Deck 13: Foreign Exchange Risk

Question 1

Forward contracts in FX are typically written for periods exceeding 6 months.

Answer 1

False

Question 2

To a Canadian trader of foreign currencies, a direct quote indicates Canadian dollars received for each one unit of the foreign currency.

Answer 2

True

Question 3

FX trading income is derived only from profit (or loss) on the FI's speculative currency positions.

Answer 3

False

Question 4

A positive net exposure position in FX implies the FI is net short in a currency.

Question 5

A positive net exposure position in FX implies an FI has purchased more foreign currency than it has sold.

Question 6

As the Canadian dollar appreciates against the Japanese yen, Japanese goods sold in Canada become less expensive to the Canadian consumer.

Question 7

The spot foreign exchange market is where forward and futures contracts and swap agreements are transacted.

Question 8

The underlying cause of foreign exchange volatility reflects fluctuations in the demand and supply of a country's currency.

Question 9

Average daily turnover in the FX market has recently been over $4 trillion.

Question 10

The FX markets of the world have become one of the largest of all financial markets.

Question 11

Most profits or losses on foreign trading come from taking an open position in currencies.

Question 12

Most nonbank FIs have foreign exchange risk exposure that is smaller than the exposure of the large Canadian banks.

Question 13

The foreign exchange market in Tokyo is the largest FX trading market.

Question 14

An FI can eliminate its currency risk exposure by matching its foreign currency assets to its foreign currency liabilities.

Question 15

As the Canadian dollar appreciates against the Japanese yen, Canadian goods become less expensive to Japanese consumers.

Question 16

FX trading risk exposure continues into the night until all FI operations are closed.

Question 17

The greater the volatility of foreign exchange rates given any net exposure position, the greater the fluctuations in value of the foreign exchange portfolio.

Question 18

The exposure to foreign exchange risk by Canadian FIs has decreased with the growth of the various derivative markets.

Question 19

The market in which foreign currency is traded for future delivery is the forward foreign exchange market.

Question 20

Canadian pension funds invest approximately one percent (1%) of their portfolios in foreign securities.

Question 21

The reason an FI receives a fee when purchasing foreign currencies to allow customers to complete international transactions is because the FI assumes some FX risk.

Question 22

Directly matching foreign asset and liability books in the same FX currency will allow an FI to hedge or lock in a profit spread regardless of future changes in exchange rates.

Question 23

A positive net exposure position in FX implies that the FI is

A)net long in a currency and exposed to depreciation of the foreign currency.
B)net short in a currency and exposed to depreciation of the foreign currency.
C)net long in a currency and exposed to appreciation of the foreign currency.
D)net short in a currency and exposed to appreciation of the foreign currency.
E)neither long nor short in a currency.

Question 24

Off-balance-sheet hedging involves taking a position in FX forward or other derivative securities even though no FX assets or liabilities are on the balance sheet.

Question 25

An FI can control its FX risk exposure by on-balance-sheet and off-balance-sheet hedging.

Question 26

Profits in foreign exchange trading have grown despite the decreased volatility in FX rates in European countries.

Question 27

On-balance-sheet hedging involves making changes in the on-balance-sheet assets and liabilities to protect FI profits from FX risk without the use of derivative securities.

Question 28

The market in which foreign currency is traded for immediate delivery is the

A)spot market.
B)forward market.
C)futures market.
D)currency swap market.
E)London capital market.

Question 29

The FI is acting as a FX market agent for its customers when it

A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in its domestic currency.
E)advises customers on their international business.

Question 30

A negative net exposure position in FX implies that the FI is

A)net long in a currency and exposed to depreciation of the foreign currency.
B)net short in a currency and exposed to depreciation of the foreign currency.
C)net long in a currency and exposed to appreciation of the foreign currency.
D)net short in a currency and exposed to appreciation of the foreign currency.
E)neither long nor short in a currency.

Question 31

Violation of the interest rate parity theorem would allow arbitrage profits.

Question 32

The real interest rate reflects the underlying real sector demand and supply for funds denominated in the domestic currency.

