Ch 9: International Financial Markets

CHAPTER 9 INTERNATIONAL FINANCIAL MARKETS

TRUE/FALSE QUESTIONS 1. Well-functioning financial markets funnel money from organizations and economies with excess funds to those with shortages. (True; Easy; p. !"; #$1% . &nternational financial markets allow companies to exchange one currency for another. (True; Easy; p. '(; #$1% ). The international financial market is composed of two interrelated systems* the international capital market and the foreign goods market. (+alse; Easy; p. !"; #$1% ,. - capital market is a system that allocates financial resources in the form of de.t and e/uity according to their most efficient uses. (True; Easy; p. '(; #$1% !. The international capital market is a network of indi0iduals1 companies1 financial institutions1 and go0ernments that in0est and .orrow across national .oundaries. (True; 2oderate; p. !3; #$1% '. Through the international capital market1 a company that is una.le to o.tain funds from in0estors in its own nation can seek financing from in0estors elsewhere. (True; 2oderate; p. !3; #$1% 4. &f the money supply increases1 its price5in the form of interest rates5also increases. (+alse; Easy; p. '(; #$1% ". -n excess money supply creates a .orrower6s market1 forcing down interest rates and the cost of .orrowing. (True; Easy; p. '(; #$1% 3. 7i0en the glo.alization trend1 the international capital market reduces the a0aila.le set of in0estment opportunities. (+alse; 2oderate; p. '(; #$1% 1(. &n0estors increase risk .y holding international securities whose prices mo0e independently. (+alse; 2oderate; p. '(; #$1% 11. When o.taining microcredit1 small groups of low-income entrepreneurs can .orrow money at competiti0e rates without ha0ing to put up collateral. (True; Easy; p. '(; #$1% 8--9:;* Ethics< 1 . The microcredit concept was pioneered in de0eloped countries as a way for de0eloping countries to create the foundation for a market economy. (True; 2oderate; p. '(; #$1% 8--9:;* Ethics<

Ch 9: International Financial Markets

1).

The rapid growth of the international capital market can .e traced to three main factors* deregulation1 inno0ati0e financial instruments1 and information technology. (True; 2oderate; p. '1; #$1% 1,. =eregulation of national capital markets has .een instrumental in the expansion of the international capital market. (True; Easy; p. '1; #$1% 1!. &ncreased regulation of national capital markets has .een instrumental in the expansion of the international capital market. (+alse; 2oderate; p. '1; #$1% 1'. :ecuritization is the un.undling and repackaging of hard-to-trade financial assets into more li/uid1 negotia.le1 and marketa.le financial instruments. (True; Easy; p. '1; #$1% 14. The world6s three most important financial centers are >ew ?ork1 9hicago1 and #ondon. (+alse; 2oderate; p. '1; #$1% 1". $ffshore financial centers tend to .e characterized .y economic and political insta.ility and poor telecommunications infrastructures. (+alse; 2oderate; p. '1; #$1% 13. -n offshore financial center is a country or territory whose financial sector features 0ery few regulations and few1 if any1 taxes. (True; 2oderate; p. '1; #$1% ;ooking centers are usually located on small island nations and territories with fa0ora.le tax and@or secrecy laws. (True; 2oderate; p. ' ; #$1% The most important factor fueling growth in the international .ond market is high interest rates in de0eloped nations. (+alse; =ifficult; p. '); #$ % Aigh interest rates outside the de0eloped nations ha0e fueled increased acti0ity in the international .ond market. (True; =ifficult;p. '); #$ % Typical .uyers of international .onds include medium- and large-sized .anks1 pension funds1 mutual funds1 and go0ernments with excess financial reser0es. (True; 2oderate; p. '); #$ % ;y issuing .onds in the international .ond market1 .orrowers from newly industrialized and de0eloping countries can .orrow money from other nations where interest rates are lower. (True; 2oderate; p. '); #$ % !. :amurai .onds are .onds issued in Bapan .y non-Bapanese entities. (True; 2oderate; p. '); #$ % ,. ). . 1. (.

