Deck 9: Foreign Exchange Markets

Question 1

In 2009, the U.S. imported goods and services worth about _____________ and exported about _________ leading to a current account ____________.

A) $2.4 trillion; $2.2 trillion; deficit
B) $2.2 trillion; $2.4 trillion; surplus
C) $2.4 trillion; $2.2 trillion; surplus
D) $2.2 trillion; $2.4 trillion; deficit
E) $2.0 trillion; $2.0 trillion; balance

Answer 1

A

Question 2

If you can convert 150 Swiss francs to $90, the exchange rate is 1.67 francs per dollar.

Answer 2

True

Question 3

A U.S. bank has made £12 million worth of loans and £10 million worth of deposits in Britain. The bank would benefit from a drop in the value of the pound against the dollar.

Answer 3

False

Question 4

A drop in value of the dollar hurts U.S. importers and helps U.S. exporters, ceteris paribus.

Question 5

If the dollar is initially worth 120 yen and then the exchange rate changes so that the dollar is now worth 115 yen, the value of the yen has depreciated.

Question 6

A country with lower interest rates than another country is likely to see its currency appreciate if parity holds.

Question 7

If the United States has inflation of 3% and Europe has inflation of 5%, the value of the euro should increase, ceteris paribus.

Question 8

If the euro per yen ratio falls, the value of the yen has risen.

Question 9

A U.S. firm has £50 million in assets in Britain that they need to repatriate in 6 months. They could hedge the exchange rate risk by

A) buying pounds forward.
B) selling pounds forward.
C) borrowing pounds.
D) both B and C would hedge the risk
E) both A and C would hedge the risk

Question 10

A U.S. firm agrees to import textiles from Hong Kong and pay in 90 days. The invoice requires payment in Hong Kong dollars. The U.S. importer could hedge this currency risk by buying the HK dollar forward.

Question 11

A U.S. bank borrowed dollars, converted them to euros, and invested in euro-denominated CDs to take advantage of interest rate differentials. To cover the currency risk the investor should

A) sell dollars forward.
B) sell euros forward.
C) buy euros forward.
D) sell euros spot.
E) none of the above

Question 12

Foreign exchange trading in 2010 averaged about _____________ per day.

A) $101 million
B) $4.0 trillion
C) $101 billion
D) $1.88 trillion
E) $101 trillion

Question 13

In 1973, the Smithsonian Agreement II eliminated fixed exchange rates for the major economies.

Question 14

If a foreign currency appreciates, that country's goods and services become relatively more expensive for U.S. buyers.

Question 15

A U.S. investor has borrowed pounds, converted them to dollars, and invested the dollars in the United States to take advantage of interest rate differentials. To cover the currency risk, the investor should

A) sell pounds forward.
B) buy dollars forward.
C) buy pounds forward.
D) sell pounds spot.
E) none of the above

Question 16

In 1971, the Bretton Woods Agreement established that, for the first time, currency values would be fixed against one another within narrow bands.

Question 17

The dollar's value increased when the Fed cut interest rates in late 2007.

Question 18

The ongoing accumulation of foreign currency reserves by foreign monetary authorities contributed to the dollar's drop in 2006.

Question 19

New York is the global center of foreign exchange trading with the largest daily volume of currency trading.

Question 20

During much of the 1800s, developed nations employed what came to be known as the Bretton Woods international monetary system to manage exchange rates.

Question 21

Which of the following are likely to lead to an appreciation of the U.S. dollar (ceteris paribus)?
I) Higher real U.S. interest rates
II) Lower U.S. inflation
III) Higher nominal U.S. interest rates

A) II and III only
B) I and III only
C) I and II only
D) II only
E) I, II, and III

Question 22

An investor starts with $1 million and converts it to 0.75 million pounds, which is then invested for one year. In a year the investor has 0.7795 million pounds, which she then converts to dollars at an exchange rate of 0.72 pounds per dollar. The U.S. dollar annual rate of return earned was _____.

A) 4.97%
B) 5.27%
C) 6.45%
D) 7.69%
E) 8.26% [(0.7795 million pounds/0.72)/$1 million] - 1 = 8.26%

Question 23

An investor starts with €1 million and converts it to £694,500, which is then invested for one year. In a year the investor has £736,170, which she then converts back to euros at an exchange rate of 0.68 pounds per euro. The annual euro rate of return earned was _____.

