CH 9

ch9
Student: ___________________________________________________________________________
1.
The foreign exchange market is a market for converting the currency of one country into that of another country. True False
2.
Currency fluctuations can make seemingly profitable trade and investment deals unprofitable and vice versa. True False
3.
The rate at which one currency is converted into another is known as the fluctuation rate. True False
4.
The risk that arises from volatile changes in exchange rates is known as foreign exchange risk. True False
5.
It is possible for a firm to purchase complete insurance against the risks that arise from changes in exchange rates in the foreign exchange market. True False
6.
When a tourist changes one currency into another, the tourist is participating in the foreign exchange market. True False
7.
Currency speculation involves the long-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates. True False
8.
When a tourist goes to a bank in a foreign country to convert money into the local currency, the exchange rate used is the spot rate. True False
9.
A spot exchange rate is quoted for 30 days, 90 days, and 180 days into the future. True False
10. The value of a currency is determined by the interaction between the demand and the supply of that currency relative to the demand and supply of other currencies. True False
11. 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. True False
12. When two parties agree to exchange currency and execute the deal at some specific time in the future, a forward exchange occurs. True False
13. To minimize the risk of an unanticipated change in exchange rates, a company can protect itself by entering into a forward exchange contract. True False
14. 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. True False
15. Differences in the spot exchange rate and the 30-day forward rate are normal and reflect the expectations of the foreign exchange market about future currency movements. True False
16. Changes in spot exchange rates can be advantageous for an international business. True False
17. 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. True False
18. A currency swap is the rate at which a foreign exchange dealer converts one currency into another on a particular day. True False
19. The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. True False
20. The most important trading centers for currencies are in Zurich, Frankfurt, Paris, Hong Kong, and Sydney. True False
21. The foreign exchange market is open for only 12 hours in a day. True False
22. Arbitrage opportunities abound in the foreign exchange markets and they tend to be available for long periods of time. True False
23. Although a foreign exchange transaction can involve any two currencies, most transactions involve pounds on one side. True False
24. According to the law of one price, at the most basic level, exchange rates are determined by supply and demand. True False
25. There are no impediments to the free flow of goods and services in an efficient market. True False
26. According to a less extreme version of the PPP theory, given relatively efficient markets, the price of a "basket of goods" should be roughly equivalent in each country. True False
27. Price inflation occurs when the quantity of money in circulation rises faster than the stock of goods and services. True False
28. When the growth in a country's money supply is faster than output increases, inflation is fueled. True False
29. According to the PPP, a country with a high inflation rate will see depreciation in its currency exchange rate. True False
30. The PPP theory is a strong predictor of short-run movements in exchange rates covering time spans of five years or less. True False
31. The Fisher Effect states that a country's real interest rate 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. True False
32. 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 for the two countries. True False
33. The International Fisher Effect has proven to have substantial power at predicting short-run changes in spot exchange rates. True False
34. An inefficient market is one in which prices do not reflect all available information. True False
35. Technical analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. True False
36. If a country has an externally convertible currency, neither residents nor nonresidents are allowed to convert it into a foreign currency. True False
37. Capital flight is most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation, or when a country's economic prospects are shaky in other respects. True False
38. Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. True False
39. The impact of currency exchange rates on the reported financial statements of a company is translation exposure. True False
40. A lag strategy involves attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate. True False
41. The rate at which one currency is converted into another is the: A. B. C. D. replacement percentage. resale rate. exchange rate. interchange ratio.
42. The risks that arise from volatile changes in exchange rates are commonly referred to as: A. B. C. D. interest rate risks. basis risks. operational risks. foreign exchange risks.
43. The foreign exchange market serves two main functions. These are: A. collect duties on imported products and convert the currency of one country into the currency of another. B. insure companies against foreign exchange risk and set interest rates charged to foreign investors. C. collect duties on imported products and set interest rates charged to foreign investors. D. convert the currency of one country into the currency of another and provide some insurance against foreign exchange risk. 44. A pair of shoes costs 30 in Britain. The identical pair costs $45 in the United States. The exchange rate is 1 = $1.80. In terms of cost of the shoes: A. B. C. D. the U.S. offers a better deal. the deal is the same in both countries. Britain offers a better deal. the U.S. deal is comparatively worse.
45. An exchange rate of 1 = $1.30 indicates that: A. B. C. D. $1 is worth 1.30 euros. one could sell 1.30 euros for $1. one euro buys $1.30. there are 1.30 euros for every dollar.
46. The _____ helps us to compare the relative prices of goods and services in different countries. A. B. C. D. interest rate customs rate exchange rate tariff rate