Question 33

The use of an exchange rate forward contract assures the FI of the opportunity to buy (or sell) the foreign currency at a future time at a known price.

Question 34

Which of the following is NOT a source of foreign exchange risk?

A)Trading foreign currencies.
B)Making domestic-currency loans to foreign corporations.
C)Buying foreign-issued securities.
D)Issuing foreign currency-denominated debt.
E)Making foreign currency loans.

Question 35

During the late 2000's financial crisis, global stock market return correlations decreased relative to the decade before the crisis.

Question 36

The total FX risk for a domestic bank that is making a one-year loan in a foreign currency is that the interest income expected on the loan is exposed to a depreciation of the foreign currency.

Question 37

Long-term violations of the interest rate parity relationship may occur if imperfections in the international financial markets are allowed to exist.

Question 38

Interest rate parity implies that the discounted spread between interest rates in two currencies should equal the percentage spread between forward and spot exchange rates.

Question 39

The FI is acting as a hedger when it

A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in a currency.
E)advises customers on their international business.

Question 40

Purchasing power parity is based on the difference in productive output (GDP) that exists between two countries.

Question 41

When purchasing and selling foreign currencies to allow customers to take positions in foreign real and financial investments, the FI

A)acts defensively as a hedger.
B)acts aggressively as a speculator.
C)assumes the FX risk itself.
D)acts as an agent.
E)acts as a market maker.

Question 42

The FI is acting as a speculator when it

A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in a currency.
E)advises customers on their international business.

Question 43

The decline in European FX volatility during the last decade has been offset in part by

A)the greater volatilities of Asian currencies.
B)a reduction in inflation rates in European countries.
C)the fixing of exchange rates among European countries.
D)the replacement of domestic currencies with the euro.
E)All of these.

Question 44

The following are the net currency positions of a Canadian FI (stated in Canadian dollars). What is the FI's net exposure in the Swiss franc?

A)+2,400.
B)+400.
C)-2,800.
D)-2,400.
E)+3,200.

Question 45

According to purchasing power parity (PPP), foreign currency exchange rates between two countries adjust to reflect changes in each country's

A)unemployment rates.
B)export competitiveness.
C)inflation rates.
D)foreign exchange reserves.
E)reserve requirements.

Question 46

If foreign currency exchange rates are highly positively correlated, how can a FI reduce its exchange rate risk exposure?

A)By taking net long positions in all currencies.
B)By taking net short positions in all currencies.
C)By taking opposing net short and net long positions in different currencies.
D)By maximizing net FX exposure in each currency, independently.
E)By minimizing net FX exposure in each currency, independently.

Question 47

Most profits or losses on foreign trading for FIs come from

A)open positions or speculation.
B)market making.
C)acting as agents for retail customers.
D)acting as agents for wholesale customers.
E)hedging activities.

Question 48

Which of the following is an example of interest rate parity?

A)The Japanese yen trades at the same exchange rate as the Swiss franc.
B)U.S. dollar rates on one year U.S. Treasury securities equal 1 year Japanese government bond rates.
C)U.S. dollar rates on one year U.S. Treasury securities equal 1 year Japanese government bond rates, restated in dollars.
D)British pound 2 year forward rates equal 2 year Swiss franc forward rates.
E)All currency exchange rates and interest rates move in unison.

Question 49

In which of the following FX trading activities does the FI not assume FX risk?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)In both the purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions, and the purchase and sale of foreign currencies to allow customers to take positions in foreign and real and financial investments.

Question 50

Deviations from the international currency parity relationships may occur because of

A)free capital movements across national boundaries.
B)barriers to cross-border financial flows.
C)perfect rationality of market participants.
D)differences in each country's productive capacity.
E)Basel capital regulations.

Question 51

As of 2012, which of the following FX "markets" is the largest?

A)London.
B)New York.
C)Tokyo.
D)Hong Kong.
E)Zurich.

Question 52

The following are the net currency positions of a Canadian FI (stated in Canadian dollars). What is the FI's net exposure in the Japanese yen?

A)+30,000.
B)+40,600.
C)-19,400.
D)-40,600.
E)+20,600.

