Deck 10: The Foreign Exchange Market

Question 1

Assume that the euro/dollar exchange rate is €1 = $1.20.If it costs $36 to buy a European product,the stated price of the product would be €36.

Answer 1

False

Question 2

The integration of financial centers implies there can be no significant difference in exchange rates quoted in the foreign exchange trading centers.

Answer 2

True

Question 3

Inflation occurs when the money supply in a country increases faster than output increases.

Answer 3

True

Question 4

When companies wish to convert currencies,they typically enter the foreign exchange market directly.

Question 5

In countries where inflation is expected to be high,interest rates also will be high.

Question 6

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 7

In the context of The Economist's "Big Mac Index," assume that the average price of a Big Mac in South Korea is $3.98 at the prevailing won/dollar exchange rate.The average price of a Big Mac in the United States is $4.93.This suggests that the Korean won is overvalued against the U.S.dollar.

Question 8

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

Question 9

When a firm enters into a spot exchange contract,it is taking out insurance against adverse future exchange rate movements.

Question 10

Unlike the purchasing power parity theory,the international Fisher effect is a good predictor of short-run changes in spot exchange rates.

Question 11

Relative monetary growth,relative inflation rates,and nominal interest rate differentials are all moderately good predictors of long-run changes in exchange rates.

Question 12

What happens in the foreign exchange market does not directly impact the sales,profits,and strategy of a multinational enterprise.

Question 13

Currency swaps are transacted between international businesses and their banks,between banks,and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange risk.

Question 14

Spot exchange rates and the 30-day forward rates are the same.

Question 15

The forward exchange rate refers to the rate at which a foreign exchange dealer converts one currency into another currency on a particular day.

Question 16

Carry trade is a kind of speculation whose success is based upon a belief that there will be no adverse movement in exchange rates.

Question 17

The foreign exchange market offers complete insurance against foreign exchange risk.

Question 18

For price discrimination to work,arbitrage opportunities must be unlimited.

Question 19

In terms of exchange rate forecasting,the efficient market school argues that companies should spend additional money trying to forecast short-run exchange rate movements.

Question 20

A common kind of currency swap is spot against forward.

Question 21

Leading and lagging strategies involve accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries.

Question 22

Economic exposure,a category of foreign exchange risk,is distinct from transaction exposure,which is concerned with the effect of exchange rate changes on individual transactions,most of which are short-term affairs that will be executed within a few weeks or months.

Question 23

Assume that the interest rate on borrowings in India is 1 percent while the interest rate on bank deposits in a U.S.bank is 6 percent.John,an active currency trader borrows in Japanese yen,converts the money into U.S.dollars and deposits it in a U.S.bank.The speculative element of John's carry trade is that its success is based upon his belief that

A)there will be no adverse movement in exchange rates or interest rates.
B)liquidity is the key factor in determining interest rates.
C)increasing money supply will not drive inflation.
D)spot exchange rates are more favorable than forward exchange rates.
E)hedging insures a company against foreign exchange risks.

Question 24

Technical analysis,an approach to foreign exchange forecasting,does not rely on a consideration of economic fundamentals.

Question 25

Which of the following caused a decline in the dollar/yen carry trade during 2008-2009?

A)increase in risk appetite making the carry trade less attractive
B)decrease in interest rate differentials as the U.S.rates came down
C)increase in interest rate differentials as Japanese interest rates came down
D)decrease in interest rate differentials as the U.S.interest rates went up
E)decrease in interest rate differentials as the Japanese rates went up

Question 26

Steven converted $1,000 to ×105,000 for a trip to Japan.However,he spent only ×50,000.During this period,the value of the dollar weakened against the yen.Considering a current exchange rate of $1 = ×100,how many dollars did Steven spend on the trip?

A)$550
B)$523
C)$450
D)$600
E)$500

Question 27

When residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency,the phenomenon is generally referred to as capital flight.

