Deck 16: Foreign Exchange Derivative Markets

Question 1

If a commercial bank expects the euro to appreciate against the dollar, it may take a ____ position in euros and a ____ position in dollars.

A)short; short
B)long; short
C)short; long
D)long; long

Answer 1

B

Question 2

Assume interest rate parity exists. If the spot rate on the British pound is $2 and the 1-year British interest rate is 7 percent, and the 1-year U.S. interest rate is 11 percent, what is the pound's forward discount or premium?

A)3.74 percent premium
B)3.74 percent discount
C)3.60 percent premium
D)3.60 percent discount

Answer 2

A

Question 3

Beginning with an equilibrium situation, if European inflation suddenly ____ than U.S. inflation, this forced ____ pressure on the value of the euro.

A)becomes much higher; upward
B)becomes much higher; downward
C)becomes much less; upward
D)becomes much less; downward
E)B and C

Answer 3

E

Question 4

The ____ allowed for the devaluation of the dollar in 1971.

A)Bretton Woods Agreement
B)Louvre Accord
C)Smithsonian Agreement
D)none of the above

Question 5

A country that pegs its currency is still able to maintain complete control over its local interest rates.

Question 6

Which of the following statements is incorrect?

A)Central banks often consider adjusting a currency's value to influence economic conditions.
B)If the U.S. central bank wishes to stimulate the economy, it could weaken the dollar.
C)A weaker dollar could cause U.S. inflation by reducing foreign competition.
D)Direct intervention occurs when the central bank influences the factors that determine the dollar's value.

Question 7

If the demand for British pounds ____, the pound will ____, other things being equal.

A)increases; appreciate
B)decreases; appreciate
C)increases; depreciate
D)B and C

Question 8

If the U.S. government imposed trade restrictions on U.S. imports, this would ____ the U.S. demand for foreign currencies, and would place ____ pressure on the values of foreign currencies (with respect to the dollar).

A)increase; upward
B)increase, downward
C)limit; upward
D)limit; downward

Question 9

Generally, a ____ home currency can ____ domestic economic growth.

A)weak; dampen
B)strong; stimulate
C)strong; dampen
D)A and B

Question 10

Direct intervention is always extremely effective.

Question 11

If U.S. interest rates suddenly become much higher than European interest rates (and if it does not cause concern about higher inflation there), the U.S. demand for euros would ____, and the supply of euros to be exchanged for dollars would ____, other factors held constant.

A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 12

A system whereby exchange rates are market determined without boundaries but subject to government intervention is called

A)a dirty float.
B)a free float.
C)the gold standard.
D)the Bretton Woods era.

Question 13

A(n) ____ in the supply of euros for sale will cause the euro to ____.

A)increase; appreciate
B)increase; depreciate
C)decrease; depreciate
D)none of the above

Question 14

A system whereby one currency is maintained within specified boundaries of another currency or unit of account is a

A)pegged system.
B)free float.
C)dirty float.
D)managed float.

Question 15

Which of the following is most likely to provide currency forward contracts to their customers?

A)commercial banks
B)international mutual funds
C)brokerage firms
D)insurance companies

Question 16

Purchasing Power Parity suggests that the exchange rate will on average change by a percentage that reflects the ____ differential between two countries.

A)income
B)interest rate
C)inflation
D)tax

Question 17

At any given point in time, the price at which banks will buy a currency is ____ the price at which they sell it.

A)higher than
B)lower than
C)the same as
D)none of the above

Question 18

When a government influences factors, such as inflation, interest rates, or income, in order to affect currency's value, this is an example of

A)direct intervention.
B)indirect intervention.
C)a freely floating system.
D)a pegged system.

Question 19

In reality, exchange rates do not always change as suggested by purchasing power parity.

Question 20

The Bretton Woods Era was the era

A)of free-floating exchange rates.
B)of floating rates without boundaries, but subject to government intervention.
C)in which governments maintained exchange rates within 1 percent of a specified rate.
D)in which exchange rates were maintained within 10 percent of a specified rate.

Question 21

A ____ home currency can ____ domestic inflation.

A)strong; increase
B)weak; decrease
C)strong; decrease
D)A and B

Question 22

In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.65. The Australian dollar (A$) is quoted for $0.60. What is the value of the Australian dollar in British pounds?

A)A$2.75
B)A$0.36
C)£2.75
D)£0.36
E)none of the above

Question 23

Assume that a British pound put option has a premium of $.03 per unit, and an exercise price of $1.60. The present spot rate is $1.61. The expected future spot rate on the expiration date is $1.52. The option will be exercised on this date if at all. What is the expected per unit net gain (or loss) resulting from purchasing the put option?

