818 = 200,000/110). This guarantees her a profit of $182 per computer ($2,000 - $1,818). She also insures herself against the possibility that an unanticipated change in the dollar/yen exchange rate will turn a profitable deal into an unprofitable one.
AACSB: Reflective thinking BT: Comprehension Difficulty: Medium Learning Objective: 9-2 Learning Objective: 9-3 Topic: The Functions of the Foreign Exchange Market
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143. (p. 314) Where is the foreign exchange market located? What is the nature of the market? Is the market growing or shrinking on a global basis?
The foreign exchange market is not located in any one place. It is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. When companies wish to convert currencies, they typically go through their own banks rather than entering the market directly. The foreign exchange market has been growing at a rapid pace, reflecting a general growth in the volume of cross-border trade and investment.
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144. (p. 315) Explain the concept of arbitrage and give an example. How likely is it that someone could profit greatly from arbitrage?
Arbitrage is the purchase of securities in one market for immediate resale in another to profit from the price discrepancy. For example, if the prices for a yen/dollar exchange were higher in New York than London, a dealer could purchase the yen in London and immediately sell it in New York for a profit. Because foreign exchange dealers are always watching their computer screens for arbitrage opportunities, the few that arise tend to be small, and they disappear in minutes.
145. (p. 316-317) How does purchasing power parity and the law of one price relate to prices and exchange rate movements? Describe the purchasing power parity theory and the law of one price.
Purchasing power parity (PPP) and the law of one price help us understand how prices relate to exchange rate movements. 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. Regarding purchasing power parity, 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 countries, it would be possible to determine the PPP exchange rate that would exist if markets were efficient. In essence, PPP theory predicts that changes in relative prices will result in a change in exchange rates.
AACSB: Reflective thinking BT: Application Difficulty: Medium Learning Objective: 9-4 Topic: Economic Theories of Exchange Rate Determination
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146. (p. 323) What is the International Fisher Effect?
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.
147. (p. 323-324) Explain how the psychology of investors and bandwagon effects can have an impact on the movement in exchange rates. Do you believe that bandwagon effects really happen? Explain your answer.
As noted by the text, empirical evidence suggests that neither the PPP theory nor the International Fisher Effect are particularly good at explaining short-term movements in exchange rates. One reason for this may be the impact of investor psychology on short-run exchange rate movements. Evidence accumulated over 10 years reveals that various psychological factors play an important role in determining the expectations of market traders as to likely future exchange rates. In turn, expectations have a tendency to become selffulfilling prophecies. As a bandwagon effect builds up, the expectations of investors become a self-fulfilling prophecy, and the market moves in the way the investors expected. According to a number of studies, investor psychology and bandwagon effects play a major role in determining short-run exchange rate movements.
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148. (p. 326-327) Describe the efficient and inefficient market schools of thought. What conflicting theories do these schools offer?
A company's need to predict future exchange rate variations raises the issue of whether it is worthwhile for the company to invest in exchange rate forecasting services. The efficient market is one in which prices reflect all available market information. The inefficient market is one in which prices do not reflect all available information. The efficient market school argues that forward exchange rates do the best possible job of forecasting future spot exchange rates. Therefore, investing in forecasting services is a waste of money. In contrast, the inefficient market school argues that companies can improve the foreign exchange market's estimate of future exchange rates by investing in forecasting services.
149. (p. 327-328) In the context of forecasting exchange rate movements, describe the difference between fundamental analysis and technical analysis. Which approach is preferred by economists? Why?
Fundamental analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. The variables contained in these models typically include relative money supply growth rates, inflation rates, and interest rates. In addition, they may include variables related to countries' balance-of-payments positions. In contrast, technical analysis uses price and volume data to determine past trends, which are expected to continue into the future. This approach does not rely on a consideration of economic fundamentals. 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. Since there is no theoretical rationale for the assumption of predictability that underlies technical analysis, most economists compare technical analysis to fortune-telling, and prefer fundamental analysis. However, despite this skepticism, technical analysis has gained favor in recent years.
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150. (p. 330) Explain the concept of transaction exposure.
Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. Such exposure 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.
AACSB: Reflective thinking BT: Comprehension Difficulty: Easy Learning Objective: 9-6 Topic: Focus on Managerial Implications
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Chapter 09 - The Foreign Exchange Market

Chapter 09 The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

146. (p. 323) What is the International Fisher Effect?

Chapter 09 - The Foreign Exchange Market

Chapter 09 - The Foreign Exchange Market

150. (p. 330) Explain the concept of transaction exposure.

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