Deck 14: Foreign Exchange Markets and Exchange Rates

Question 1

Commercial bank deposits outside the country of their issue are commonly referred to as

A)reserve deposits
B)Eurocurrency
C)foreign deposits
D)exchange deposits

Answer 1

B

Question 2

An effective exchange rate is a:

A)spot rate
B)forward rate
C)flexible exchange rates
D)weighted average of the exchange rates between the domestic currency and the nation's most important trade partners

Answer 2

D

Question 3

The currency of the nation with the lower interest rate is usually at a

A)forward premium
B)forward discount
C)covered interest arbitrage parity
D)any of the above

Answer 3

A

Question 4

Which is not a function of the foreign exchange market?

A)to transfer funds from one nation to another
B)to finance trade
C)to diversify risks
D)to provide the facilities for hedging

Question 5

A capital outflow from New York to Frankfurt under covered interest arbitrage can take place if the interest differential in favor of Frankfurt is:

A)smaller than the forward discount on the euro
B)equal to the forward discount on the euro
C)larger than the forward discount on the euro
D)none of the above

Question 6

If SR=$1/€1 and the three-month FR=$0.99/€1:

A)the euro is at a three-month forward discount of 1%
B)the euro is at a forward discount of 1% per year
C)the euro is at a three-month forward premium of 1%
D)the dollar is at a three-month forward discount of 1%

Question 7

If the three-month FR=$1/€1,and a speculator anticipates that SR=$1.02/€1 in three months,he can earn a profit by:

A)selling euros forward
B)purchasing euros forward
C)selling dollars forward
D)purchasing dollars forward

Question 8

Which of the following is NOT a reason for the smaller interest rate spread in Eurocurrency markets

A)the absence of legal reserve requirements
B)lack of competition for deposits
C)economies of scale
D)risk diversification

Question 9

The exchange rate is kept within narrow limits in different monetary centers by:

A)hedging
B)exchange arbitrage
C)interest arbitrage
D)speculation

Question 10

A change from $1=€1 to $2=€1 represents

A)depreciation of the dollar
B)an appreciation of the dollar
C)a depreciation of the pound
D)none of the above

Question 11

When the interest differential in favor of the foreign country is equal to the forward premium on the foreign currency,we:

A)are at covered interest arbitrage parity
B)are not at covered interest arbitrage parity
C)may or may not be at covered interest arbitrage parity
D)cannot say without additional information

Question 12

A U.S.importer scheduled to make a payment of €100,000 in three months can hedge his foreign exchange risk by:

A)purchasing $100,000 in the forward market for delivery in three months
B)selling €100,000 in the spot market for delivery in three months
C)purchasing €100,000 in the forward market for delivery in three months
D)selling €100,000 in the spot market for delivery in three months

Question 13

Spot currency transactions must settle within

A)two business days
B)one week
C)one month
D)one year

Question 14

An increase in the pound price of the dollar represents:

A)an appreciation of the dollar
B)a depreciation of the dollar
C)an appreciation of the pound
D)a devaluation of the dollar

Question 15

According to the theory of covered interest arbitrage,if the interest differential in favor of the foreign country exceeds the forward discount on the foreign currency,there will be a:

A)capital inflow under covered interest arbitrage
B)capital outflow under covered interest arbitrage
C)no capital flow under a covered interest arbitrage
D)any of the above

Question 16

Destabilizing speculation refers to the:

A)sale of the foreign currency when the exchange rate falls or is low
B)purchase of the foreign currency when the exchange rate falls or is low
C)sale of the foreign currency when the exchange rate rises or is high
D)all of the above

Question 17

Hedging refers to:

A)the acceptance of a foreign exchange risk
B)the covering of a foreign exchange risk
C)foreign exchange speculation
D)foreign exchange arbitrage

Question 18

A shortage of pounds under a flexible exchange rate system results in:

A)a depreciation of the pound
B)a depreciation of the dollar
C)an appreciation of the dollar
D)no change in the exchange rate

Question 19

The opposite of hedging is

A)speculation
B)interest arbitrage
C)holding
D)none of the above

Question 20

The spot sale of a currency combined with a forward repurchase of the same currency is a

A)stop gap transaction
B)forward discount transaction
C)premium transaction
D)currency swap

Question 21

The U.S.interest rate is 2%.The U.K.interest rate is 2.25% The spot rate is 2.01 $/£,and the forward rate (for a 12 month contract)is 1.96 $/£ .
What do you expect to happen to forward and spot rates?
Explain carefully why this must happen.

Question 22

Explain what carry trade is.

Question 23

What is arbitrage and how does it impact the exchange rate across foreign exchange markets?

Question 24

What is the principle function of foreign exchange markets?

Question 25

(a)If the positive interest rate differential in favor of a foreign monetary center is 3 percent per year and the foreign currency is at a forward discount of 1 percent per year,roughly how much would an interest arbitrageur earn from the purchase of foreign three-month treasury bills if he covers the foreign exchange risk?
(b)How much would an interest arbitrageur earn if the foreign currency were instead at a forward premium of 1 percent per year?
(c)What would happen if the foreign currency were at a forward discount of 3 percent per year?

Question 26

Most activity in the foreign exchange market consists of

A)spot transactions and foreign exchange swaps
B)currency swaps.
C)options.
D)futures.

Question 27

Discuss the reasons for the existence and growth of Eurocurrency markets

Question 28

Carry trade refers to

A)covered interest arbitrage in the spot and forward markets.
B)moving investment funds to countries in which there is less risk.
C)borrowing low-yielding currencies and lending high-yielding currencies.
D)exporting to one country and importing from another.

Question 29

The U.S. interest rate is 2%. The U.K. interest rate is 2.25% The spot rate is 2.01 $/£, and the forward rate (for a 12 month contract) is 1.96 $/£ .
Does the covered interest arbitrage condition hold? If not, in which country would you be better off investing? Show how you know.

Question 30

How does covered interest arbitrage create efficiency in foreign exchange markets?