A)$.01 loss
B)$.09 loss
C)$.09 gain
D)$.05 gain

Question 24

Assume the following information.
$\bullet$ Interest rate on borrowed euros is 5 percent annualized
$\bullet$ Interest rate on dollars loaned out is 6 percent annualized
$\bullet$ Spot rate for €0.83 per dollar (one € = $1.20)
$\bullet$ Expected spot rate in five days is €0.85 per dollar
$\bullet$ Alonso Bank can borrow €10 million
What is the euro profit to Alonso Bank over the five-day period from shorting euros and going long on dollars?

A)€200,311.11
B)€207,111.11
C)€201,555.56
D)none of the above

Question 25

If the spot rate ____ the exercise price, a currency ____ option would not be exercised.

A)remains below; call
B)remains below; put
C)remains below; put
D)A and B

Question 26

If European inflation suddenly becomes much higher than U.S. inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro.

A)increase; decline; upward
B)increase; decline; downward
C)decrease; increase; upward
D)decrease; increase; downward
E)none of the above

Question 27

Which of the following is not a method of forecasting exchange rate volatility?

A)using the volatility of historical exchange rate movements
B)using a time series of volatility patterns in previous periods
C)using the volatility of future exchange rate movements
D)using the exchange rate's implied standard deviation

Question 28

If the spot rate of the British pound is $2, and the 180-day forward rate is $2.05, what is the annualized premium or discount?

A)2.5 percent discount
B)2.5 percent premium
C)10 percent premium
D)5 percent discount
E)5 percent premium

Question 29

If the forward rate of a foreign currency ____ the existing spot rate, the forward rate will exhibit a ____.

A)exceeds; discount
B)is below; premium
C)is below; discount
D)A and B

Question 30

Currency futures contracts differ from forward contracts in that they

A)are an obligation.
B)are not an obligation.
C)are standardized.
D)can specify any amount and maturity date.

Question 31

Which of the following statements is incorrect?

A)Forward contracts are contracts typically negotiated with a commercial bank that allow the purchase or sale of a specified amount of a particular foreign currency at a specified exchange rate on a specified future date.
B)The forward market is located in New York City.
C)Many of the commercial banks that offer foreign exchange on a spot basis also offer forward transactions for the widely traded currencies.
D)Forward contracts can hedge a corporation's risk that a currency's value may appreciate over time.

Question 32

The pegged exchange rate system is no longer used by any countries.

Question 33

____ forecasting involves the use of historical exchange rate data to predict future values.

A)Technical
B)Fundamental
C)Market-based
D)Mixed

Question 34

____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.

A)Pension funds
B)International mutual funds
C)Insurance companies
D)Commercial banks
E)None of the above

Question 35

____ forecasting is usually based on either the spot rate or the forward rate.

A)Technical
B)Fundamental
C)Market-based
D)Mixed

Question 36

According to interest rate parity, if the interest rate in a foreign country is ____ than in the home country, the forward rate of the foreign country will have a ____.

A)higher; discount
B)lower; premium
C)higher; premium
D)A and B

Question 37

Fundamental forecasting has been found to be consistently superior to the other forecasting techniques.

Question 38

If a firm planning to hedge receivables is certain of the future direction a spot rate will move, and requires a tailor-made hedge in terms of amount and maturity date, it should use a

A)call options contract traded on an exchange.
B)futures contract traded on an exchange.
C)forward contract.
D)put options contract traded on an exchange.

Question 39

The speculative risk of purchasing a ____ is that the foreign currency value ____ over time.

A)put option; increases
B)put option; decreases
C)call option; increases
D)futures contract; increases

Question 40

Bank A asks $.555 for Swiss francs and Banks B and C are willing to pay $.557 for francs. An institution could capitalize on these differences by engaging in

A)covered interest arbitrage.
B)triangular arbitrage.
C)locational arbitrage.
D)witching hour arbitrage.

Question 41

A speculator who expects a foreign currency to appreciate could purchase the currency forward and, when received, sell it in the spot market.

Question 42

When countries experience substantial net outflows of funds, they commonly use indirect intervention by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency.

Question 43

The forward rate is the exchange rate for immediate delivery.

Question 44

Purchasing power parity suggests that the forward rate premium (or discount) should be about equal to the differential in interest rates between the countries of concern.

Question 45

The following information refers to Fresno Bank and Champaign Bank.
Based on this information, locational arbitrage would be profitable.

Question 46

The primary advantage of currency options over forward and futures contracts is that they provide a right rather than an obligation to purchase or sell a particular currency at a specified price within a given period.

Question 47

The euro is presently pegged to the British pound in order to stabilize international payments between European countries.

Question 48

Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory.

Question 49

If British interest rates suddenly increase substantially relative to U.S. interest rates, the demand by U.S. investors for British pounds ____, the supply of British pounds to be sold in exchange for dollars ____, and the British pound will ____.