Question 28

An American company imports laptop computers from Japan.The company knows that after a shipment arrives,it must pay in yen to the Japanese supplier within 30 days.In a particular exchange,the American company must pay the Japanese supplier ×150,000 for each computer at the current dollar/yen spot exchange rate of $1 = ×110.The company intends to resell the computers the day they arrive for $1,600 each but it does not have the funds to pay the Japanese supplier until the computers have been sold.Which of the following will happen if the exchange rate after 30 days is $1 = ×90?

A)The importer will earn a profit of approximately $236 per computer.
B)The importer will earn a profit of approximately $67 per computer.
C)The importer will incur a loss of approximately $236 per computer.
D)The importer will incur a loss of approximately $67 per computer.
E)The importer will incur a loss of approximately $90 per computer.

Question 29

Assume that the interest rate on borrowings in India is 1 percent while the interest rate on bank deposits in a U.S.bank is 6 percent.John,an active currency trader borrows in Japanese yen,converts the money into U.S.dollars and deposits it in a U.S.bank.John is engaging in

A)currency speculation.
B)hedging.
C)currency swap.
D)arbitrage.
E)carry trade.

Question 30

Robben Inc.converts $1,000,000 into euros when the exchange rate is $1 = €0.75.After three months,the company converts this back into dollars when the exchange rate is $1 = €0.80.Which of the following is the outcome of this transaction?

A)loss of $62,500
B)loss of $66,667
C)gain of $50,000
D)gain of $62,500
E)loss of $50,000

Question 31

Which of the following refers to currency speculation?

A)short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates
B)exchange rate at which a foreign exchange dealer will convert one currency into another that particular day
C)simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
D)purchase of securities in one market for immediate resale in another to profit from a price discrepancy
E)growth in a country's money supply exceeding the growth in its output,leading to price inflation

Question 32

How are spot exchange rates determined?

A)using historical average prices of different currencies
B)the interaction between demand and supply of a currency relative to other currencies
C)taking the average of a basket of currencies
D)government decree
E)predicting future currency movements in nonmember countries

Question 33

A French company wants to invest 20 million euros for three months.The company found that investing in a Thai money market account would give it a higher interest rate than domestic investments.Which of the following is true about this investment?

A)The investment is risk-free because money market investments are considered to be equivalent to bank deposits.
B)The investment is not risk-free because foreign currency movements in the intervening period can affect the profitability of the firm.
C)The investment is risk-free because such investments also lock foreign exchange rates for the duration of the investment.
D)The investment is not risk-free because money market instruments are considered to be the most speculative of all investments.
E)The investment is risk-free because the Thai money market is considered to be more stable and secure than other markets.

Question 34

Which of the following enables organizations to conduct international trade without having to resort to barter?

A)foreign exchange market
B)Caribbean Single Market and Economy
C)auction market
D)countertrade
E)balance-of-trade equilibrium

Question 35

The interest rate on borrowings in Rhodia is 2 percent and the interest rate on bank deposits in Maritia is 7.5 percent.In this scenario,a carry trade would be to

A)borrow money in Maritian currency,convert it into Rhodian currency,and deposit it in a Rhodian bank.
B)borrow money in Rhodian currency and invest in stocks with good growth potential in Rhodia.
C)borrow money in Rhodian currency,convert it into Maritian currency,and deposit it in a Maritian bank.
D)invest in bank deposits of Maritia and reinvest the earnings in Rhodia.
E)invest in bank deposits of Rhodia and reinvest the earnings in Maritia.

Question 36

The currency of the country of Venadia falls sharply in value against the currency of Lutetia,a neighboring country.Which of the following is a consequence of this exchange rate movement?

A)Lutetia's products will achieve a competitive pricing in Venadia.
B)Venadia's exports to Lutetia will increase,because Venadian goods will become cheaper in Lutetia.
C)Venadia's products will cost more in Lutetia.
D)There will be no difference in the volume or direction of trade.
E)Lutetia's exports to Venadia will increase,because Lutetian goods will become cheaper in Venadia.

Question 37

Omega,Inc.,a U.S.-based firm entered into an agreement with another party to exchange currency and execute the deal at a specific date in the future.What is Omega,Inc.engaging in when it insures itself against foreign exchange risk?