A) 7.55%
B) 6.00%
C) 7.45%
D) 8.13%
E) 8.26% [(£736,170/0.68)/€1 million] - 1

Question 24

A U.S. firm has borrowed £50 million from a British firm. The borrower will need to convert dollars to pounds to repay the loan when it is due. The U.S. firm could hedge the exchange rate risk by

A) buying pounds forward.
B) selling pounds forward.
C) borrowing pounds.
D) both B and C would hedge the risk
E) both A and C would hedge the risk

Question 25

The levels of foreign currency assets and liabilities at banks have ___________ in recent years and the level of foreign currency trading has ____________.

A) increased; increased
B) decreased; decreased
C) increased; decreased
D) decreased; increased
E) decreased; stayed the same

Question 26

At the beginning of the year the exchange rate between the Brazilian Real and the U.S. dollar was 2.2 Reals per dollar. Over the year Brazilian inflation was 12% and U.S. inflation was 4%. If purchasing power parity holds, at year-end the exchange rate should be approximately ________________ dollars per Real.

A) 2.3913
B) 0.4895
C) 2.8498
D) 0.4182
E) 0.3440 [(2.2% - 12%) x (1/2.2)] + (1/2.2) = 0.4182

Question 27

If a firm has more foreign currency assets than liabilities, and no other foreign currency transactions, it has

A) positive net exposure
B) negative net exposure
C) a fully balanced position
D) zero net exposure

Question 28

The agreement that ended the era of fixed exchange rates for the major economies was called the

A) Louvre Accord
B) Bretton Woods Agreement
C) Smithsonian Agreement I
D) Smithsonian Agreement II
E) Plaza Accord

Question 29

A European investor can earn a 4.75% annual interest rate in Europe or 2.75% per year in the United States. If the spot exchange rate is $1.58 per euro, at what one-year forward rate would an investor be indifferent between the U.S. and Japanese investments?

A) $1.5484
B) $1.6108
C) $1.5335
D) $1.5498
E) $1.5977 (1.0275/1.0475) x $1.58 = $1.5498

Question 30

The largest center for trading in foreign exchange is

A) New York
B) London
C) Tokyo
D) Hong Kong
E) Geneva

Question 31

Bank's net foreign exposure is equal to

A) net foreign assets
B) net FX bought
C) net foreign assets + net FX bought
D) assets - liabilities
E) none of the above

Question 32

The large U.S. current account deficit implies that

A) U.S. interest rates are too high.
B) the value of the dollar is too weak.
C) dollar foreign currency reserves at Asian central banks are too low.
D) the presidential administration desires to improve growth of overseas economies.
E) the United States must rely on foreigners to be willing to invest in the United States.

Question 33

Which of the following conditions may lead to a decline in the value of a country's currency?
I) Low interest rates
II) High inflation
III) Large current account deficit

A) I only
B) I and II only
C) II and III only
D) II only
E) III only

Question 34

A U.S. bank converted $1 million to Swiss francs to make a Swiss franc loan to a valued corporate customer when the exchange rate was 1.2 francs per dollar. The borrower agreed to repay the principle plus 5% interest in 1 year. The borrower repaid Swiss francs at loan maturity and when the loan was repaid the exchange rate was 1.3 francs per dollar. What was the bank's dollar rate of return?

A) 26.00%
B) -2.69%
C) 7.14%
D) -3.08%
E) 5.00% {[($1 million x SFr 1.2 x 1.05)/SFr 1.3/$]/$1 million} - 1

Question 35

A Swiss bank converted 1 million Swiss francs to euros to make a euro loan to a customer when the exchange rate was 1.85 francs per euro. The borrower agreed to repay the principle plus 3.75% interest in 1 year. The borrower repaid euros at loan maturity and when the loan was repaid the exchange rate was 1.98 francs per dollar. What was the bank's franc rate of return?

A) 7.75%
B) 11.04%
C) 9.94%
D) -2.82%
E) 5.71% {[((SFr1 million * €/SFr 1.85) * 1.0375) * SFr 1.98/€]/SFr1 million} - 1

Question 36

A Japanese investor can earn a 1% annual interest rate in Japan or about 3.5% per year in the United States. If the spot exchange rate is 101 yen to the dollar, at what one-year forward rate would an investor be indifferent between the U.S. and Japanese investments?

A) ¥100.58
B) ¥98.56
C) ¥101.68
D) ¥97.42
E) ¥103.50 (1.04/1.01) x (1/101) = ¥98.56

Question 37

The spot rate for the Argentine peso is $0.3600 per peso. Over the year inflation in Argentina is 10% and U.S. inflation is 4%. If purchasing power parity holds, at year-end the exchange rate should be approximately ______________ dollars per Real.