A)increases; decreases; appreciate
B)increases; decreases; depreciate
C)decreases; increases; appreciate
D)decreases; increases; depreciate
E)none of the above

Question 50

Financial institutions rarely use the forward market.

Question 51

Central bank intervention can be overwhelmed by market forces and may not always succeed in reversing exchange rate movements.

Question 52

Assume the following information.
$\bullet$ Interest rate on borrowed euros is 5 percent annualized.
$\bullet$ Interest rate on dollars loaned out is 6 percent annualized.
$\bullet$ Spot rate is 1.10 euros per dollar (one euro = $0.909).
$\bullet$ Expected spot rate in five days is 1.15 euros per dollar.
$\bullet$ Fabrizio Bank can borrow 10 million euros.
If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is

A)2,653,597.22 euros.
B)455,266.81 euros.
C)452,426.04 euros.
D)none of the above

Question 53

A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates.

Question 54

The indirect exchange rate specifies the value of the currency in U.S. dollars.

Question 55

If the quoted cross rate between two foreign currencies is not aligned with the two corresponding exchange rates, investors can profit from triangular arbitrage.

Question 56

The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on an annualized basis.

Question 57

The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements.

Question 58

The Smithsonian Agreement allowed for a devaluation of the dollar and for a widening of the boundaries within which currencies were allowed to fluctuate.

Question 59

The forward rate premium is dictated by the national income differential of the two currencies.

Question 60

A country that pegs its currency does not have complete control over its local interest rates, as its interest rates must be aligned with the interest rates of the currency to which it is tied.

Question 61

Currency futures contracts are standardized, whereas forward contracts are more flexible and can specify whatever amount and maturity date are desired.

Question 62

The supply and demand for a currency are influenced by all of the following, except

A)differential interest rates.
B)differential inflation rates.
C)direct government intervention.
D)indirect government intervention.
E)The supply and demand for a currency are affected by all of the above.

Question 63

The act of capitalizing on the discrepancy between the forward rate premium and the interest rate differential is called

A)triangular arbitrage.
B)locational arbitrage.
C)covered interest arbitrage.
D)interest rate parity.

Question 64

Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S. inflation suddenly decreased to 2 percent, the euro will ____ against the dollar by approximately ____ percent, according to purchasing power parity.

A)appreciate; 2
B)depreciate; 2
C)appreciate; 4
D)depreciate; 4
E)none of the above

Question 65

The exchange rate between two foreign (nondollar) currencies is known as a(n):

A)indirect dollar rate.
B)forward rate.
C)cross-exchange rate.
D)derived exchange rate.

Question 66

A speculator who expects the euro to depreciate might:

A)sell euros forward and then purchase them in the spot market just before fulfilling the forward obligation.
B)purchase euros forward and, when they are received, sell them in the spot market.
C)purchase futures contracts on euros and, when the euros are received, sell them in the spot market.
D)all of the above

Question 67

____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.

A)Commercial banks
B)International mutual funds
C)Insurance companies
D)Pension funds
E)All of the above

Question 68

Which of the following is the least feasible strategy for a speculator who expects the Australian dollar to depreciate?

A)sell Australian dollars forward and then purchase them in the spot market just before fulfilling the forward obligation
B)sell futures contracts on Australian dollar; purchase Australian dollars in the spot market just before fulfilling the futures obligation
C)purchase put options on Australian dollars, at some point before the expiration date, when the spot rate is less than the exercise price, purchase Australian dollars in the spot market and then exercise the put option
D)purchase call options on Australian dollars; at some point before the expiration date, exercise the call option and then sell the Australian dollars received in the spot market
E)All of the above are possible strategies for a speculator who expects the Australian dollar to depreciate.

Question 69

The indirect exchange rate is always the reciprocal of the direct exchange rate.

Question 70

If U.S. inflation suddenly becomes much higher than European inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro.

A)increase; decline; upward
B)increase; decline; downward
C)decrease; increase; upward
D)decrease; increase; downward
E)none of the above

Question 71

When the Federal Reserve attempt to lower interest rates by increasing the U.S. money supply, it puts upward pressure on the value of the dollar.

Question 72

The devaluation of a country's currency:

A)makes foreign products more expensive for consumers in that country.
B)increases foreign demand for that country's exports.
C)can lead to deflation in that country.
D)A and B

Question 73

In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.67. The Australian dollar (A$) is quoted for $0.62. What is the value of the Australian dollar in British pounds?

A)A$2.69
B)£0.37
C)£2.69
D)A$0.37
E)none of the above

Question 74

In a(n) ____ exchange rate system, the foreign exchange market is totally free from government intervention.

A)pegged
B)dirty floating
C)freely floating
D)Bretton Woods
E)none of the above

Question 75

____ are not foreign exchange derivatives.

A)Forward contracts
B)Currency futures contracts
C)Currency swaps
D)Currency options
E)All of the above are foreign exchange derivatives.