A)currency speculation
B)carry trade
C)hedging
D)currency swap
E)arbitrage

Question 38

A U.S.company that imports laptop computers from Japan knows that in 30 days it must pay in yen to a Japanese supplier when a shipment arrives.The company will pay the Japanese supplier ×150,000 for each computer,and the current dollar/yen spot exchange rate is $1 = ×110.The importer can sell the computers the day they arrive for $1,600 each.However,the importer will not have the funds to pay the Japanese supplier until the computers have been sold.The importer enters into a 30-day forward exchange transaction with a foreign exchange dealer at $1 = ×105.Which of the following will happen if the exchange rate after 30 days is $1 = ×90?

A)The importer will earn a profit of approximately $236 per computer.
B)The importer will earn a profit of approximately $171 per computer.
C)The importer will earn a profit of approximately $65 per computer.
D)The importer will incur a loss of approximately $67 per computer.
E)The importer will incur a loss of approximately $105 per computer.

Question 39

Which of the following is a function of the foreign exchange market?

A)provide some insurance against foreign exchange risk
B)protect short-term cash flow from adverse changes in exchange rates
C)eliminate volatile changes in exchange rates
D)reduce the economic exposure of a firm
E)enable companies to engage in capital flight when countertrade is not possible

Question 40

Transaction exposure,a category of foreign exchange risk,refers to the impact of currency exchange rate changes on the reported financial statements of a company.

Question 41

Assume that the yen/dollar exchange rate quoted in London at 3:00 p.m.is 125 yen = 1 dollar.Sylvia finds out that the rate quoted in New York at 10:00 a.m.New York time (3:00 p.m.in London)is 130 yen = 1 dollar.Sylvia decides to buy yen in New York and sell it in London.Sylvia is engaging in

A)currency swapping.
B)currency speculation.
C)carry trade.
D)arbitrage.
E)hedging.

Question 42

If a basket of goods costs $100 in the United States and €120 in Europe,what would the purchasing power parity theory's prediction of the dollar/euro exchange rate be?

A)$1 = €1.20
B)$1 = €1
C)$1 = €0.80
D)$1 = €0.90
E)$1 = €1.10

Question 43

Assume that the yen/dollar exchange rate quoted in London at 3 p.m.is ×120 = $1,and the New York yen/dollar exchange rate at the same time (10 a.m.New York time)is ×123 = $1.Which of the following transactions would yield immediate profit?

A)forward exchange
B)carry trade
C)currency swap
D)arbitrage
E)currency speculation

Question 44

Which of the following has no impediments to the free flow of goods and services,such as trade barriers?

A)economic union
B)currency board
C)efficient market
D)carry trade
E)European Monetary System

Question 45

The yen/dollar exchange rate is ×120 = $1 in London and ×123 = $1 in New York at the same time.What is the net profit if a dealer takes $1,000,000 to purchase ×123,000,000 in New York and engages in arbitrage by selling it in London?

A)$34,000
B)$20,390
C)$25,000
D)$46,666
E)$39,454

Question 46

Which of the following occurs when two parties agree to exchange currency and execute the deal at some specific date in the future?

A)forward exchange
B)spot exchange
C)carry trade
D)currency swap
E)arbitrage

Question 47

Tom boasts that he is often one of the first buyers of any new technology product.Tom saw a new Apple watch at the Amsterdam airport when he was hurrying to catch a flight back home to New York.Tom saw that the watch sold for 100 Euros.Tom did not have time to buy the watch in Amsterdam.Assume that the euro/dollar exchange rate is €1 = $1.20.According to the law of one price,at what price would it make sense to buy the watch in New York?

A)$150
B)$140
C)$120
D)$125
E)$150

Question 48

Which of the following is true of the differences in relative demand and supply of currencies?

A)They cannot be used to explain the determination of exchange rates.
B)While they provide an understanding of the major factors underlying exchange rates,they exclude minor factors.
C)They provide a high-level understanding of exchange rates.
D)While they provide an accurate explanation for appreciation of currencies,they fail to explain depreciation.
E)They cannot explain or predict when the demand of a particular currency would exceed its supply and vice versa.