Question 53

The nominal interest rate is equal to the

A)real interest rate minus the inflation premium.
B)real interest rate minus the trailing inflation rate.
C)real interest rate plus the expected interest rate increase.
D)real interest rate plus the expected inflation rate.
E)real interest rate plus the interest rate volatility.

Question 54

Which of the following factors help explain the decline in FX trading in the early years of this century?

A)Introduction of the euro.
B)Consolidation in the banking industry.
C)Growth of electronic brokering.
D)Mergers in the corporate sector.
E)All of these.

Question 55

Which of the following FX trading activities is used to hedge FX risk?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)None of these.

Question 56

The decrease in European FX volatility during the last decade has occurred because of

A)the stabilizing force of the euro.
B)reduction in inflation rates in European countries.
C)the reduced volatility in many emerging-market countries.
D)the greater volatilities of Asian currencies.
E)the stabilizing force of the euro, and reduction in inflation rates in European countries.

Question 57

The following are the net currency positions of a Canadian FI (stated in Canadian dollars). How would you characterize the FI's risk exposure to fluctuations in the British pound to dollar exchange rate?

A)The FI is net short in the British pound and therefore faces the risk that the British pound will rise in value against the U.S. dollar.
B)The FI is net short in the British pound and therefore faces the risk that the British pound will fall in value against the U.S. dollar.
C)The FI is net long in the British pound and therefore faces the risk that the British pound will fall in value against the U.S. dollar.
D)The FI is net long in the British pound and therefore faces the risk that the British pound will rise in value against the U.S. dollar.
E)The FI has a balanced position in the British pound.

Question 58

Which of the following FX trading activities is used for purposes of speculation?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)None of these.

Question 59

FX risk exposure of an FI essentially relates to which of the following activities?

A)Purchase and sale of foreign currencies to allow customers to participate in and complete international commercial trade transactions.
B)Purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
C)Purchase and sale of foreign currencies for hedging purposes to offset customer exposure in any given currency.
D)Purchase and sale of foreign currencies for speculative purposes through forecasting or anticipating future movements in FX rates.
E)None of these.

Question 60

The following are the net currency positions of a Canadian FI (stated in Canadian dollars). What is the FI's net exposure in British pounds?

A)-45,400.
B)-150,600.
C)-196,000.
D)+105,200.
E)+196,000.

Question 61

The one-year CD rates for financial institutions with AA ratings are 5 percent in Canada and 8 percent in France. An AA-rated Canadian financial institution can borrow by issuing GICs or lend by purchasing GICs at these rates in either market. The current spot rate is $0.20/Euro. If the bank receives a quote of $0.1975/€ for one-year forward rates for the Euro (to buy and to sell), what is the arbitrage profit for the bank if it uses $1,000,000 as the notional amount?

A)$5,000.
B)$16,500.
C)$19,350.
D)$22,000.
E)$25,675.

Question 62

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C$1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US$0.78493 per Canadian dollar. If in one year there is no change to either interest rates or exchange rates, what is the end-of-year profit or loss for the bank? (Hint: Annual interest is paid on both the Canadian bonds and the CD on the date of liquidation in exactly one year.)

A)Profit of US$20,000.
B)Loss of C$224,000.
C)Profit of US$50,000.
D)Profit of C$63,700.
E)Profit of US$313,000.

Question 63

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C$1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US$0.78493 per Canadian dollar. What is the end-of-year profit or loss to the bank if in one year Canadian bond rates increase to 7.538 percent? (Assume no change in either current U.S. interest rates or current exchange rates, US$0.78493/C$1.)

A)Loss of US$5,000.
B)Profit of US$15,000.
C)Loss of C$119,000.
D)Profit of C$50,000.
E)Loss of C$50,000.

Question 64

An FI has purchased (borrowed) a one-year $10 million Eurodollar deposit at an annual interest rate of 6 percent. It has invested these proceeds in one-year Euro (€) bonds at an annual rate of 6.5 percent after converting them at the current spot rate of €1.75/$. Both interest and principal are paid at the end of the year. What is the spread earned by the bank if the end-of-year exchange rate is €1.77/$?