Ch 9: International Financial Markets - rise in a country6s currency forces .orrowers to shell out more local currency to pay off the interest owed on .onds denominated in an unaffected currency. (+alse; =ifficult; p. '); #$ % The international .ond market consists of all stocks .ought and sold outside the issuer6s home country. (+alse; 2oderate; p. ',; #$ % ". The speed of pri0atization is encouraging the growth of the international e/uity market. (True; 2oderate; p. ',; #$ % -lthough historically more de0oted to e/uity as a means of financing1 Europe has more recently disco0ered the 0alue of de.t. (+alse; 2oderate; p. ',; #$ % )(. -ll of Europe6s currencies com.ined are referred to as Eurocurrency. (+alse; 2oderate; p. ',; #$ % )1. The main appeal of the Eurocurrency market is the complete a.sence of regulation. (True; 2oderate; p. '!; #$ % ) . The #ondon &nter.ank ;id Cate (#&;&=% is the interest rate that #ondon .anks charge other large .anks for .orrowing Eurocurrency. (+alse; =ifficult; p. '!; #$ % )). The rate at which one currency is exchanged for another depends on the size of the transaction1 the trader conducting it1 and general economic conditions. (True; 2oderate; p. '!; #$)% ),. The practice of insuring against potential losses that result from ad0erse changes in exchange rates is called currency ar.itrage. (+alse; Easy; p. ''; #$)% )!. &nterest ar.itrage is the profit-moti0ated purchase and sale of interest-paying securities denominated in different currencies. (True; Easy; p. ''; #$)% )'. There are two components of e0ery /uoted exchange rate* the de.t and the e/uity rates. (+alse; 2oderate; p. '"; #$,% )4. &f an exchange rate /uotes the num.er of &ndian rupees needed to .uy one D.:. dollar1 the dollar is the /uoted currency and the rupee is the .ase currency. (+alse; 2oderate; p. '"; #$,% )". &n any exchange rate1 the /uoted currency is always the numerator and the .ase currency is always the denominator. (True; 2oderate; p. '"; #$,% )3. Exchange rate risk is the risk of ad0erse changes in exchange rates. (True; Easy; p. '3; #$,% 3. 4. '.

Ch 9: International Financial Markets ,(. &nternational transactions .etween two currencies other than the D.:. dollar often use the dollar as a 0ehicle currency. (True; 2oderate; p. 4(; #$,% ,1. 9ross rates .etween two currencies can .e calculated using either currency6s indirect or direct exchange rates with another currency. (True; 2oderate; p. 4(; #$,% , . -n exchange rate re/uiring deli0ery of the traded currency within two .usiness days is called a cross rate. (+alse; Easy; p. 41; #$,% ,). &f you are tra0eling to another country and want to exchange currencies at your .ank .efore departing1 you will .e /uoted the spot rate since you are exchanging on the spot. (+alse; 2oderate; p. 41; #$,% ,,. +orward rates represent the expectations of currency traders and .ankers regarding a currency6s future spot rate. (True; Easy; p. 4 ; #$,% ,!. +orward contracts .elong to a family of financial instruments called ar.itrage. (+alse; Easy; p. 4 ; #$,% ,'. &f a currency6s forward rate is higher than its spot rate1 the currency is trading at a discount. (+alse; 2oderate; p. 4 ; #$,% ,4. - currency swap is the simultaneous purchase and sale of foreign exchange for two different dates. (True; Easy; p. 4); #$,% ,". -lthough #ondon has a .etter location and the preferred time zone1 >ew ?ork dominates the foreign exchange market .ecause the maEority of the trades in0ol0e the D.:. dollar. (+alse; =ifficult; p. 4,; #$!% ,3. The process of aggregating the currencies that one .ank owes another and then carrying out the transaction is called clearing. (True; Easy; p. 4!; #$!% 8--9:;* Technology< !(. -ll foreign exchange transactions can .e performed in the o0er-the-counter ($T9% market. (True; 2oderate; p. 4'; #$!% !1. - con0erti.le currency (or soft currency% is traded freely in the foreign exchange market with its price determined .y the #ondon .anks. (+alse; Easy; p. 44; #$'% ! . $ne goal of currency restriction is to preser0e hard currencies to pay for imports and to finance trade deficits. (True; 2oderate; p. 44; #$'% !). - way to get around national restrictions on currency con0erti.ility is to use .arter. (True; 2oderate; p. 4"; #$'%

