Deck 13: Foreign Exchange Risk

Question 1

Assume an FI holds US$250 000 in assets and US$350 000 in liabilities.Which of the following statements is true?

A)The FI has a net long in US$.
B)The FI has a net short in US$.
C)The FI has a net exposure of US$100 000.
D)The FI has a net exposure of -US$100 000.

Answer 1

B

Question 2

The proposition stating that the discounted spread between domestic and foreign interest rates equals the percentage spread between forward and spot exchange rates is called:

A)Interest rate parity theorem.
B)Domestic and foreign interest rate agreement.
C)Percentage spread theorem.
D)None of the listed options are correct.

Answer 2

A

Question 3

Assume an FI holds US$200 000 in assets and US$150 000 in liabilities.Which of the following statements is true?

A)The FI has a net long in US$.
B)The FI has a net short in US$.
C)The FI has a net exposure of $50 000.
D)The FI has a net exposure of -$50 000.

Answer 3

A

Question 4

Which of the following statements is true?

A)Holding more assets than liabilities in a given currency is referred to as a net short position.
B)Holding more assets than liabilities in a given currency is referred to as a net long position.
C)Holding more assets than liabilities in a given currency is referred to as a gross short position.
D)Holding more assets than liabilities in a given currency is referred to as a gross long position.

Question 5

Assume an Australian FI has US$100 000 in assets and US$200 000 in liabilities.Further, the FI has bought US$40 000 and sold US$20 000.What is the net exposure of the Australian FI?

A)-US$20 000
B)-US$80 000
C)US$20 000
D)US$80 000

Question 6

Which of the following statements is true?

A)The market in which foreign currency is traded for future delivery is called the forward market for foreign exchange.
B)The market in which foreign currency is traded for future delivery is called the future market for foreign exchange.
C)The market in which foreign currency is traded for future delivery is called the spot market for foreign exchange.
D)The market in which foreign currency is traded for future delivery is called the business market for foreign exchange.

Question 7

Which of the following statements is true for an FI that holds €200 000 in assets and €250 000 in liabilities?

A)The FI is in a net short position.
B)The FI has net foreign assets of €50 000.
C)The FI faces the risk that the euro will fall in value against domestic currency.
D)All of the listed options are correct.

Question 8

Assume an Australian FI has US$100 000 in assets and US$200 000 in liabilities.Further, the FI has bought US$40 000 and sold US$20 000.What is the net FX bought position of the Australian FI?

A)-US$20 000
B)US$20 000
C)US$80 000
D)US$100 000

Question 9

Which of the following statements is true?

A)The difference between a nominal interest rate and the rate of inflation is called the spread.
B)The difference between a nominal interest rate and the rate of inflation is called the interest rate spread.
C)The difference between a nominal interest rate and the rate of inflation is called the accumulated interest rate.
D)The difference between a nominal interest rate and the rate of inflation is called the real interest rate.

Question 10

Which of the following statements is true?

A)Foreign exchange rate is the exchange rate agreed to today for future delivery of a currency.
B)Future exchange rate is the exchange rate agreed to today for future delivery of a currency.
C)Forward exchange rate is the exchange rate agreed to today for future delivery of a currency.
D)Future exchange rate is the exchange rate agreed to today for future delivery of a currency futures contract.

Question 11

Spot market for foreign exchange refers to the market in which foreign currency is traded for:

A)delivery at an agreed point in time.
B)delivery in two business days' time.
C)delivery in one week's time.
D)immediate delivery.

Question 12

Which of the following statements best describes the interest rate parity theorem (IRPT)?

A)The IRPT is a proposition stating that the nominal spread between domestic and foreign interest rates equals the percentage spread between forward and spot exchange rates.
B)The IRPT is a proposition stating that the nominal spread between domestic and foreign currency rates equals the percentage spread between forward and spot exchange rates.
C)The IRPT is a proposition stating that the discounted spread between domestic and foreign currency rates equals the percentage spread between forward and spot exchange rates.
D)The IRPT is a proposition stating that the discounted spread between domestic and foreign interest rates equals the percentage spread between forward and spot exchange rates.

