Deck 10: The Foreign Exchange Market

Question 1

The foreign exchange market is a market for converting the currency of one country into that of another country.

Answer 1

True

Question 2

Carry trade is non-speculative in nature.

Answer 2

False

Question 3

If $1 bought more yen with a spot exchange than with a 30-day forward exchange it indicates the dollar is expected to depreciate against the yen in the next 30 days.When this occurs,we say the dollar is selling at a premium on the 30-day forward market.

Answer 3

False

Question 4

Differences in the spot exchange rate and the 30-day forward rate are normal and reflect the expectations of the foreign exchange market about future currency movements.

Question 5

The foreign exchange market is a global network of banks,brokers,and foreign exchange dealers connected by electronic communications systems.

Question 6

If the spot exchange rate is £1=$1.50 when the market opens,and £1=$1.48 at the end of the day,the pound has appreciated,and the dollar has depreciated.

Question 7

A currency swap is the rate at which a foreign exchange dealer converts one currency into another on a particular day.

Question 8

To minimize the risk of an unanticipated change in exchange rates,a company can protect itself by entering into a forward exchange contract.

Question 9

When two parties agree to exchange currency and execute the deal at some specific time in the future,a forward exchange occurs.

Question 10

Currency fluctuations can make seemingly profitable trade and investment deals unprofitable and vice versa.

Question 11

The foreign exchange market is open for only 12 hours in a day.

Question 12

The risk that arises from volatile changes in exchange rates is known as foreign exchange risk.

Question 13

When a tourist goes to a bank in a foreign country to convert money into the local currency,the exchange rate used is the forward rate.

Question 14

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.

Question 15

A spot exchange rate is quoted for 30 days,90 days,and 180 days into the future.

Question 16

If the spot rate is $1 = ¥120,and the 30-day forward rate is $1 = ¥130,the dollar is selling at a discount in the forward market.

Question 17

A currency swap deal enables companies to insure themselves against foreign exchange risk.

Question 18

The value of a currency is determined by the interaction between the demand and supply of that currency relative to the demand and supply of other currencies.

Question 19

The most important trading centers for currencies are Zurich,Frankfurt,Paris,Hong Kong,and Sydney.

Question 20

The rate at which one currency is converted into another is known as the fluctuation rate.

Question 21

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 for the two countries.

Question 22

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

Question 23

The PPP theory is a strong predictor of short-run movements in exchange rates covering time spans of five years or less.

Question 24

An inefficient market is one in which prices do not reflect all available information.

Question 25

Capital flight 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.

Question 26

The International Fisher Effect has proven to have substantial power at predicting short-run changes in spot exchange rates.

Question 27

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

Question 28

The efficient market school argues that investing in exchange rate forecasting services would be a waste of money.

Question 29

The PPP theory argues that the exchange rate will change even if relative prices remain unchanged.

Question 30

There is no evidence that psychological factors play an important role in determining the expectations of market traders as to likely future exchange rates.

Question 31

Technical analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements.

Question 32

Transaction 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.

Question 33

The PPP theory tells us that a country with a high inflation rate will see depreciation in its currency exchange rate.

Question 34

Inflation occurs when output increases faster than the money supply.

Question 35

If a country has an externally convertible currency,neither residents nor nonresidents are allowed to convert it into a foreign currency.

Question 36

Arbitrage opportunities abound in the foreign exchange markets and they tend to be available for long periods of time.

Question 37

There are no impediments to the free flow of goods and services in an efficient market.

Question 38

A lag 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.

Question 39

The impact of currency exchange rates on the reported financial statements of a company is called economic exposure.

Question 40

Although a foreign exchange transaction can involve any two currencies,most transactions involve pounds on one side.

Question 41

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) rational price theory

Question 42

The short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates is known as:

A) currency arbitrage.
B) currency speculation.
C) currency hedging.
D) currency risk mitigation.

Question 43

An exchange rate of €1 = $1.30 indicates that:

A) $1 is worth 1.30 euros.
B) one could get 1.30 euros for $1.
C) one euro buys 1.30 dollars.
D) one euro buys 0.77 dollars.

Question 44

Assume that the interest rate on borrowings in Japan is 1 percent,while the interest rate on deposits in Australian banks is 5 percent.A trader borrows in yen and then converts the money into Australian dollars and deposits it in an Australian bank to make a 4 percent margin.Which type of trade is this an example of?

A) Swing trade
B) Carry trade
C) Channel trade
D) Price action trade

Question 45

The _____ helps us to compare the relative prices of goods and services in different countries.

A) interest rate
B) GDP growth rate
C) exchange rate
D) tariff rate

Question 46

Assume that the current exchange rate is €1 = $1.50.If you exchange 1,000 euros for dollars,you will receive _____.

A) $1,000
B) $750
C) $1,500
D) $667

Question 47

Which term refers to the rate at which one currency is converted into another?

A) Basis point
B) Spread
C) Exchange rate
D) Interchange rate

Question 48

A pair of shoes costs £40 in Britain.An identical pair costs $50 in the United States when the exchange rate is £1 = $1.50.Which of the following is correct?

A) The U.S.offers a better deal.
B) The deal is the same in both countries.
C) Britain offers a better deal.
D) A trader can make money by buying the shoes in Britain and selling it in the U.S.at $50.

Question 49

Assuming the 30-day forward exchange rate were $1 = ¥130 and the spot exchange rate were $1 = ¥120,the dollar is selling at a _____ on the 30-day forward market.

A) premium
B) margin
C) discount
D) subsidy

Question 50

Which of the following refers to the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates?