A)-1.00 percent.
B)-0.70 percent.
C)-0.25 percent.
D)0.00 percent.
E)0.20 percent.

Question 65

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C$1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US$0.78493 per Canadian dollar. If you wanted to hedge your bank's risk exposure, what hedge position would you take?

A)A short interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S. dollar.
B)A short interest rate hedge to protect against interest rate increases and a short currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S. dollar.
C)A long interest rate hedge to protect against interest rate increases and a long currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S. dollar.
D)A long interest rate hedge to protect against interest rate declines and a long currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S. dollar.
E)A long interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S. dollar.

Question 66

Suppose that the current spot exchange rate of Canadian dollars for Russian rubles is $0.15/1ruble. The price of Russian-produced goods increases by 8 percent, and the Canadian price index increases by 3 percent. According to PPP, the 8 percent rise in the price of Russian goods relative to the 3 percent rise in the price of Canadian goods results in a(n)

A)depreciation of the Russian ruble by 5 percent.
B)depreciation of the Russian ruble by 6 percent.
C)appreciation of the Russian ruble by 5 percent.
D)appreciation of the Russian ruble by 6 percent.
E)depreciation of the Russian ruble by 7 percent.

Question 67

The following are the net currency positions of a U.S. FI (stated in U.S. dollars). Note: Net currency positions are foreign exchange bought minus foreign exchange sold restated in U.S. dollar terms. What is the FI's total FX investment?

A)US$671,500.
B)US$1,236,700.
C)-US$671,500.
D)-US$1,236,700.
E)0

Question 68

Suppose that the current spot exchange rate of Canadian dollars for Russian rubles is $0.15/1ruble. The price of Russian-produced goods increases by 8 percent, and the Canadian price index increases by 3 percent. According to PPP, the new exchange rate of Russian rubles to dollars is

A)0.15.
B)0.1425.
C)0.141.
D)0.1605.
E)0.159.

Question 69

The following are the net currency positions of a Canadian FI (stated in Canadian dollars). How would you characterize the FI's risk exposure to fluctuations in the yen/dollar exchange rate?

A)The FI is net short in the yen and therefore faces the risk that the yen will rise in value against the U.S. dollar.
B)The FI is net short in the yen and therefore faces the risk that the yen will fall in value against the U.S. dollar.
C)The FI is net long in the yen and therefore faces the risk that the yen will fall in value against the U.S. dollar.
D)The FI is net long in the yen and therefore faces the risk that the yen will rise in value against the U.S. dollar.
E)The FI has a balanced position in the Japanese yen.

Question 70

The following are the net currency positions of a U.S. FI (stated in U.S. dollars). Note: Net currency positions are foreign exchange bought minus foreign exchange sold restated in U.S. dollar terms. How would you characterize the FI's risk exposure to fluctuations in the Euro to dollar exchange rate?

A)The FI is net short in the Euro and therefore faces the risk that the Euro will rise in value against the U.S. dollar.
B)The FI is net short in the Euro and therefore faces the risk that the Euro will fall in value against the U.S. dollar.
C)The FI is net long in the Euro and therefore faces the risk that the Euro will fall in value against the U.S. dollar.
D)The FI is net long in the Euro and therefore faces the risk that the Euro will rise in value against the U.S. dollar.
E)The FI has a balanced position in the Euro.

Question 71

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C$1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US$0.78493 per Canadian dollar. What is the end-of-year profit or loss to the bank if in one year the exchange rate falls to US$0.765 per Canadian dollar? (Assume that there is no change in interest rates.)

A)Loss of US$75,000.
B)Profit of C$274,000.
C)Loss of US$7,000.
D)Profit of C$9,000.
E)Loss of US$5,000.

Question 72

The following are the net currency positions of a Canadian FI (stated in Canadian dollars). How would you characterize the FI's risk exposure to fluctuations in the Swiss franc/dollar exchange rate?