Ch 9: International Financial Markets MULTIPLE CHOICE QUESTIONS 1. The ease with which .ondholders and shareholders may con0ert their in0estments into cash is called FFFFFFFF. a. .arter .. hedging c. ar.itrage d. li/uidity (d; 2oderate; p. !3; #$1% Which of the following is >$T trueG a. The international capital market expands the a0aila.le set of lending opportunities. .. &n0estors reduce their o0erall risk .y spreading their money o0er a greater num.er of de.t and e/uity instruments. c. &n0estors increase risk .y holding international securities whose prices mo0e independently. d. &n0esting in international securities .enefits in0estors .ecause some economies are growing while others are in decline. (c; 2oderate; p. !3- '(; #$1% ). -n expanded money supply FFFFFFFF. a. reduces the cost of .orrowing .. makes it difficult for financial institutions to lend money c. increases the cost of .orrowing d. diminishes the entrepreneurial initiati0es of a country (a; 2oderate; p. !3- '(; #$1% ,. Which of the following is not a purpose of the international capital marketG a. Ceducing in0estor risk .. Expanding the money supply for .orrowers c. Ceducing the cost of money to .orrowers d. Hreser0ing hard currencies to finance trade deficits (d; 2oderate; p. !3- '(; #$1% !. The international capital market FFFFFFFF. a. limits the a0aila.le set of lending opportunities .. increases o0erall portfolio risk for in0estors c. is easily accessi.le to e0eryone d. allows in0estors to reduce risk .y holding international securities whose prices mo0e independently (d; 2oderate; p. !3- '(; #$1% '. - small group of low-income entrepreneurs from less-de0eloped countries .orrowing money at competiti0e rates with little or no collateral is called FFFFFFFF. a. microde.it .. microcredit c. capital loans d. capital credit (.; 2oderate; p. '(; #$1% 8--9:;* Ethics< 4. 2icrocredit loans in de0eloping countries typically a0erage FFFFFFFF. .

Ch 9: International Financial Markets a. more than I1(( .. less than I1(( c. more than I!(( d. less than I!(( (.; 2oderate; p. '(; #$1% 8--9:;* Ethics< ". The international capital market6s rapid growth rate is traced to all these EJ9EHT FFFFFFFF. a. inno0ati0e financial instruments .. information technology c. foreign exchange rates d. deregulation (c; 2oderate; p. '1; #$1% 8--9:;* Ethics< 3. =eregulation of capital markets resulted in all of the following EJ9EHT FFFFFFFF. a. increased competition .. lowered the cost of financial transactions c. opened many national markets to glo.al in0esting and .orrowing d. reduced the use of microcredit (d; 2oderate; p. '1; #$1% 1(. The international .ond market consists of all .onds sold .y issuing companies1 go0ernments1 or other organizations FFFFFFFF. a. within their own countries .. to #ondon .anks c. outside their own countries d. to de0eloping nations only (c; Easy; p. ' ; #$ % 11. The most important factor fueling growth in the international .ond market is FFFFFFFF. a. former communist countries6 transformation to capitalist .. technology deregulation c. rising stock markets worldwide d. low interest rates (d; 2oderate; p. '); #$ % 1 . Typical .uyers of .onds include all of the following EJ9EHT FFFFFFFF. a. medium- to large-sized .anks .. pension funds c. mutual funds d. go0ernments in need of funds (d; 2oderate; p. '); #$ % 1). Euro.onds account for FFFFFFFF percent of all international .onds. a. ( to ! .. )( to ,( c. !( to '! d. 4! to "( (d; =ifficult; p. '); #$ % 1,. - .ond issued .y a Kenezuelan company1 denominated in D.:. dollars1 and sold in ;ritain1 +rance1 and 7ermany is called a(n% FFFFFFFF.