Question 49

Which of the following is a key feature of the foreign exchange market?

A)The foreign exchange market never sleeps.
B)The foreign exchange market is located in London.
C)The foreign exchange market is characterized by high transaction costs.
D)The foreign exchange market is shut for two hours every day.
E)The foreign exchange market is poorly interconnected giving rise to ample arbitrage opportunities.

Question 50

A base model Fitbit costs $100 in the United States and €125 in Europe.What would the purchasing power parity theory's prediction of the dollar/euro exchange rate be based on this example?

A)$1 = €1.25
B)$1 = €1
C)$1 = €0.80
D)$1 = €0.90
E)$1 = €1.10

Question 51

Assume that the dollar is selling at a premium on the 30-day dollar/euro forward market.Which of the following is true of the foreign exchange dealers' market's expectations about the dollar over the next 30 days?

A)The dollar will depreciate against the euro.
B)The market is undecided about the direction of currency movement.
C)The dollar will appreciate against the euro.
D)The dollar/euro exchange rate will be steady.
E)The dollar will buy more euros with a spot exchange than with a 30-day forward exchange.

Question 52

The law of one price states that

A)by comparing the prices of identical products in different currencies,it would be possible to determine the "real" or PPP exchange rate that would exist if markets were efficient.
B)a country's "nominal" interest rate (i)is the sum of the required "real" rate of interest (r)and the expected rate of inflation over the period for which the funds are to be lent (I).
C)a country in which price inflation is running wild should expect to see its currency depreciate against that of countries in which inflation rates are lower.
D)when the growth in a country's money supply is faster than the growth in its output,price inflation is fueled.
E)in competitive markets free of transportation costs and trade barriers,identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.

Question 53

A(n)_____ is used to move out of one currency and into another for a limited period without incurring foreign exchange risk.

A)currency swap
B)currency speculation
C)carry trade
D)spot exchange
E)arbitrage

Question 54

Which of the following foreign exchange trading centers has the highest percentage of activity?

A)Frankfurt
B)London
C)Paris
D)Hong Kong
E)Sydney

Question 55

Which of the following instances indicates that the dollar is selling at a premium on the 30-day forward market?

A)The spot exchange rate is currently $1 = ×120 and changes to $1 = ×130 after 30 days.
B)The spot exchange rate is currently $1 = ×120 and changes to $1 = ×110 after 30 days.
C)The current spot exchange rate is $1 = ×120 and the 30-day forward rate is $1 = ×110 after 30 days.
D)The current spot exchange rate is $1 = ×120 and the 30-day forward rate is $1 = ×130 after 30 days.
E)The current spot exchange rate is $1 = ×120 and the 30-day forward rate is $1 = ×120.

Question 56

Which of the following indicates that the dollar is selling at a discount on the 30-day forward market?

A)The spot exchange rate is $1 = ×120 currently and $1 = ×130 after 30 days.
B)The spot exchange rate is $1 = ×120 currently and $1 = ×100 after 30 days.
C)The current spot exchange rate is $1 = ×120 and the 30-day forward rate is $1 = ×110 after 30 days.
D)The current spot exchange rate is $1 = ×120 and the 30-day forward rate is $1 = ×130 after 30 days.
E)The current spot exchange rate is $1 = ×120 and the 30-day forward rate is $1 = ×120 after 30 days.

Question 57

Which of the following is a reason for London's dominance in the foreign exchange market?

A)Great Britain's decision to retain the British pound instead of using the euro
B)The preeminence of Financial Times Stock Exchange (FTSE)index as an economic health indicator
C)London's location making it the link between the East Asian and New York markets
D)London being the preferred headquarters destination for major multinational corporations
E)London's trading centers opening soon after Tokyo's and New York's trading centers closing for the night

Question 58

The euro/dollar exchange rate is €1 = $1.20.According to the law of one price,how much would a camera that retails for $300 in New York sell for in Germany?