47. International businesses use foreign exchange markets for all of the following reasons except: A. B. C. D. to receive payments from foreign investments that may be in foreign currencies. to pay a foreign company for its products or services in its country's currency. to invest for short terms in money markets when they have spare cash. to cover themselves from all risks involved in currency speculation.
48. 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. B. C. D. currency arbitrage. currency speculation. currency supposition. short selling.
49. One function of the foreign exchange market is to provide some insurance against the risks that arise from changes in exchange rates, commonly referred to as: A. B. C. D. foreign market hazard. global jeopardy. foreign exchange risk. commerce uncertainty.
50. When two parties agree to exchange currency and execute the deal immediately, the transaction is a: A. B. C. D. point-in-time exchange. temporal exchange. spot exchange. forward exchange.
51. If lots of people want euros and euros are in short supply, and a few people want Japanese yen and yen are in plentiful supply, the euro is likely to _____ against the yen. A. B. C. D. depreciate appreciate devalue stabilize
52. _____ are exchange rates governing some specific future date foreign exchange transactions. A. B. C. D. Spot exchange rates Forward exchange rates Future exchange rates Currency swaps
53. Assuming the 30-day forward exchange rate were $1 = 130 and the spot exchange rate were $1 = 120, the dollar is selling at a _____ on the 30-day forward market. A. B. C. D. premium margin discount subsidy
54. The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates is referred to as a: A. B. C. D. fiscal barter. liquid trade. currency exchange. currency swap.
55. Assume that the yen/dollar exchange rate quoted in London at 3:00 p.m. is 120 = $1, and the New York yen/dollar exchange rate at the same time is 125 = $1. A dealer makes a profit by buying a currency low and selling it high. The dealer has engaged in a(n): A. B. C. D. currency swap. arbitrage. backwardation. straddle.
56. 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. B. C. D. The dollar will appreciate against the yen The dollar will depreciate against the yen The exchange rates will remain the same The yen will appreciate against the dollar
57. According to the _____, 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. B. C. D. law of one price principle of consistent pricing model of fair pricing principle of equitable pricing
58. According to the law of one price, if the exchange rate between the British pound and the dollar is 1 = $1.50, a jacket that retails for $75 in New York should sell for _____ in London. A. 40 B. 50 C. 60 D. 75 59. The _____ suggests that given relatively efficient markets, the price of a "basket of goods" should be roughly equivalent in each country. A. B. C. D. theory of efficient markets law of one price theory of price inflation PPP theory
60. Suppose the price of a Big Mac in New York is $3.00 and the price of a Big Mac in Paris is $3.75 at the prevailing euro/dollar exchange rate, then according to PPP the euro is: A. B. C. D. undervalued by 25 percent against the dollar. overvalued by 25 percent against the dollar. appreciating relative to the dollar. depreciating relative to the dollar.
61. Identify the incorrect statement about the PPP theory. A. B. C. D. It predicts that exchange rates are determined by relative prices. It yields accurate predictions in the short run. It best predicts exchange rate changes for countries with high rates of inflation. It assumes away transportation costs and barriers to trade.
62. _____ involves dominant enterprises setting different prices in different markets to reflect varying demand conditions. A. B. C. D. Conditional pricing Dual pricing Price discrimination Foreign market pricing
63. 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. B. C. D. PPP theory efficient market theory inefficient market theory Fisher Effect
64. Economic theory suggests that when inflation is expected to be high: A. B. C. D. interest rates will be low. exchange rates will be high. the International Fisher Effect does not hold. interest rates will be high.
65. _____ 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. B. C. D. The Fisher Effect The International Fisher Effect The efficient market theory The inefficient market theory
66. When traders move as a herd in the same direction at the same time such as what occurred when George Soros betted against the British pound in 1992, a(n) _____ occurs. A. B. C. D. efficient market inefficient market bandwagon effect Fisher Effect
67. The _____ 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. B. C. D. inefficient market school efficient market school Fisher Effect international Fisher Effect
68. _____ draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. A. B. C. D. Efficient market theory Inefficient market theory Fundamental analysis Technical analysis
69. _____ uses price and volume data to determine past trends, which are expected to continue into the future. A. B. C. D. Technical analysis Fundamental analysis The Fisher Effect The International Fisher Effect
70. A currency is said to be freely convertible when: A. the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. B. only nonresidents may convert it into a foreign currency without any limitations. C. neither residents nor nonresidents are allowed to convert it into a foreign currency. D. only residents may convert it internally into a foreign currency. 71. A currency is said to be externally convertible when: A. the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. B. only nonresidents may convert it into a foreign currency without any limitations. C. neither residents nor nonresidents are allowed to convert it into a foreign currency. D. only residents may convert it internally into a foreign currency. 72. When a currency is nonconvertible: A. the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. B. only nonresidents may convert it into a foreign currency without any limitations. C. neither residents nor nonresidents are allowed to convert it into a foreign currency. D. only residents may convert it internally into a foreign currency. 73. _____ is most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation or when a country's economic prospects are shaky in other respects. A. B. C. D. The bandwagon effect The Fisher Effect The International Fisher Effect Capital flight
74. A range of barter-like agreements by which goods and services can be traded for other goods and services is known as: A. B. C. D. countertrade. protracted trade. intermediate sales. countersale.