Ch 9: International Financial Markets a. Keno.ond .. +oro.ond c. Euro.ond d. #atino.ond (c; 2oderate; p. '); #$ % 1!. Euro.onds are popular .ecause FFFFFFFF. a. they are less risky than traditional .onds .. they are always denominated in euros c. of the a.sence of go0ernment regulation d. European companies are considered 0ery sta.le (c; 2oderate; p. '); #$ % 1'. The a.sence of go0ernment regulation in the Euro.ond market FFFFFFFF. a. su.stantially reduces the cost of issuing a .ond .. lowers the risk le0el of the .ond c. makes Euro.onds less popular than foreign .onds d. exists .ecause of the difficulty of regulating a multi-country market (a; 2oderate; p. '); #$ % 14. ;onds sold outside the .orrower6s country and denominated in the currency of the country in which they are sold are called FFFFFFFF. a. international .onds .. foreign .onds c. Euro.onds d. local .onds (.; Easy; p. '); #$ % 1". +oreign .onds account for a.out FFFFFFFF percent of all international .onds. a. ( to ! .. ! to ,( c. !( to 4( d. more than 3( (a; =ifficult; p. '); #$ % 13. +oreign .onds issued in Bapan are called FFFFFFFF. a. .ulldog .onds .. yankee .onds c. samurai .onds d. dragon .onds (c; 2oderate; p. '); #$ % The most commonly /uoted rate in the Eurocurrency market is the FFFFFFFF. a. #ondon &nter.ank $ffer Cate (#&;$C% .. #ondon &nter.ank ;id Cate (#&;&=% c. spot rate d. cross rate (a; 2oderate; p. '!; #$ % 1. Cates that the world6s largest .anks charge one another for loans are called FFFFFFFF. a. inter.ank interest rates (.

Ch 9: International Financial Markets .. standardized interest rates c. exchange rates d. none of the a.o0e (a; Easy; p. '!; #$ % The market in which currencies are .ought and sold and their prices determined is called the FFFFFFFF. a. Eurocurrency market .. international capital market c. international .ond market d. foreign exchange market (d; Easy; p. '!; #$)% The rate at which one currency is exchanged for another is called the FFFFFFFF. a. exchange rate .. #&;$C c. #&9D rate d. +ederal funds rate (a; Easy; p. '!; #$)% The .id-ask spread in the foreign exchange market is the FFFFFFFF. a. price at which a .ank will .uy a currency .. price of currency in the foreign exchange market c. difference .etween the .id and ask /uotes for a currency d. price a .ank will pay for a currency (c; Easy; p. '!; #$)% +or which of the following reasons do in0estors use the foreign exchange marketG a. 9urrency hedging .. 9urrency speculation c. 9urrency ar.itrage d. 9urrency con0ersion e. -ll of the a.o0e (e; 2oderate; p. '!; #$)% The exchange rate .etween two currencies depends on FFFFFFFF. a. the size of the transaction .. the trader conducting the transaction c. general economic conditions d. all of the a.o0e (d; 2oderate; p. '!; #$)% The practice of insuring against potential losses that result from ad0erse changes in exchange rates is called currency FFFFFFFF. a. hedging .. ar.itrage c. speculation d. con0ersion (a; Easy; p. ''; #$)% ". FFFFFFFF is the instantaneous purchase and sale of a currency in different markets for profit. 4. '. !. ,. ). .