Question 13

Which of the following statements is true?

A)Net exposure refers to the degree to which a bank is net long (negative) or net short (positive) in a given currency.
B)Gross exposure refers to the degree to which a bank is net long (negative) or net short (positive) in a given currency.
C)Net exposure refers to the degree to which a bank is net long (positive) or net short (negative) in a given currency.
D)Gross exposure refers to the degree to which a bank is net long (positive) or net short (negative) in a given currency.

Question 14

Assume an Australian FI has US$100 000 in assets and US$200 000 in liabilities.Further, the FI has bought US$40 000 and sold US$20 000.What is the net foreign asset of the Australian FI?

A)-US$100 000
B)-US$80 000
C)US$80 000
D)US$100 000

Question 15

Which of the following statements is true?

A)An open position is a hedged position in a particular currency.
B)An open position is an unhedged position in a particular currency.
C)An open position is an unhedged position in an open market.
D)An open position is a hedged position in an open market.

Question 16

Which of the following statements is true?

A)The rate of inflation is the difference between the real interest rate and a nominal interest rate.
B)The real interest rate is the product of a nominal interest rate and the expected rate of inflation.
C)The real interest rate is the difference between a nominal interest rate and the expected rate of inflation.
D)The nominal interest rate is the difference between a real interest rate and the expected rate of inflation.

Question 17

Which of the following statements is true for an FI that holds €200 000 in assets and €250 000 in liabilities?

A)The FI faces the risk that the euro will fall in value against domestic currency.
B)The FI faces the risk that the euro will rise in value against domestic currency.
C)The FI has net foreign assets of €200 000.
D)The FI has net foreign assets of €50 000.

Question 18

Which of the following statements is true for an FI that holds €200 000 in assets and €150 000 in liabilities?

A)The FI is in a net long position.
B)The FI has net foreign assets of €50 000.
C)The FI faces the risk that the euro will fall in value against domestic currency.
D)All of the listed options are correct.

Question 19

Which of the following statements is true?

A)Holding less assets than liabilities in a given currency is referred to as a net short position.
B)Holding less assets than liabilities in a given currency is referred to a net long position.
C)Holding less assets than liabilities in a given currency is referred to as a gross short position.
D)Holding less assets than liabilities in a given currency is referred to as a gross long position.

Question 20

An FI's net exposure can be measured as:

A)(FX liabilities_i - FX assets_i) + (FX bought_i - FX sold_i)
B)(FX liabilities_i - FX assets_i) + (FX sold_i - FX bought_i)
C)(FX assets_i - FX liabilities_i) + (FX sold_i - FX bought_i)
D)(FX assets_i - FX liabilities_i) + (FX bought_i - FX sold_i)

Question 21

Assume an FI sells A$100 million for US$ on the spot currency markets at an exchange rate of A$1.20 to $US1.00.What is the US$ value of the investment (round to two decimals)?

A)$100 million * $1.2 = US$120 000.00 million
B)$100 million / $1.2 = US$83 333.33 million
C)$100 million / ($1.2 - US$1.0) = US$500 000.00 million
D)$100 million * ($1.2 - US$1.0) = US$20 000.00 million

Question 22

Which of the following statements is true?

A)In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as an agent of its customers for a fee and does assume part of the FX risk.
B)In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as an agent of its customers for a fee but does not assume any of the FX risk.
C)In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as a hedger to reduce the FX exposure.
D)In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as an agent of its customers for a fee and as a hedger to reduce the FX exposures.

Question 23

Assume an FI sells $100 million for euros on the spot currency markets at an exchange rate of $1.20 to €1.00 and invests the euro assets at an interest rate of 11 per cent for one year.What is the weighted annual return on the FI's portfolio assuming that the $100 million are 20 per cent of the FI's total assets and that the remaining assets are invested in Australian dollar assets at an average interest rate of 8 per cent p.a.(round to two decimals)?