75. Countries might be forced to use countertrade when a currency is: A. B. C. D. freely convertible. externally convertible. internally convertible. nonconvertible.
76. The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values is known as: A. B. C. D. economic exposure. financial exposure. translation exposure. transaction exposure.
77. _____ is the impact of currency exchange rates changes on the reported financial statements of a company. A. B. C. D. Economic exposure Financial exposure Translation exposure Transaction exposure
78. The extent to which a firm's future international earning power is affected by changes in exchange rates is known as: A. B. C. D. translation exposure. financial exposure. economic exposure. transaction exposure.
79. A(n) _____ involves attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate. A. B. C. D. follower strategy interim strategy lead strategy lag strategy
80. A(n) _____ involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate. A. B. C. D. follower strategy interim strategy lead strategy lag strategy
81. With the help of an example explain how a tourist participates in the foreign exchange market.
82. What are the main uses of foreign exchange markets for international business?
83. What is the difference between a spot exchange rate and a forward exchange rate?
84. What is meant by the phrases the dollar is selling at a discount' on the 30-day forward market and the dollar is selling at a premium' on the 30-day forward market?
85. What is a currency swap?
86. Where is the foreign exchange market located? What is the nature of the market? Is the market growing or shrinking on a global basis?
87. Discuss the nature of the foreign exchange market. How fast has it been growing? Where are the most important trading centers?
88. What is the law of one price?
89. Explain PPP. Use an example to show how PPP can help explain exchange rates.
90. Discuss the failure of PPP theory to predict exchange rates accurately. What is the purchasing power puzzle?
91. Compare and contrast the Fisher Effect and the International Fisher Effect.
92. Consider the role of investor psychology and bandwagon effects on how well PPP and the International Fisher Effect explain short-term movements in exchange rates.
93. Discuss the two schools of thought on exchange rate forecasting.
94. Explain the difference between fundamental analysis and technical analysis.
95. Compare and contrast currencies that are freely convertible, externally convertible, and nonconvertible.
96. What is countertrade? Why would a firm engage in countertrade?
97. What is transaction exposure? How can transaction exposure be minimized?
98. Describe translation exposure. How can translation exposure be minimized?
99. Explain the notion of economic exposure. How can economic exposure be minimized?
100.How can a firm minimize its foreign exchange exposure?
ch9 Key
1.
(p. 312)
The foreign exchange market is a market for converting the currency of one country into that of another country. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Knowledge Difficulty: Easy Hill - Chapter 09 #1 Learning Objective: 09-1
2.
(p. 312)
Currency fluctuations can make seemingly profitable trade and investment deals unprofitable and vice versa. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Knowledge Difficulty: Medium Hill - Chapter 09 #2 Learning Objective: 09-1
3.
(p. 312)
The rate at which one currency is converted into another is known as the fluctuation rate. FALSE
4.
(p. 313)
The risk that arises from volatile changes in exchange rates is known as foreign exchange risk. TRUE
5.
(p. 312)
It is possible for a firm to purchase complete insurance against the risks that arise from changes in exchange rates in the foreign exchange market. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Comprehension Difficulty: Medium Hill - Chapter 09 #5 Learning Objective: 09-1
6.
(p. 313)
When a tourist changes one currency into another, the tourist is participating in the foreign exchange market. TRUE
7.
(p. 314)
Currency speculation involves the long-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates. FALSE
8.
(p. 315)
When a tourist goes to a bank in a foreign country to convert money into the local currency, the exchange rate used is the spot rate. TRUE
9.
(p. 315)
A spot exchange rate is quoted for 30 days, 90 days, and 180 days into the future. FALSE
10.
(p. 315)
The value of a currency is determined by the interaction between the demand and the supply of that currency relative to the demand and supply of other currencies. TRUE
11.
(p. 315)
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. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Application Difficulty: Medium Hill - Chapter 09 #11 Learning Objective: 09-2
12.
(p. 316)
When two parties agree to exchange currency and execute the deal at some specific time in the future, a forward exchange occurs. TRUE
13.
(p. 316)
To minimize the risk of an unanticipated change in exchange rates, a company can protect itself by entering into a forward exchange contract. TRUE
14.
(p. 316)
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. FALSE
15.
(p. 316)
Differences in the spot exchange rate and the 30-day forward rate are normal and reflect the expectations of the foreign exchange market about future currency movements. TRUE
16.
(p. 316)
Changes in spot exchange rates can be advantageous for an international business. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Comprehension Difficulty: Easy Hill - Chapter 09 #16 Learning Objective: 09-3
17.
(p. 316)
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. FALSE
18.
(p. 317)
A currency swap is the rate at which a foreign exchange dealer converts one currency into another on a particular day. FALSE
19.
(p. 318)
The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. TRUE
AACSB: Use of Information Technology Blooms: Knowledge Difficulty: Medium Hill - Chapter 09 #19 Learning Objective: 09-3
20.
(p. 318)
The most important trading centers for currencies are in Zurich, Frankfurt, Paris, Hong Kong, and Sydney. FALSE
AACSB: Domestic and Global Economic Environments Blooms: Knowledge Difficulty: Medium Hill - Chapter 09 #20 Learning Objective: 09-3
21.
(p. 318)
The foreign exchange market is open for only 12 hours in a day. FALSE
22.
(p. 319)
Arbitrage opportunities abound in the foreign exchange markets and they tend to be available for long periods of time. FALSE
23.
(p. 319)
