Deck 16: Foreign Exchange Derivative Markets

Question 1

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

Answer 1

C

Question 2

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.

Answer 2

D

Question 3

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

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

Answer 3

A

Question 4

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 5

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

Question 6

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 7

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 8

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 9

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 10

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 11

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 12

____ 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 13

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

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

Question 14

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 15

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

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

Question 16

S. interest rates suddenly become much higher than European interest rates (and if this does not cause concern about higher inflation in the United States), 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 17

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 (withrespect to the dollar).

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

Question 18

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 19

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 20

A speculator who expects the euro to appreciate might:

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

Question 21

____ 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 22

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

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

Question 23

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

Question 24

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

Question 25

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 $152. 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 26

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

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

Question 27

In the Wall Street Journal, you observe that the British pound (£) is quoted at $1.65. The Australian dollar (A$) is quoted at $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 28

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 29

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 30

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 31

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

Question 32

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

Question 33

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

Question 34

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

Question 35

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

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

Question 36

The European Central Bank is responsible for setting fiscal policy for all countries in the eurozone.

Question 37

The forward rate is the exchange rate for immediate delivery.

Question 38

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

Question 39

Financial institutions rarely use the forward market.

Question 40

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

Question 41

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

Question 42

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

Question 43

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 pricewithin a given period.

Question 44

____ 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.

Question 45

When the Federal Reserve attempts to lower interest rates by increasing the U.S. money supply and has no impact on inflationary expectations, it puts upward pressure on the value of the dollar.

Question 46

The following information refers to Fresno Bank and Champaign Bank.

Question 47

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 48

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

Question 49

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 anydownward pressure on the value of their currency.

Question 50

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 51

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 52

Which of the following is typically used as the basis of a market-based forecast?

A) the currency's spot rate
B) a time-series model showing the currency's moving average
C) the currency's volatility index
D) the currency's forward rate
E) A and D

Question 53

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 54

Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S. inflation suddenly decreases 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 55

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 56

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

Question 57

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 58

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 59

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