A)€320
B)€300
C)€250
D)€360
E)€150

Question 59

Assume that the exchange rate between the British pound and the U.S.dollar is 1 pound = 2 dollars.An Armani jacket sells for $80 in New York and 40 pounds in London.This is an example of

A)hedging
B)arbitrage.
C)currency swap.
D)exchange rate risk.
E)the law of one price.

Question 60

To express the PPP theory in symbols,let P_$ be the U.S.dollar price of a basket of particular goods and P_× be the price of the same basket of goods in Japanese yen.What does the purchasing power parity (PPP)theory predict to be the equivalent of the dollar/yen exchange rate,E_$/×?

A)E_$/× = (1 + P_×)/P_$
B)E_$/× = (1 + P_$)/P_×
C)E_$/× = P_×/P_$
D)E_$/× = P_$/P_×
E)E_$/× = (1 + P_$)/(1 + P_×)

Question 61

Assume that a Big Mac cost $4.93 in the U.S.and that the Brazilian real is undervalued by 23 percent.According to the Big Mac Index published by The Economist,a Big Mac would

A)cost a bit more in Brazil than in the U.S.by By 16 percent 16 16 percent
B)cost less in Brazil than in the U.S.
C)cost the same in both countries.Cost the same in bothThe Unconnected
D)would cost twice as much in Brazil.
E)would cost less than half of the U.S.price in Brazil.

Question 62

Which of the following is true of inflation?

A)It occurs when the demand for a particular currency is more than the supply.
B)It occurs when securities are purchased in one market for immediate resale in another.
C)It occurs when two parties agree to exchange currency and execute a deal at a specific date in the future.
D)It occurs when the quantity of money in circulation rises faster than the stock of goods and services.
E)It occurs when output increases faster than the money supply.

Question 63

During inflation,an increase in the amount of currency available leads to

A)overheating of the economy thereby reducing the production levels in the economy.
B)changes in the relative demand-and-supply conditions in the foreign exchange market.
C)a reduction in the rate of inflation thus leading to an appreciation of the currency.
D)decreased lending by banks thereby resulting in more savings.
E)a decrease in the demand for goods and services,which drives currency value higher.

Question 64

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

A)currency crisis.
B)banking crisis.
C)purchasing power parity puzzle.
D)bandwagon effect.
E)foreign exchange risk.

Question 65

Which of the following is true of the purchasing power parity (PPP)theory?

A)A country's "nominal" interest rate (i)is the sum of the required "real" rate of interest (r)and the expected rate of inflation over the period for which the funds are to be lent (I).
B)The exchange rate will not change if relative prices change.
C)The price of a "basket of goods" should be roughly equivalent in each country in relatively efficient markets.
D)In competitive markets free of transportation costs and trade barriers,identical products sold in different countries must sell for the same price.
E)If the law of one price were true for all goods and services,the PPP exchange rate could not be found from any individual set of prices.

Question 66

When dominant enterprises in an industry exercise a degree of pricing power,setting different prices in different markets to reflect varying demand conditions,it is referred to as

A)price discrimination.
B)premium pricing.
C)psychological pricing.
D)price skimming.
E)price leadership.

Question 67

Which of the following 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)Bandwagon effect
B)Law of one price
C)International Fisher effect
D)Helms-Burton Act
E)Purchasing power parity (PPP)theory

Question 68

Which of the following is a way in which an enterprise with some market power might limit arbitrage so that their price discrimination policy works?

A)Pricing its products identically despite huge differences in demand across different markets
B)Differentiating otherwise identical products among nations along some line,such as design or packaging
C)Adopting a pricing strategy that matches what competitors charge in each of the different national markets
D)Limiting sales of its products to only a few nations
E)Selling its products at higher prices than normal to break even by selling fewer units

Question 69

The nominal interest rate is 9 percent in Brazil and 6 percent in Japan.Applying the international Fisher effect,the Brazilian real should

A)appreciate by 3 percent against the Japanese yen.
B)depreciate by 3 percent against the Japanese yen.
C)appreciate by 1.5 percent against the Japanese yen.
D)depreciate by 1.5 percent against the Japanese yen.
E)appreciate by 15 percent against the Japanese yen.