A)The FI is net short in the franc and therefore faces the risk that the franc will rise in value against the U.S. dollar.
B)The FI is net short in the franc and therefore faces the risk that the franc will fall in value against the U.S. dollar.
C)The FI is net long in the franc and therefore faces the risk that the franc will fall in value against the U.S. dollar.
D)The FI is net long in the franc and therefore faces the risk that the franc will rise in value against the U.S. dollar.
E)The FI has a balanced position in the Swiss franc.

Question 73

The one-year CD rates for financial institutions with AA ratings are 5 percent in Canada and 8 percent in France. An AA-rated Canadian financial institution can borrow by issuing GICs or lend by purchasing GICs at these rates in either market. The current spot rate is $0.20/Euro. What should be the spot rate in order for no arbitrage to take place, assuming the one-year forward rate is $0.1975/€?

A)$0.1944/€.
B)$0.1975/€.
C)$0.2000/€.
D)$0.2025/€.
E)$0.2031/€.

Question 74

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C$1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US$0.78493 per Canadian dollar. What is the end of year profit or loss on the bank's cash position if in one year both Canadian bond rates increase to 7.538 percent and the exchange rate falls to US$0.765 per Canadian dollar? (Assume no change in U.S. interest rates.)

A)Loss of US$12,000.
B)Loss of US$75,000.
C)Profit of C$9,000.
D)Profit of US$50,000.
E)Loss of C$119,800.

Question 75

The following are the net currency positions of a U.S. FI (stated in U.S. dollars). Note: Net currency positions are foreign exchange bought minus foreign exchange sold restated in U.S. dollar terms. How would you characterize the FI's risk exposure to fluctuations in the yen/dollar exchange rate?

A)The FI is net short in the yen and therefore faces the risk that the yen will rise in value against the U.S. dollar.
B)The FI is net short in the yen and therefore faces the risk that the yen will fall in value against the U.S. dollar.
C)The FI is net long in the yen and therefore faces the risk that the yen will fall in value against the U.S. dollar.
D)The FI is net long in the yen and therefore faces the risk that the yen will rise in value against the U.S. dollar.
E)The FI has a balanced position in the Japanese yen.

Question 76

An FI has purchased (borrowed) a one-year $10 million Eurodollar deposit at an annual interest rate of 6 percent. It has invested these proceeds in one-year Euro (€) bonds at an annual rate of 6.5 percent after converting them at the current spot rate of €1.75/$. Both interest and principal are paid at the end of the year. What is the spread earned by the bank at the end of the year if the exchange rate remains at €1.75/$?

A)0.50 percent.
B)1.00 percent.
C)1.5 percent.
D)2.0 percent.
E)2.5 percent.

Question 77

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C$1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US$0.78493 per Canadian dollar. Your position is exposed to

A)interest rate risk only.
B)credit risk only.
C)exchange rate risk only.
D)interest rate and exchange rate risk only.
E)interest rate risk, exchange rate risk, and credit risk.

Question 78

The following are the net currency positions of a U.S. FI (stated in U.S. dollars). Note: Net currency positions are foreign exchange bought minus foreign exchange sold restated in U.S. dollar terms. What is the portfolio weight of the Euro in this FI's portfolio of foreign currency?

A)+0.18 percent.
B)-36.62 percent.
C)+75.20 percent.
D)-5.47 percent.
E)+66.70 percent.

Question 79

The following are the net currency positions of a U.S. FI (stated in U.S. dollars). Note: Net currency positions are foreign exchange bought minus foreign exchange sold restated in U.S. dollar terms. What is the portfolio weight of the Japanese yen in this FI's portfolio of foreign currency?

A)+0.18 percent.
B)-36.62 percent.
C)+75.20 percent.
D)-5.47 percent.
E)+66.70 percent.

Question 80

The one-year CD rates for financial institutions with AA ratings are 5 percent in Canada and 8 percent in France. An AA-rated Canadian financial institution can borrow by issuing GICs or lend by purchasing GICs at these rates in either market. The current spot rate is $0.20/Euro. What should be the one-year forward rate in order to prevent any arbitrage?

A)$0.1944/€.
B)$0.1975/€.
C)$0.2000/€.
D)$0.2025/€.
E)$0.2031/€.