Ch 9: International Financial Markets a. 9urrency hedging .. 9urrency ar.itrage c. 9urrency speculation d. 9urrency con0ersion (.; Easy; p. ''; #$)% The profit-moti0ated purchase and sale of interest-paying securities denominated in different currencies is called FFFFFFFF. a. currency ar.itrage .. currency hedging c. interest ar.itrage d. interest hedging (c; 2oderate; p. ''; #$)% )(. The exchange rate .etween the euro (L% and the dollar is L(.",'1@I. Which of the following is the correct direct /uote on the dollarG a. I . (@L .. I1.1"13@L c. I!.!(@L d. I(.",'1@L (.; =ifficult; p. '3; #$,% )1. -n exchange rate calculated using two other exchange rates is called a FFFFFFFF. a. ar.itrage rate .. hedge rate c. forward rate d. cross rate (d; Easy; p. 4(; #$,% ) . Which of the following is an exchange rate that re/uires deli0ery of the traded currency within two .usiness daysG a. =eri0ati0e rate .. :pot rate c. =iscount rate d. +orward rate (.; Easy; p. 41; #$,% )). The exchange rate at which two parties agree to exchange currencies on a specified future date is called a FFFFFFFF. a. forward rate .. .id-ask rate c. spot rate d. ar.itrage rate (a; Easy; p. 4 ; #$,% ),. &f a currency6s forward rate is higher than its spot rate1 the currency is trading at a FFFFFFFF. a. discount .. swap rate c. deri0ati0e rate d. premium (d; 2oderate; p. 4 ; #$,% 3.

Ch 9: International Financial Markets

)!.

&f the spot for the ;ritish pound (7;H% is I1.'3!(@7;H and the )(-day forward rate is I1.'3 1@7;H1 then the pound is trading at a FFFFFFFF in the )(-day market. a. premium .. discount c. neither a premium nor a discount d. none of the a.o0e (.; 2oderate; p. 4 ; #$,% )'. Which of these is the simultaneous purchase and sale of foreign exchange for two different datesG a. +orward swap .. ;id-ask swap c. 9urrency swap d. :ecurity swap (c; 2oderate; p. 4); #$,% 8--9:;* Technology< )4. - currency used as an intermediary to con0ert funds .etween two other currencies is called a(n% FFFFFFFF. a. spot currency .. 0ehicle currency c. forward currency d. inter.ank currency (.; Easy; p. 4,; #$!% )". The world6s largest .anks exchange currencies at spot and forward rates in the FFFFFFFF. a. securities exchanges .. Eurocurrency market c. inter.ank market d. o0er-the-counter market (c; Easy; p. 4!; #$!% )3. - FFFFFFFF currency is traded freely in the foreign exchange market. a. .arter .. con0erti.le c. 0ehicular d. soft (.; 2oderate; p. 44; #$'% ,(. 7o0ernments impose currency restrictions to FFFFFFFF. a. protect a currency from speculators .. preser0e hard currencies to finance trade deficits or repay de.ts c. keep resident indi0iduals and .usinesses from in0esting in other nations d. all of the a.o0e (d; 2oderate; p. 44; #$'% SHORT-ANSWER QUESTIONS 1. -n FFFFFFFF is a country or territory whose financial sector features 0ery few regulations and few1 if any1 taxes.

Ch 9: International Financial Markets (offshore financial center; 2oderate; p. '1; #$1% . Hrominent operational centers include FFFFFFFF and FFFFFFFF. (#ondon1 :witzerland; =ifficult; p. '1; #$1% ). FFFFFFFF are usually located on small island nations or territories with fa0ora.le tax and@or secrecy laws. (;ooking centers; 2oderate; p. ' ; #$1% ,. The FFFFFFFF consists of all .onds sold .y issuing companies1 go0ernments1 or other organizations outside their own countries. (international .ond market; 2oderate; p. ' ; #$ % !. - .ond issued outside the country in whose currency it is denominated is called a(n% FFFFFFFF. (Euro.ond; 2oderate; p. '); #$ % '. ;onds sold outside the .orrower6s country and denominated in the currency of the country in which they are sold are called FFFFFFFF. (foreign .onds; 2oderate; p. '); #$ % 4. Today1 the most important factor fueling growth in the international .ond market is FFFFFFFF. (low interest rates; 2oderate; p. '); #$ % ". ;y issuing .onds in the international .ond market1 .orrowers from newly industrialized and de0eloping nations can .orrow money from other nations where interest rates are FFFFFFFF. (lower; Easy; p. '); #$ % 3. The FFFFFFFF consists of all stocks .ought and sold outside the issuer6s home country. (international e/uity market; Easy; p. ',; #$ % 1(. &n a /uoted exchange rate1 the currency that is to .e purchased with another currency is called the FFFFFFFF. (.ase currency; =ifficult; p. '"; #$,% 11. The exchange rate calculated using two other exchange rates is called the FFFFFFFF. (cross rate; Easy; p. 4(; #$,% 1 . The exchange rate re/uiring deli0ery of the traded currency within two .usiness days is called the FFFFFFFF. (spot rate; Easy; p. 41; #$,% 1). The exchange rate at which two parties agree to exchange currencies on a specified future date is called the FFFFFFFF. (forward rate; 2oderate; p. 4 ; #$,% 1,. - FFFFFFFF is a contract re/uiring the exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate. (forward contract; 2oderate; p. 4 ; #$,%