Although a foreign exchange transaction can involve any two currencies, most transactions involve pounds on one side. FALSE
24.
(p. 320)
According to the law of one price, at the most basic level, exchange rates are determined by supply and demand. FALSE
25.
(p. 320)
There are no impediments to the free flow of goods and services in an efficient market. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 09 #25 Learning Objective: 09-4
26.
(p. 320)
According to a less extreme version of the PPP theory, given relatively efficient markets, the price of a "basket of goods" should be roughly equivalent in each country. TRUE
27.
(p. 321)
Price inflation occurs when the quantity of money in circulation rises faster than the stock of goods and services. TRUE
28.
(p. 321)
When the growth in a country's money supply is faster than output increases, inflation is fueled. TRUE
29.
(p. 322)
According to the PPP, a country with a high inflation rate will see depreciation in its currency exchange rate. TRUE
30.
(p. 323)
The PPP theory is a strong predictor of short-run movements in exchange rates covering time spans of five years or less. FALSE
31.
(p. 324)
The Fisher Effect states that a country's real interest rate 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. FALSE
32.
(p. 325)
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 for the two countries. TRUE
33.
(p. 325)
The International Fisher Effect has proven to have substantial power at predicting short-run changes in spot exchange rates. FALSE
34.
(p. 328)
An inefficient market is one in which prices do not reflect all available information. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 09 #34 Learning Objective: 09-4
35.
(p. 330)
Technical analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. FALSE
36.
(p. 330)
If a country has an externally convertible currency, neither residents nor nonresidents are allowed to convert it into a foreign currency. FALSE
37.
(p. 330)
Capital flight is most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation, or when a country's economic prospects are shaky in other respects. TRUE
38.
(p. 331)
Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. TRUE
39.
(p. 332)
The impact of currency exchange rates on the reported financial statements of a company is translation exposure. TRUE
40.
(p. 332)
A lag strategy involves attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Knowledge Difficulty: Hard Hill - Chapter 09 #40 Learning Objective: 09-6
41.
(p. 312)
The rate at which one currency is converted into another is the: A. B. C. D. replacement percentage. resale rate. exchange rate. interchange ratio.
The foreign exchange market is the lubricant that enables companies based in countries that use different currencies to trade with each other.
42.
(p. 312)
The risks that arise from volatile changes in exchange rates are commonly referred to as: A. B. C. D. interest rate risks. basis risks. operational risks. foreign exchange risks.
Foreign exchange risk is the adverse consequences of unpredictable changes in exchange rates.
43.
(p. 313)
The foreign exchange market serves two main functions. These are: A. collect duties on imported products and convert the currency of one country into the currency of another. B. insure companies against foreign exchange risk and set interest rates charged to foreign investors. C. collect duties on imported products and set interest rates charged to foreign investors. D. convert the currency of one country into the currency of another and provide some insurance against foreign exchange risk. The first is to convert the currency of one country into the currency of another. A second function of the foreign exchange market is to provide insurance against foreign exchange risk, which is the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm.
44.
(p. 313)
A pair of shoes costs 30 in Britain. The identical pair costs $45 in the United States. The exchange rate is 1 = $1.80. In terms of cost of the shoes: A. B. C. D. the U.S. offers a better deal. the deal is the same in both countries. Britain offers a better deal. the U.S. deal is comparatively worse.
When a tourist changes one currency into another, he/she is participating in the foreign exchange market. The exchange rate is the rate at which the market converts one currency into another. The exchange rate allows us to compare the relative prices of goods and services in different countries.
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Application Difficulty: Hard Hill - Chapter 09 #44 Learning Objective: 09-1
45.
(p. 313)
An exchange rate of 1 = $1.30 indicates that: A. B. C. D. $1 is worth 1.30 euros. one could sell 1.30 euros for $1. one euro buys $1.30. there are 1.30 euros for every dollar.
When a tourist changes one currency into another, he/she is participating in the foreign exchange market. The exchange rate is the rate at which the market converts one currency into another. The exchange rate allows us to compare the relative prices of goods and services in different countries.
46.
(p. 313)
The _____ helps us to compare the relative prices of goods and services in different countries. A. B. C. D. interest rate customs rate exchange rate tariff rate
The exchange rate is the rate at which the market converts one currency into another. The exchange rate allows us to compare the relative prices of goods and services in different countries.
47.
(p. 313314)
International businesses use foreign exchange markets for all of the following reasons except: A. B. C. D. to receive payments from foreign investments that may be in foreign currencies. to pay a foreign company for its products or services in its country's currency. to invest for short terms in money markets when they have spare cash. to cover themselves from all risks involved in currency speculation.
In general, companies should beware, because speculation by definition is a very risky business. The company cannot know for sure what will happen to exchange rates. While speculators may profit handsomely if future currency movements go in the direction predicted, they can also lose vast amounts of money if they move in the other direction.
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Comprehension Difficulty: Hard Hill - Chapter 09 #47 Learning Objective: 09-1
48.
(p. 314)
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. B. C. D. currency arbitrage. currency speculation. currency supposition. short selling.
Currency speculation is one of the uses of foreign exchange markets.