Question 70

Which of the following is true when a government is strongly committed to controlling the rate of growth in money?

A)The country's future inflation rate may be low.
B)The country's currency will steadily depreciate significantly and instantly in the foreign exchange market.
C)The country's economy will be marked by an abundance of liquidity.
D)The country will see a good number of populist measures not funded by taxation.
E)The country will struggle to match money supply with adequate supply of goods and services.

Question 71

Which of the following is a drawback of the purchasing power parity theory?

A)It does not appear to be a strong predictor of short-run movements in exchange rates covering time spans of five years.
B)It does not explain change in exchange rates in terms of change in relative prices.
C)It cannot explain when the demand of a particular currency would exceed its supply and vice versa.
D)It does not address inflation in situations where governments control the rate of growth in money supply.
E)It cannot predict exchange rate changes for countries with high rates of inflation and underdeveloped capital markets.

Question 72

The Fisher effect states that

A)a country's "nominal" interest rate (i)is the sum of the required "real" rate of interest (r)and the expected rate of inflation over the period for which the funds are to be lent (I).
B)by comparing the prices of identical products in different currencies,it is possible to determine the "real" or purchasing power parity exchange rate that would exist if markets were efficient.
C)a country in which price inflation is running wild should expect to see its currency depreciate against that of countries in which inflation rates are lower.
D)when the growth in a country's money supply is faster than the growth in its output,price inflation is fueled.
E)in competitive markets free of transportation costs and trade barriers,identical products sold in different countries must sell for the same price.

Question 73

Which of the following is a reason for the failure of the purchasing power parity (PPP)theory to predict exchange rates accurately?

A)It assumes away transportation costs and trade barriers.
B)It does not take into account the law of one price.
C)It does not take into account the practice of arbitrage.
D)It assumes that the markets are not efficient.
E)It does not consider government influence on a nation's money supply.

Question 74

In countries where inflation is expected to be high,interest rates also will be high,because investors want compensation for the decline in the value of their money.This relationship is referred to as the

A)PPP theory puzzle.
B)lead strategy.
C)Fisher effect.
D)bandwagon effect.
E)international Fisher effect.

Question 75

According to the Fisher effect,if the "real" rate of interest in a country is 4 percent and the expected annual inflation is 9 percent,what would the "nominal" interest rate be?

A)5 percent
B)13 percent
C)9 percent
D)36 percent
E)2.25 percent

Question 76

To jumpstart its slow economy,the government of Mesoma increased the money supply.Which of the following is a likely consequence of Mesoma's action?

A)It results in an overall decrease in credit.
B)It makes it difficult for individuals and companies to borrow from banks.
C)It makes it easier for banks to borrow from the government.
D)It causes a decrease in demand for goods and services.
E)It causes price deflation as the money supply exceeds goods and services output.

Question 77

Which of the following weakens the link between relative price changes and changes in exchange rates predicted by purchasing power parity (PPP)theory by violating the assumption of efficient markets?

A)government intervention in cross-border trade
B)relationship between money supply and price inflation
C)impact of increase in currency on relative demand and supply conditions of currencies
D)excessive growth in money supply
E)insignificant impact of transportation costs on international trade

Question 78

What can happen if a country's government does not control the rate of growth in money supply?

A)Its future inflation rate will be low.
B)Its taxes will decrease in the future.
C)It will see reduced spending on public infrastructure projects.
D)Its currency could depreciate in the future.
E)Its output of goods and services will exceed money supply,thereby fueling deflation.

Question 79

The purchasing power parity (PPP)theory tells us that a country with a high inflation rate will see

A)appreciation in its currency exchange rate.
B)a decrease in interest rates.
C)the collapse of the gold standard.
D)depreciation in its currency exchange rate.
E)a decrease in its money supply.

Question 80

The purchasing power parity (PPP)theory best predicts exchange rate changes for countries with

A)appreciating currencies.
B)stable currencies.
C)underdeveloped capital markets.
D)small differentials in inflation rates.
E)industrialized economies.