A)9.50 per cent p.a.
B)8.60 per cent p.a.
C)20.00 per cent p.a.
D)10.40 per cent p.a.

Question 24

Which of the following is the largest market for FX?

A)Tokyo
B)London
C)New York
D)Berlin.

Question 25

Which of the following is a reason for the decline in FX trading?

A)The number of FX traders has decreased due to mergers of investment banks.
B)Advancements in technology have increased the efficiency of each FX trader, reducing the need for as many.
C)The move towards a single currency in Europe has reduced the need for FX trading.
D)All of the listed options are correct.

Question 26

Which of the following are common FX trading activities?

A)The purchase and sale of foreign currencies for speculative purposes through forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers (or the FI itself) to take positions in foreign real and financial investments.
C)The purchase and sale of foreign currencies for hedging purposes to offset customer (or FI) exposure in any given currency.
D)All of the listed options are correct.

Question 27

Assume an FI sells A$100 million for US dollars on the spot currency markets at an exchange rate of A$1.10 to US $1.00 and invests the US dollar assets at an interest rate of 12 per cent for one year.What is the Australian dollar proceeds from the US dollar investment (round to two decimals)?

A)A$100.00 million
B)A$112.00 million
C)A$90.91 million
D)A$101.82 million

Question 28

Assume an FI sells A$100 million for US dollars on the spot currency markets at an exchange rate of A$1.20 to US$1.00 and invests the US dollar assets at an interest rate of 12 per cent for one year.What is the value of the US dollar assets at the end of the year (round to two decimals)?

A)US$134 400.00 million
B)US$22 400.00 million
C)US$93 333.33 million
D)US$560 000.00 million

Question 29

Which of the following statements is true?

A)FX trading is becoming increasingly popular globally.
B)FX trading has become redundant due to stable foreign exchange rates.
C)FX trading is a popular tool to generate profits, as there is little risk involved.
D)The number of FX traders has decreased over the years due to merger activities and as a consequence the number of FX transactions has decreased over time.

Question 30

Assume an FI sells A$100 million for euros at the spot exchange rate today and receives A$100 million/ A$1.15 = €86.96 million.Further assume that the FI immediately lends the €86.96 to a German customer at 12 per cent p.a.for one year.Which of the following statements is true regarding this transaction?

A)The FI can sell the expected principal and interest proceeds from the euro loan forward for Australian dollars today at today's forward rate for one-year delivery to hedge its position.
B)Assuming the FI decides to enter into a forward contract on its FX exposure at the current forward one-year exchange rate between Australian dollars and euros at A$1.10/€1, then it means that the buyer of the forward contract promises to pay €86.96 * (A$1.10/€1) = A$95.57 million to the FI.
C)At maturity, the German borrower repays the loan to the FI plus interest in dollars, i.e.(€86.96 * 1.12) * (A$1.15/€1) = A$112.00 million.
D)All of the listed options are correct.

Question 31

Which of the following statements is true?

A)Conceptually, an FX rate will appreciate in value relative to other currencies when demand is high.
B)Conceptually, an FX rate will appreciate in value relative to other currencies when supply is low.
C)Conceptually, an FX rate will depreciate in value relative to other currencies when demand is low.
D)All of the listed options are correct.

Question 32

Which of the following statements is true?

A)The smaller the FI's net exposure in a foreign currency and the larger the foreign currency's exchange rate volatility, the larger is the potential dollar loss or gain to an FI's earnings.
B)The smaller the FI's net exposure in a foreign currency and the smaller the foreign currency's exchange rate volatility, the larger is the potential dollar loss or gain to an FI's earnings.
C)The larger the FI's net exposure in a foreign currency and the smaller the foreign currency's exchange rate volatility, the larger is the potential dollar loss or gain to an FI's earnings.
D)The larger the FI's net exposure in a foreign currency and the larger the foreign currency's exchange rate volatility, the larger is the potential dollar loss or gain to an FI's earnings.

