Deck 10: The Foreign Exchange Market

Question 1

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.

Answer 1

False

Question 2

Governments allow convertibility to preserve their foreign exchange reserves.

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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 5

There are many impediments to the free flow of goods and services in an efficient market.

Question 6

The foreign exchange market converts the currency of one country into that of another country.

Question 7

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 between the two countries.

Question 8

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 9

Parla liked to gamble, so she sometimes moved her funds from dollars to euros in the hope that she would make money based on the exchange rates. This demonstrates a carry trade.

Question 10

Carry trade is nonspeculative in nature.

Question 11

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

Question 12

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

Question 13

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

Question 14

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

Question 15

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

Question 16

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.

Question 17

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

Question 18

Arbitrage opportunities in foreign exchange markets tend to be small and disappear quickly.

Question 19

When Krista traveled from the United States to England, she had to change her money from dollars into pounds. Krista was participating in the currency exchange market.

Question 20

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 21

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 22

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 23

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

A) currency swap rate.
B) forward rate.
C) carry trade.
D) spot rate.

Question 24

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 25

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 26

An American company today invests some of its spare cash in a Hungarian money market account that will earn 8 percent for 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 27

Currency ________ typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.

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

Question 28

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 29

International businesses use foreign exchange markets for many reasons. Which of the following is one of these reasons?

A) to receive payments from domestic investors that are in local currencies
B) to pay a foreign company for its products or services in its native 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 30

The ________ helps consumers 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 31

________ arises from volatile changes in exchange rates.

A) Translational exposure
B) Foreign exchange risk
C) Economic exposure
D) Transactional exposure

Question 32

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 33

Assume that the interest rate on borrowing 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 34

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

Question 35

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 36

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 United States 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 in the United States at $50.

Question 37

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

A) trading foreign company equities and converting currency
B) reducing currency volatility and setting interest rates
C) insuring companies against interest rate risk and enabling imports and exports
D) converting currency and providing some insurance against foreign exchange risk

Question 38

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

A) exchange rate.
B) currency swap rate.
C) fluctuation rate.
D) carry over rate.

Question 39

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 40

________ are reported on a real-time basis on many financial websites and are continually changing-their value being determined by supply and demand for that currency relative to others.

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

Question 41

The foreign exchange market is

A) open for only 12 hours in a day.
B) the market never sleeps.
C) open for most of the day, but closes for three hours each day-between 2:00 a.m. and 5:00 a.m. Greenwich Mean Time.
D) open during normal business hours (9:00 a.m. to 5:00 p.m., local time) in each of the primary locations from which it operates: Tokyo, London, and New York.

Question 42

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) a currency swap.
B) an arbitrage.
C) an carry trade.
D) a straddle.

Question 43

The Fisher Effect states that

A) 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.
B) there is a weak relationship between inflation rates and interest rates.
C) 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.
D) when investors are free to transfer capital between countries, "nominal" interest rates will be the same in every country.

Question 44

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

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

Question 45

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

A) currency swap
B) forward exchange
C) hedging
D) spot exchange

Question 46

The International Fisher Effect has

A) proven to have substantial power at predicting long-run changes in forward exchange rates.
B) proven to have substantial power at predicting short-run changes in spot exchange rates.
C) not proven to be a good predictor of long-run changes in forward exchange rates.
D) not proven to be a good predictor of short-run changes in spot exchange rates.

Question 47

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

A) export more goods to other countries.
B) see depreciation in its currency exchange rate.
C) import more goods from other countries.
D) see an appreciation in its currency exchange rate.

Question 48

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

A) foreign exchange market
B) united global database
C) global marketplace
D) foreign market database

Question 49

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

A) pounds
B) yen
C) dollars
D) euros

Question 50

Which of the following is one of the most important trading centers in the foreign exchange market?

A) Beijing
B) Sau Paulo
C) Zurich
D) Seoul

Question 51

Purchasing power parity theory states that given relatively efficient markets, the price of a "basket of goods" should be

A) much less in industrialized countries.
B) much less in third world countries.
C) variable depending upon the current rate of exchange between the producer and consumer of the products in the "basket."
D) roughly equivalent in each country.

Question 52

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

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

Question 53

________ 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.

A) Carry trades
B) Currency swaps
C) Arbitrages
D) Currency pairing

Question 54

________ 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 55

________ is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

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

Question 56

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 57

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

A) anticipated currency swap rates.
B) stability in the global marketplace.
C) future currency movements.
D) the carry trades that will occur.

Question 58

________ is quoted for 30 days, 90 days, and 180 days into the future.

A) A forward exchange rate
B) A currency swap
C) A spot exchange rate
D) An arbitrage

Question 59

Inflation occurs when

A) the quantity of money in circulation rises faster than the stock of goods and services.
B) the stock of goods and services increases and the quantity of money in circulation decreases.
C) output increases faster than the money supply.
D) the money supply decreases and the output increases.

Question 60

The purchasing power parity (PPP) theory argues that the exchange rate will

A) increase if a country is experiencing inflation.
B) change even if relative prices remain unchanged.
C) increase if a country is experiencing deflation.
D) change if relative prices change.

Question 61

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 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 62

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 63

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 64

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 65

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 66

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 67

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

A) Lead strategy
B) Fundamental analysis
C) Lag strategy
D) Technical analysis

Question 68

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 69

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 70

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 71

Identify the correct 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 low rates of inflation.
D) It includes transportation costs and trade tariffs.

Question 72

If a country has an externally convertible currency

A) neither residents nor nonresidents are allowed to convert it into a foreign currency.
B) both residents and nonresidents can purchase unlimited amounts of a foreign currency with it.
C) only nonresidents may convert it into a foreign currency without any limitations.
D) the government limits convertibility to preserve foreign exchange reserves.

Question 73

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 74

A(n) ________ is one in which prices do not reflect all available information.

A) inefficient market
B) speculative market
C) efficient market
D) externally convertible market

Question 75

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 76

With which of the following would a follower of the inefficient market school of thought agree

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.

Question 77

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 78

________ 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 79

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 80

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.