49.
(p. 315)
One function of the foreign exchange market is to provide some insurance against the risks that arise from changes in exchange rates, commonly referred to as: A. B. C. D. foreign market hazard. global jeopardy. foreign exchange risk. commerce uncertainty.
One of the functions of the foreign exchange market is to provide insurance against foreign exchange risk, which is the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm.
50.
(p. 315)
When two parties agree to exchange currency and execute the deal immediately, the transaction is a: A. B. C. D. point-in-time exchange. temporal exchange. spot exchange. forward exchange.
Exchange rates governing "on the spot" trades are referred to as spot exchange rates.
51.
(p. 315)
If lots of people want euros and euros are in short supply, and a few people want Japanese yen and yen are in plentiful supply, the euro is likely to _____ against the yen. A. B. C. D. depreciate appreciate devalue stabilize
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.
52.
(p. 316)
_____ are exchange rates governing some specific future date foreign exchange transactions. A. B. C. D. Spot exchange rates Forward exchange rates Future exchange rates Currency swaps
Forward exchange rates represent market participants' collective predictions of likely spot exchange rates at specified future dates.
53.
(p. 316)
Assuming the 30-day forward exchange rate were $1 = 130 and the spot exchange rate were $1 = 120, the dollar is selling at a _____ on the 30-day forward market. A. B. C. D. premium margin discount subsidy
$1 would buy more yen with a forward exchange than with a spot exchange. In such a case, we say the dollar is selling at a premium on the 30-day forward market.
54.
(p. 317)
The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates is referred to as a: A. B. C. D. fiscal barter. liquid trade. currency exchange. currency swap.
Swaps 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.
55.
(p. 318)
Assume that the yen/dollar exchange rate quoted in London at 3:00 p.m. is 120 = $1, and the New York yen/dollar exchange rate at the same time is 125 = $1. A dealer makes a profit by buying a currency low and selling it high. The dealer has engaged in a(n): A. B. C. D. currency swap. arbitrage. backwardation. straddle.
Buying a currency low and selling it high is arbitrage.