Question 33

Which of the following statements is true?

A)Conceptually, an FX rate will appreciate in value relative to other currencies when demand is low.
B)Conceptually, an FX rate will appreciate in value relative to other currencies when supply is high.
C)Conceptually, an FX rate will depreciate in value relative to other currencies when demand is low.
D)Conceptually, an FX rate will appreciate in value relative to other currencies when supply is low.

Question 34

Which of the following is an appropriate definition of a currency swap?

A)A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities.
B)A swap used to hedge against the general depreciation of a currency.
C)A swap used to hedge against the general appreciation of a currency.
D)A swap used to speculate on the depreciation or appreciation of a currency.

Question 35

Which of the following statements is true?

A)The implications of the interest rate parity theorem is that in a competitive market for deposits, loans and foreign exchange, the potential profit opportunities from overseas investment for the FI manager are likely to be large.
B)The implications of the interest rate parity theorem is that in a competitive market for deposits, loans and foreign exchange, the potential profit opportunities from overseas investment for the FI manager are likely to be non-existent.
C)The implications of the interest rate parity theorem is that in a competitive market for deposits, loans and foreign exchange, the potential profit opportunities from overseas investment for the FI manager are likely to be small.
D)None of the listed options are correct.

Question 36

The case of the National Australia Bank shows that:

A)FX trading can result in significant losses for an FI.
B)FX trading losses can result in reputational loss for an FI.
C)the announcement of FX trading losses can lead to a fall in the share price of the FI at which the losses occurred.
D)All of the listed options are correct.

Question 37

The dollar loss/gain in a particular currency i can be calculated as:

A)Net exposure in foreign currency i multiplied by the volatility to the ($/foreign currency i) exchange rate.
B)Net exposure in foreign currency i measured in Australian dollars divided by the volatility to the ($/foreign currency i) exchange rate.
C)Net exposure in foreign currency i divided by the volatility to the ($/foreign currency i) exchange rate.
D)Net exposure in foreign currency i measured in Australian dollars multiplied by the volatility to the ($/foreign currency i) exchange rate.

Question 38

Which of the following statements is true?

A)By directly matching its foreign asset and liability book, an FI can lock in a positive return on profit spread if exchange rates rise over the investment period.
B)By directly matching its foreign asset and liability book, an FI can lock in a positive return on profit spread if exchange rates fall over the investment period.
C)By directly matching its foreign asset and liability book, an FI can lock in a positive return on profit spread whichever direction exchange rates change over the investment period.
D)By directly matching its foreign asset and liability book, an FI holds a neutral position, i.e.earnings equalling zero, whichever direction exchange rates change over the investment period.

Question 39

Assume that an FI has the following assets and liabilities: Assets
Liabilities
A$100 million loans (one year)
A$200 million securities (one year)
A$100 million equivalent German loans (one year) (loans made in euros)
Which of the following statements is true?

A)The FI has a net long position in euros.
B)The FI has mismatched the currency composition of its asset and liabilities portfolio.
C)The FI has matched the maturities of its assets and liabilities.
D)All of the listed options are correct.

Question 40

Which of the following statements is true?

A)The reason why in a currency swap it is usual to include both principal and interest payments as part of the swap agreement is that both principal and interest are exposed to foreign exchange risk.
B)In a currency swap it is usual to include both principal and interest payments as part of the swap agreement as this makes the currency conversion less complex.
C)In a currency swap it is usual to include both principal and interest payments as part of the swap agreement as otherwise it is impossible to value the swap.
D)It is not usual to include both principal and interest payments as part of the swap agreement.

Question 41

Which of the following is an example of interest rate parity?

A)The Japanese yen trades at the same exchange rate as the Swiss franc.
B)US dollar rates on one-year US Treasury securities equal one-year Japanese government bond rates.
C)US dollar rates on one-year US Treasury securities equal one-year Japanese government bond rates, restated in dollars.
D)British pound two-year forward rates equal two-year Swiss franc forward rates.