Ch 9: International Financial Markets 1!. &f a currency6s forward rate is higher than its spot rate1 the currency is trading at a FFFFFFFF. (premium; 2oderate; p. 4 ; #$,% 1'. &f a currency6s forward rate is lower than its spot rate1 the currency is trading at a FFFFFFFF. (discount; 2oderate; p. 4 ; #$,% 14. - FFFFFFFF is the simultaneous purchase and sale of foreign exchange for two different dates. (currency swap; Easy; p. 4); #$,% 8--9:;* Technology< 1". - FFFFFFFF is a right to exchange a specific amount of a currency on a specific date at a specific rate. (currency option; Easy; p. 4); #$,% 13. - FFFFFFFF is a currency used as an intermediary to con0ert funds .etween two other currencies. (0ehicle currency; Easy; p. 4,; #$!% (. The world6s largest .anks exchange currencies at spot and forward rates in the FFFFFFFF. (inter.ank market; 2oderate; p. 4!; #$!% The process of aggregating the currencies that one .ank owes another and then carrying out that transaction is called FFFFFFFF. (clearing; Easy; p. 4!; #$!% 8--9:;* Technology< 9urrency that trades freely in the foreign exchange market1 with its price determined .y the forces of supply and demand1 is called a FFFFFFFF. (con0erti.le currency (or hard currency%; 2oderate; p. 44; #$'% ). Exchange of goods and ser0ices .etween two parties without money is called FFFFFFFF. (countertrade; Easy; p. 4"; #$'% ESSAY QUESTIONS 1. =escri.e the purposes of the international capital market1 and the factors accounting for its rapid growth. (=ifficult; p. !3- '1; #$1% What is an offshore financial centerG =ifferentiate .etween an operational and a .ooking center1 pro0iding country examples of each. (2oderate; p. '1; #$1% ). ;riefly descri.e any two of the three main components of the international capital market. (2oderate; p. ' - '!; #$ % ,. &dentify and explain factors responsi.le for the growth of the international e/uity market. (2oderate; p. ',; #$ % !. What is the foreign exchange marketG Explain why in0estors use this market. (2oderate; p. '!- ''; #$)% . . 1.

Ch 9: International Financial Markets

'. =ifferentiate .etween currency speculation and currency ar.itrage. Which is riskierG (=ifficult; p. ''; #$)% 4. =ifferentiate .etween a /uoted exchange rate and a cross rate pro0iding an example. (=ifficult; p. '"- 4(; #$,% ". &dentify and explain the types of currency instruments used in the forward market. (2oderate; p. 4 ; #$,% 3. Explain what a 0ehicle currency is and the role it plays in the foreign exchange market. (Easy; p. 4,- 4!; #$!% 1(. ;riefly descri.e the three main institutions of the foreign exchange market. (2oderate; p. 4!- 4'; #$!% 11. &dentify and discuss strategies for effecti0e foreign exchange management. (=ifficult; p. 4'; #$!% 1 . Why do go0ernments impose currency restrictions and how can companies get around such restrictionsG (2oderate; p. 44- 4"; #$'%