56.
(p. 319)
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. B. C. D. The dollar will appreciate against the yen The dollar will depreciate against the yen The exchange rates will remain the same The yen will appreciate against the dollar
At the most basic level, exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another.
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Comprehension Difficulty: Hard Hill - Chapter 09 #56 Learning Objective: 09-4
57.
(p. 320)
According to the _____, 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. B. C. D. law of one price principle of consistent pricing model of fair pricing principle of equitable pricing
The law of one price is an economic proposition to understand how prices are related to exchange rate movements.
58.
(p. 320)
According to the law of one price, if the exchange rate between the British pound and the dollar is 1 = $1.50, a jacket that retails for $75 in New York should sell for _____ in London. A. 40 B. 50 C. 60 D. 75 The law of one price 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.
59.
(p. 320)
The _____ suggests that given relatively efficient markets, the price of a "basket of goods" should be roughly equivalent in each country. A. B. C. D. theory of efficient markets law of one price theory of price inflation PPP theory
If the law of one price were true for all goods and services, the PPP exchange rate could be found from any individual set of prices. By comparing the prices of identical products in different currencies, it would be possible to determine the "real" or PPP exchange rate that would exist if markets were efficient.
60.
(p. 320)
Suppose the price of a Big Mac in New York is $3.00 and the price of a Big Mac in Paris is $3.75 at the prevailing euro/dollar exchange rate, then according to PPP the euro is: A. B. C. D. undervalued by 25 percent against the dollar. overvalued by 25 percent against the dollar. appreciating relative to the dollar. depreciating relative to the dollar.
To calculate the Big Mac index, The Economist converts the price of a Big Mac in a country into dollars at current exchange rates and divides that by the average price of a Big Mac in America. According to the PPP theorem, the prices should be the same. If they are not, it implies that the currency is either overvalued against the dollar or undervalued.
61.
(p. 323)
Identify the incorrect statement about the PPP theory. A. B. C. D. It predicts that exchange rates are determined by relative prices. It yields accurate predictions in the short run. It best predicts exchange rate changes for countries with high rates of inflation. It assumes away transportation costs and barriers to trade.
While PPP theory seems to yield relatively accurate predictions in the long run, it does not appear to be a strong predictor of short-run movements in exchange rates covering time spans of five years or less.
62.
(p. 324)
_____ involves dominant enterprises setting different prices in different markets to reflect varying demand conditions. A. B. C. D. Conditional pricing Dual pricing Price discrimination Foreign market pricing
For price discrimination to work, arbitrage must be limited. Enterprises with some market power may be able to control distribution channels and therefore limit the unauthorized resale of products purchased in another national market.
63.
(p. 324)
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. B. C. D. PPP theory efficient market theory inefficient market theory Fisher Effect
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 inflation rates.
64.
(p. 324)
Economic theory suggests that when inflation is expected to be high: A. B. C. D. interest rates will be low. exchange rates will be high. the International Fisher Effect does not hold. interest rates will be high.
Economic theory tells us that interest rates reflect expectations about likely future inflation rates. In countries where inflation is expected to be high, interest rates also will be high because investors want compensation for the decline in the value of their money.
65.
(p. 325)
_____ 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. B. C. D. The Fisher Effect The International Fisher Effect The efficient market theory The inefficient market theory
Since there is a link between inflation and exchange rates according to the PPP theory, and since interest rates reflect expectations about inflation, it follows that there must also be a link between interest rates and exchange rates. This link is known as the International Fisher Effect.
66.
(p. 325326)
When traders move as a herd in the same direction at the same time such as what occurred when George Soros betted against the British pound in 1992, a(n) _____ occurs. A. B. C. D. efficient market inefficient market bandwagon effect Fisher Effect
When Soros started shorting the British pound, many foreign exchange traders, knowing Soros's reputation, jumped on the bandwagon and did likewise. This triggered a classic bandwagon effect.
67.
(p. 328)
The _____ 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. B. C. D. inefficient market school efficient market school Fisher Effect international Fisher Effect
A company's need to predict future exchange rate variations raises the issue of whether it is worthwhile for the company to invest in exchange rate forecasting services to aid decision making. Two schools of thought, the efficient market school and the inefficient market school, address this issue.
68.
(p. 329)
_____ draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. A. B. C. D. Efficient market theory Inefficient market theory Fundamental analysis Technical analysis
Fundamental analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. The variables contained in these models typically include relative money supply growth rates, inflation rates, and interest rates.
69.
(p. 330)
_____ uses price and volume data to determine past trends, which are expected to continue into the future. A. B. C. D. Technical analysis Fundamental analysis The Fisher Effect The International Fisher Effect
Technical analysis is based on the premise that there are analyzable market trends and waves and that previous trends and waves can be used to predict future trends and waves.
70.
(p. 330)
A currency is said to be freely convertible when: A. the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. B. only nonresidents may convert it into a foreign currency without any limitations. C. neither residents nor nonresidents are allowed to convert it into a foreign currency. D. only residents may convert it internally into a foreign currency. A country's currency is said to be freely convertible when the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it.
71.
(p. 330)
A currency is said to be externally convertible when: A. the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. B. only nonresidents may convert it into a foreign currency without any limitations. C. neither residents nor nonresidents are allowed to convert it into a foreign currency. D. only residents may convert it internally into a foreign currency. A currency is said to be externally convertible when only nonresidents may convert it into a foreign currency without any limitations.
72.
(p. 330)
When a currency is nonconvertible: A. the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. B. only nonresidents may convert it into a foreign currency without any limitations. C. neither residents nor nonresidents are allowed to convert it into a foreign currency. D. only residents may convert it internally into a foreign currency. A currency is nonconvertible when neither residents nor nonresidents are allowed to convert it into a foreign currency.
73.
(p. 330)
_____ is most likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation or when a country's economic prospects are shaky in other respects. A. B. C. D. The bandwagon effect The Fisher Effect The International Fisher Effect Capital flight
Governments typically impose convertibility restrictions on their currency when they fear that free convertibility will lead to a run on their foreign exchange reserves. This occurs when residents and nonresidents rush to convert their holdings of domestic currency into a foreign currencya phenomenon generally referred to as capital flight.
74.
(p. 331)
A range of barter-like agreements by which goods and services can be traded for other goods and services is known as: A. B. C. D. countertrade. protracted trade. intermediate sales. countersale.
Companies can deal with the nonconvertibility problem by engaging in countertrade.