Question 42

Most profits or losses on foreign trading for FIs come from:

A)open positions or speculation.
B)market making.
C)acting as agents for retail customers.
D)hedging activities.

Question 43

Off-balance-sheet hedging involves making changes in the on-balance-sheet assets and liabilities to protect the FI's profits from FX risk and taking positions in forward or other derivative securities to hedge FX risk.

Question 44

Currency swaps are used to hedge against exchange rate risk from mismatched currencies on assets and liabilities.

Question 45

A positive net exposure position in FX implies that the FI is net:

A)long in a currency and exposed to depreciation of the foreign currency.
B)short in a currency and exposed to depreciation of the foreign currency.
C)long in a currency and exposed to appreciation of the foreign currency.
D)short in a currency and exposed to appreciation of the foreign currency.

Question 46

According to PPP, foreign currency exchange rates between two countries adjust to reflect changes in each country's:

A)unemployment rates.
B)export competitiveness.
C)inflation rates.
D)foreign exchange reserves.

Question 47

The interest rate parity theorem implies that while interest rates are hedged, the dollar return on foreign investments can be above or below the return on domestic investments.

Question 48

An FI acts defensively as a hedger to reduce FX exposure if it engages in the purchase and sale of foreign currencies for hedging purposes to offset customer or FI exposure in any given currency.

Question 49

On-balance-sheet hedging involves taking positions in forward or other derivative securities to hedge FX risk.

Question 50

An FI that holds more foreign currency liabilities than assets has a net long position.

Question 51

Good managers can know in advance what exchange rates will be at the end of a particular time horizon.

Question 52

An FI usually creates an open position by taking an unhedged position in a foreign currency in its FX trading with other FIs.

Question 53

Which of the following is not a source of foreign exchange risk?

A)Trading foreign currencies.
B)Making domestic-currency loans to foreign corporations.
C)Buying foreign-issued securities.
D)Issuing foreign currency-denominated debt.

Question 54

A US FI wishes to hedge a €10 000 000 loan using euro currency futures.Each euro futures contract is for €125 000, and the hedge ratio is 1.40.The loan is payable in one year in euros.How many currency contracts are necessary to hedge this asset?

A)112 bought euro currency futures contracts.
B)112 sold euro currency futures contracts.
C)80 bought euro currency futures contracts.
D)80 sold euro currency futures contracts.

Question 55

A net short position exposes an FI to the risk that the foreign currency could rise in value against its domestic currency.

Question 56

When purchasing and selling foreign currencies to allow customers to take positions in foreign real and financial investments, the FI:

A)acts defensively as a hedger.
B)acts aggressively as a speculator.
C)assumes the FX risk itself.
D)acts as an agent.

Question 57

Which of the following FX trading activities is used for purposes of speculation?

A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.

Question 58

The role of the forward FX contract is to offset the uncertainty regarding the future spot rate on a particular currency at the end of the investment horizon.

Question 59

A US FI wishes to hedge a €10 000 000 loan using euro currency futures.Each euro futures contract is for €125 000, and the hedge ratio is 1.40.The loan is payable in one year in euros.What type of currency hedge is necessary to protect the FI from exchange rate risk?

A)Buy euro currency futures.
B)Sell euro currency futures.
C)Finance the loan with Eurodollar deposits.
D)Either Sell euro currency futures or finance the loan with Eurodollar deposits.

Question 60

The interest rate parity theorem implies that by hedging in the forward exchange rate market, an investor realises the same returns whether investing domestically or in a foreign country.

Question 61

Explain how forward contracts can be used to hedge an FI's FX exposures.

Question 62

Explain the concept of the interest rate parity theorem (IRPT) and its implications for FIs?

Question 63

In a currency swap it is usual to include both principal and interest payments as part of the swap agreement.