A) 0.2987
B) 0.3614
C) 0.2875
D) 0.3384
E) 0.3015 [(4% - 10%) x 0.36] + (0.36) = 0.3384

Question 38

If interest rate parity holds and the annual German nominal interest rate is 3% and the U.S. annual nominal rate is 5% and real interest rates are 2% in both countries, then inflation in Germany is about _______________ than in the United States.

A) 1% higher
B) 2% higher
C) 1% lower
D) 4% lower
E) 2% lower

Question 39

A negotiated OTC agreement to exchange currencies at a fixed date in the future but at an exchange rate specified today is a

A) currency swap agreement
B) forward foreign exchange transaction
C) currency futures contract
D) currency options contract
E) spot foreign exchange transaction

Question 40

A current account deficit implies that

A) more goods and services are exported than are imported.
B) the country borrowed from abroad more than it loaned, and/or sold off some of its assets.
C) there is excessive consumption of foreign financial assets.
D) the value of the dollar will rise.
E) the country is going bankrupt.

Question 41

What are the major differences between the interbank foreign exchange market and the foreign currency exchanges?

Question 42

What are the major purposes of the foreign exchange markets?

Question 43

You can buy or sell the yen spot at ¥102 to the dollar. You can buy or sell the yen one-year forward at ¥104 to the dollar. If U.S. annual interest rates are 4%, what must be the approximate one-year Japanese interest rate if interest rate parity holds?

A) 5.92%
B) 3.20%
C) 2.75%
D) 4.73%
E) 6.80% 4% + (1/¥104 - 1/¥102)/1/¥102 = 5.92%

Question 44

Why does the size of the U.S. current account deficit put pressure on the value of the dollar to decline? How does the size of the capital account affect that pressure? Explain.

Question 45

A U.S. FI has U.S. $200 million worth of one-year loans earning an average rate of return of 6%. The FI also has one-year single payment Canadian dollar loans of C$110 million earning 8%. The FI's funding source is $300 million in U.S.$ one-year CDs, on which they are paying 4%. Initially the exchange rate is C$1.10 per $1 U.S. The one-year forward rate is C$1.14 per $1 U.S. What is the bank's dollar % spread if they hedge fully using forwards?

Question 46

A U.S. bank has made £50 million in Britain and has £40 in deposits. The bank's currency trading desk has also contracted to buy £20 million and has short positions of £15 million. What is the bank's net exposure? How could they use forward contracts to hedge the exposure? If the bank has exposures in euros and yen, would you recommend they use the forward hedge? Why or why not?

Question 47

A U.S. bank has £120 million in loans to corporate customers and has £70 million in deposits it owes to customers with the same maturity. The bank has also sold £20 million pounds forward. The bank's net exposure is

A) £210 million
B) £30 million
C) £70 million
D) £170 million
E) £190 million

Question 48

The concept underlying purchasing power parity is the

A) Fisher effect
B) Bretton Woods Agreement
C) Law of one price
D) Big Mac Index
E) Balance of payments concept

Question 49

The ________________ measures the net flows of imports and exports of goods, services, income payments, and unilateral transfers.

A) current account
B) capital account
C) change in official reserves
D) statistical discrepancy
E) basic balance account

Question 50

Is it reasonable to expect real rates of interest to be identical across countries? Explain. What does this imply about parity?

Question 51

A bank has committed to deliver yen in 6 months to a corporate customer. The spot rate is 110 yen to the dollar and the 6-month forward rate is 105 yen per dollar. Are there costs to hedging this exposure with the forward market? Explain.

Question 52

You can buy or sell the £ spot at $1.98 to the pound. You can buy or sell the pound one-year forward at $2.01 to the pound. If U.S. annual interest rates are 5%, what must be the approximate one-year British interest rate if interest rate parity holds?

A) 4.00%
B) 5.25%
C) 2.75%
D) 3.48%
E) 5.65% 5% - ($2.01 - $1.98)/$1.98 = 3.48%

Question 53

A British bank has borrowed dollars in the United States, but is now concerned about its currency risk. What alternatives does it have to limit its risk? Be specific.

Question 54

An FI's position in FX markets generally reflects four trading activities. What are they, and which cause the FI to bear FX risk?

Question 55

Explain how a drop in the value of the dollar could affect the U.S. import and export sectors.