75.
(p. 331)
Countries might be forced to use countertrade when a currency is: A. B. C. D. freely convertible. externally convertible. internally convertible. nonconvertible.
Countertrade refers to a range of barter-like agreements by which goods and services can be traded for other goods and services.
76.
(p. 331)
The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values is known as: A. B. C. D. economic exposure. financial exposure. translation exposure. transaction exposure.
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.
77.
(p. 332)
_____ is the impact of currency exchange rates changes on the reported financial statements of a company. A. B. C. D. Economic exposure Financial exposure Translation exposure Transaction exposure
Translation exposure is concerned with the present measurement of past events.

78.
(p. 332)
The extent to which a firm's future international earning power is affected by changes in exchange rates is known as: A. B. C. D. translation exposure. financial exposure. economic exposure. transaction exposure.
Economic exposure is concerned with the long-run effect of changes in exchange rates on future prices, sales, and costs.
79.
(p. 332)
A(n) _____ involves attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate. A. B. C. D. follower strategy interim strategy lead strategy lag strategy
Leading involves accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries.
80.
(p. 332)
A(n) _____ involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate. A. B. C. D. follower strategy interim strategy lead strategy lag strategy
Lagging involves accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries.
81.
(p. 312313)
With the help of an example explain how a tourist participates in the foreign exchange market. The foreign exchange market is a market for converting the currency of one country into that of another country. When a tourist changes one currency into another, the tourist is participating in the foreign exchange market. If the euro/dollar exchange rate is 1 = $1.30, then one euro buys $1.30 U.S. dollars. If the tourist wants to buy a T-shirt in France that costs 20 euros, the tourist can go to a bank and exchange her $26 for 20.
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Application Difficulty: Easy Hill - Chapter 09 #81 Learning Objective: 09-1
82.
(p. 313314)
What are the main uses of foreign exchange markets for international business? The foreign exchange market serves four primary functions for international companies. First, the market is used to convert payments a company receives in foreign currencies into the currency of its home country. Second, the market is used to convert the currency of a company's home country into another currency when they must pay a foreign company for its products and services in their currency. Third, international businesses may use foreign exchange markets when they have spare cash that they wish to invest for short terms in money markets (of another country). Fourth, the market is used for currency speculation.
83.
(p. 315316)
What is the difference between a spot exchange rate and a forward exchange rate? The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day. Spot exchange rates are reported on a real time basis on many financial Web sites. Spot rates are continually changing, their value being determined by supply and demand for that currency relative to others. A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future. Exchange rates governing such transactions are referred to as forward exchange rates. Most major currencies are quoted 30, 90, and 120 days into the future.
AACSB: Financial Theories, Analysis, Reporting, and Markets Blooms: Knowledge Difficulty: Medium Hill - Chapter 09 #83 Learning Objective: 09-2 Learning Objective: 09-3
84.
(p. 316)
What is meant by the phrases the dollar is selling at a discount' on the 30-day forward market and the dollar is selling at a premium' on the 30-day forward market? When a dollar is selling at a discount on the 30-day forward market, it is worth less than on the spot market, or one dollar buys more foreign currency with a spot exchange than with a 30-day forward contract. If the dollar is selling at a premium on the 30-day forward market, foreign exchange dealers anticipate the dollar will appreciate against the foreign currency over the next 30 days.
85.
(p. 317)
What is a currency swap? A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. Swaps 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.
86.
(p. 318)
Where is the foreign exchange market located? What is the nature of the market? Is the market growing or shrinking on a global basis? The foreign exchange market is not located in any one place. It is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. When companies wish to convert currencies, they typically go through their own banks rather than entering the market directly. The foreign exchange market has been growing at a rapid pace, reflecting a general growth in the volume of cross-border trade and investment.
87.
(p. 318)
Discuss the nature of the foreign exchange market. How fast has it been growing? Where are the most important trading centers? The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. The market has been growing at a rapid pace. In April 2007, the average total value of global foreign exchange trading was about $3.21 trillion per day. The most important trading centers are London, New York, Zurich, Tokyo, and Singapore.
88.
(p. 320)
What is the law of one price? The law of one price 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 prices is expressed in terms of the same currency. If the exchange rate is 1 = $1.50, a bracelet that sells for $75 in New York should sell for 50 in London.
89.
(p. 320)
Explain PPP. Use an example to show how PPP can help explain exchange rates. PPP theory states that given relatively efficient markets, the price of a "basket of goods" should be roughly equivalent in each country. So, if a basket of goods costs $200 in the U.S. and 20,000 in Japan, PPP predicts that the dollar/yen exchange should be $200/20,000 or $.01 per Japanese yen.
90.
(p. 323324)
Discuss the failure of PPP theory to predict exchange rates accurately. What is the purchasing power puzzle? The failure to find a strong link between inflation rates and exchange rate movements has been referred to as the purchasing power puzzle. Several reasons contribute to the failure of PPP as a predictive tool. First, PPP theory assumes away transportation costs and barriers to entry, yet in practice this is not realistic. Second, PPP theory may not hold if many national markets are dominated by a handful of multinational enterprises that have sufficient market power to be able to exercise some influence over prices, control distribution channels, and differentiate their product offerings between nations. Third, government intervention in the foreign exchange market influences the value of currencies. Finally, investor psychology has a role in determining exchange rates.