A) Currency pairing
B) Carry trade
C) Currency exchange
D) Currency swap

Question 51

The _____ is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day.

A) spot exchange rate
B) forward exchange rate
C) futures exchange rate
D) spread

Question 52

_____ are exchange rates governing some specific future date foreign exchange transactions.

A) Spot exchange rates
B) Forward exchange rates
C) Future exchange rates
D) Currency swaps

Question 53

Assume that an American company today invests some of its spare cash in a Hungarian money market account that will earn 8 percent for a period of two months.Which of the following,if it happens during the next two months,would imply that the company will earn less than 8 percent on its investment?

A) The Hungarian forint rises in value against the dollar.
B) Interest rates in the United States move down.
C) Short-term interest rates in Hungarian money markets shoot up.
D) The dollar appreciates against the Hungarian forint.

Question 54

If the demand for dollars outstrips its supply and if the supply of Japanese yen is greater than the demand for it,what will happen?

A) The dollar will appreciate against the yen
B) The dollar will depreciate against the yen
C) The exchange rates will remain the same
D) The yen will appreciate against the dollar

Question 55

Which of the following is the most important foreign exchange trading center?

A) London
B) New York
C) Tokyo
D) Singapore

Question 56

What are the two main functions of the foreign exchange market?

A) Trading of equities of foreign companies and currency conversion
B) Reducing currency volatility and setting interest rates
C) Insuring companies against interest rate risk and enabling imports and exports
D) Currency conversion and providing some insurance against foreign exchange risk

Question 57

Which of the following involves borrowing in one currency where interest rates are low,and then using the proceeds to invest in another currency where interest rates are high?

A) Carry trade
B) Swing trade
C) Channel trade
D) Price action trade

Question 58

International businesses use foreign exchange markets for all of the following reasons except:

A) to receive payments from foreign investments that may be in foreign currencies.
B) to pay a foreign company for its products or services in its country's currency.
C) to invest for short terms in money markets when they have spare cash.
D) to cover themselves from all risks involved in currency speculation.

Question 59

When two parties agree to exchange currency and execute the deal immediately,the transaction is a:

A) futures exchange.
B) carry trade.
C) spot exchange.
D) forward exchange.

Question 60

Assume that the yen/dollar exchange rate quoted in Tokyo at 3:00 p.m.is ¥120 = $1,and the yen/dollar exchange rate quoted in New York at the same time is ¥123 = $1.A dealer in New York uses dollars to purchase yen and then immediately sells the yen to buy dollars in Tokyo,thereby making a profit.The dealer has engaged in a(n):

A) currency swap.
B) arbitrage.
C) carry trade.
D) straddle.

Question 61

A currency is said to be freely convertible when:

A) its exchange rate with respect to other currencies is decided by the central bank of the country.
B) residents alone are allowed to convert it into a foreign currency without any limitations.
C) neither residents nor nonresidents are allowed to convert it into a foreign currency.
D) both residents and nonresidents are allowed to purchase unlimited amounts of a foreign currency with it.

Question 62

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

A) economic exposure.
B) financial exposure.
C) translation exposure.
D) transaction exposure.

Question 63

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

A) Technical analysis
B) Fundamental analysis
C) Efficient market theory
D) Value investing

Question 64

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.

A) inefficient market
B) efficient market
C) random walk
D) speculative

Question 65

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 ______.

A) foreign exchange rates
B) inflation rates
C) unemployment rates
D) GDP growth rates

Question 66

Identify the incorrect statement about the PPP theory.

A) It predicts that exchange rates are determined by relative prices.
B) It yields accurate predictions of short-run movements in exchange rates.
C) It best predicts exchange rate changes for countries with high rates of inflation.
D) It assumes away transportation costs and barriers to trade.

Question 67

_____ 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.

A) The random walk effect
B) The Fisher Effect
C) The International Fisher Effect
D) Capital flight

Question 68

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.

A) follower strategy
B) interim strategy
C) lead strategy
D) lag strategy

Question 69

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.

A) purchasing power parity theory
B) efficient market theory
C) International Fisher Effect
D) law of one price

Question 70

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?

A) Inflation
B) Credit squeeze
C) Deflation
D) Production surplus

Question 71

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

A) Fisher effect
B) Bandwagon effect
C) Arbitrage
D) Decoupling of markets

Question 72

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.

A) £180
B) £50
C) £60
D) £80

Question 73

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

A) Reduced levels of inflation in countries where the growth in the money supply is faster than the growth in its output.
B) The reason why countries with high inflation rates see depreciation in their currency exchange rates.
C) Identical products being sold in different countries for the same price when their price is expressed in terms of the same currency.
D) The failure to find a strong link between relative inflation rates and exchange rate movements.

Question 74

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 _____.

A) currency swap
B) arbitrage
C) carry trade
D) straddle

Question 75

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:

A) undervalued by 25 percent against the dollar.
B) overvalued by 25 percent against the dollar.
C) appreciating relative to the dollar.
D) depreciating relative to the dollar.

Question 76

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

A) Economic exposure
B) Financial exposure
C) Translation exposure
D) Transaction exposure

Question 77

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

A) random walk theory
B) theory of competitive advantage
C) theory of price inflation
D) purchasing power parity theory

Question 78

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) law of one price
D) Fisher Effect

Question 79

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

A) Countertrade
B) Carry trade
C) Dumping
D) Capital flight

Question 80

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

A) Companies would be better off investing in foreign exchange forecasting services.
B) Forward exchange rates do the best possible job of forecasting future spot exchange rates.
C) Companies can optimize their foreign exchange transactions by using forward markets.
D) Forward rates reflect all available information about likely future changes in exchange rates.