91.
(p. 324325)
Compare and contrast the Fisher Effect and the International Fisher Effect. The Fisher Effect was put forth by Irvin Fisher who formalized the notion that in countries where inflation is expected to be high, interest rates will also be high because investors want compensation for the decline in the value of their money. More specifically, the Fisher Effect 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. The Fisher Effect was extended to incorporate the link between interest rates and exchange rates. 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.
92.
(p. 325326)
Consider the role of investor psychology and bandwagon effects on how well PPP and the International Fisher Effect explain short-term movements in exchange rates. Neither PPP nor the International Fisher Effect have proven to be good at explaining short-term movements in exchange rates. One reason for their poor explanatory power may be the impact of investor psychology on short-run exchange movements. Studies show that expectations about exchange rates tend to become self-fulfilling prophecies. A bandwagon effect occurs when investors in increasing numbers start following the lead of someone who may be pushing the value of a currency up or down due to psychological reasons. As a bandwagon effect builds up, the expectations of investors become a self-fulfilling prophecy, and the market moves in the way the investors expected.
93.
(p. 328)
Discuss the two schools of thought on exchange rate forecasting. There are two schools of thought on whether it is worthwhile for a firm to invest in exchange rate forecasting services. The efficient market school argues that forward exchange rates do the best possible job of forecasting exchange rates and therefore, it is not necessary to invest in forecasting services. The inefficient market, however, suggests that forward exchange rates are not the best predictors of future spot rates and that consequently there is value in forecasting services.
94.
(p. 329330)
Explain the difference between fundamental analysis and technical analysis. Fundamental analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. Technical analysis uses price and volume data to determine past trends that are expected to continue into the future. Both schools of thought are used to forecast exchange rate movements.
95.
(p. 330)
Compare and contrast currencies that are freely convertible, externally convertible, and nonconvertible. A country's currency is said to be freely convertible when the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it. In contrast, a currency is said to be externally convertible if only nonresidents may convert it into a foreign currency without limitations. Finally, a currency is nonconvertible when neither residents nor nonresidents are allowed to convert it into a foreign currency.
96.
(p. 331)
What is countertrade? Why would a firm engage in countertrade? Countertrade refers to a range of barter-like agreements by which goods and services can be traded for other goods and services. When a country's currency is nonconvertible, a firm may turn to countertrade. The number of countertrade deals has been falling in recent years as more governments make their currencies freely convertible.
97.
(p. 331332)
What is transaction exposure? How can transaction exposure be minimized? Transaction exposure is the extent to which the income from various transactions is affected by fluctuations in foreign exchange values. 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. Transaction exposure can be minimized by entering into forward contracts or swaps, or by leading and lagging payables and receivables.
98.
(p. 332)
Describe translation exposure. How can translation exposure be minimized? Translation exposure is the impact of currency exchange rate changes on the reported financial statements of a company. Translation exposure is basically concerned with the present measurement of past events. Like transaction exposure, translation exposure can be minimized by entering into forward contracts or swaps, or by leading and lagging payables and receivables.
99.
(p. 332333)
Explain the notion of economic exposure. How can economic exposure be minimized? Economic exposure is the extent to which a firm's future international earning power is affected by changes in exchange rates. Economic exposure is concerned with the long-run effect of changes in exchange rates on future prices, sales, and costs. To reduce economic exposure, a firm must distribute the firm's productive assets to various locations so the firm's long-run financial well-being is not severely affected by adverse changes in exchange rates.
100.
(p. 334)
How can a firm minimize its foreign exchange exposure? There are several strategies a firm can follow to minimize foreign exchange exposure. First, central control of exposure is needed to protect resources and ensure that each subunit adopts the correct mix of tactics and strategies. Second, firms should distinguish between transaction and translation exposure as compared to economic exposure. Third, the firm needs to forecast future exchange rate movements. Fourth, the firm needs to establish a good reporting system to monitor the firm's exposure positions. Finally, the firm should produce monthly foreign exchange exposure report forms.
ch9 Summary
Category AACSB: Analytic Skills AACSB: Domestic and Global Economic Environments AACSB: Financial Theories, Analysis, Reporting, and Markets AACSB: Use of Information Technology Blooms: Application Blooms: Comprehension Blooms: Knowledge Difficulty: Easy Difficulty: Hard Difficulty: Medium Hill - Chapter 09 Learning Objective: 09-1 Learning Objective: 09-2 Learning Objective: 09-3 Learning Objective: 09-4 Learning Objective: 09-5 Learning Objective: 09-6 # of Questions 4 1 94 1 10 15 75 29 6 65 100 17 8 21 27 16 12

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85. What is a currency swap?

88. What is the law of one price?

93. Discuss the two schools of thought on exchange rate forecasting.

96. What is countertrade? Why would a firm engage in countertrade?

97. What is transaction exposure? How can transaction exposure be minimized?

98. Describe translation exposure. How can translation exposure be minimized?

100.How can a firm minimize its foreign exchange exposure?

Currency speculation is one of the uses of foreign exchange markets.

Buying a currency low and selling it high is arbitrage.

Companies can deal with the nonconvertibility problem by engaging in countertrade.

Translation exposure is concerned with the present measurement of past events.

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