CHAPTER 17INTERNATIONAL BANKING: RESERVES, DEBT, AND RISK

MULTIPLE CHOICE
1. Which of the following assets makes use of the basket valuation technique?
a
.
Swap agreements
b
.
Oil facility
c
.
Buffer stock facility
d
.
Special drawing rights
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&. Swap agreements are generally conducted by the"
a
.
'ederal (eserve with foreign central banks
b
.
'ederal (eserve with foreign commercial banks
c
.
).S. %reasury with foreign central banks
d
.
).S. %reasury with foreign commercial banks
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*. Which of the following is a main central bank function of the +nternational ,onetary 'und?
a
.
%he conduct of open market operations
b
.
%he issuance of gold certificates
c
.
%he provision of monetary policy for member nations
d
.
%he granting of loans to member nations
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-. %he 'ederal (eserve.s swap network represents"
a
.
/fforts to stabili0e only the value of the dollar
b
.
/fforts to stabili0e only the value of foreign currencies
c
.
1ong2term borrowing among countries
d
.
Short2term borrowing among countries
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3. +nternational trade and investment are most frequently financed by the ).S. dollar and the"
a
.
4apanese yen
b
.
British pound
c
.
ustralian dollar
d
.
Swiss franc
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5. %he purpose of international reserves is to finance"
a
.
Short2term surpluses in the balance of payments
b
.
1ong2term surpluses in the balance of payments
c
.
Short2term deficits in the balance of payments
d
.
1ong2term deficits in the balance of payments
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7. %he currencies generally referred to as 8reserve currencies8 are the"
a
.
4apanese yen and ).S. dollar
b
.
Swiss franc and 4apanese yen
c
.
British pound and ).S. dollar
d
.
Swiss franc and British pound
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9. Which of the following does not represent a form of international liquidity?
a
.
+,' reserve positions
b
.
:eneral arrangements to borrow
c
.
).S. government securities
d
.
(eciprocal currency arrangements
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;. Which of the following is not considered an 8owned8 reserve?
a
.
!ational currencies
b
.
:old
c
.
Special drawing rights
d
.
Oil facility
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1<. Which of the following is not considered a 8borrowed8 reserve?
a
.
Special drawing rights
b
.
Oil facility
c
.
+,' drawings
d
.
(eciprocal currency arrangement
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11. /urodollars are"
a
.
#ollar2denominated deposits in overseas banks
b
.
/uropean currencies used to finance transactions in the )nited States
c
.
#ollars that ).S. residents spend in /urope
d
.
/uropean currencies used to finance imports from the )nited States
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1&. Which of the following is not a characteristic of the /urodollar market? +t"
a
.
+s mainly located in the )nited =ingdom and continental /urope
b
.
Operates as a financial intermediary> bringing together lenders and borrowers
c
.
#eals in interest2bearing time deposits and loans to governments
d
.
:rew in response to the deregulation of interest rate ceilings on ).S. savings accounts
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1*. Which of the following assets was ?were@ created in 1;7< to provide additional international liquidity>
in the belief that increasing world trade requires more liquidity for larger eApected payments
imbalances?
a
.
/urodollar market
b
.
Special drawing rights
c
.
(eciprocal currency arrangements
d
.
:eneral arrangements to borrow
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1-. Which of the following constitute?s@ the largest component of the world.s international reserves?
a
.
:old
b
.
Special drawing rights
c
.
+,' drawings
d
.
'oreign currencies
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13. With an international gold standard> if a country ended up with a deficit from the balances on its
current and capital accounts> it would"
a
.
+mport gold to settle the balance
b
.
/Aport gold to settle the balance
c
.
Officially decrease the price of gold
d
.
Officially increase the price of gold
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15. Which of the following is not a condition of the international gold standard? %hat a nation must"
a
.
6onvert gold into paper currency> and vice versa> at a stipulated rate
b
.
$ermit gold to be freely imported and eAported
c %olerate wide fluctuations in its eAchange rate
.
d
.
#efine its monetary unit in terms of a stipulated amount of gold
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17. ll of the following eAchange2rate systems require international reserves to finance balance2of2
payments disequilibriums eAcept"
a
.
$egged or fiAed eAchange rates
b
.
,anaged floating eAchange rates
c
.
dBustable pegged eAchange rates
d
.
'reely floating eAchange rates
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19. dollar shortage would indicate that the dollar is"
a
.
)ndervalued in international markets
b
.
Overvalued in international markets
c
.
Overvalued in terms of gold
d
.
Overvalued in terms of special drawing rights
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1;. %he ).S. gold outflow that began in the late 1;-<s and continued through the 1;5<s was due in part to"
a
.
6rawling pegged eAchange rates
b
.
'reely floating eAchange rates
c
.
n undervalued dollar
d
.
n overvalued dollar
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&<. %he ).S. dollar glut of the 1;5<s was due in part to"
a
.
n undervalued dollar
b
.
n overvalued dollar
c
.
'reely floating eAchange rates
d
.
6rawling pegged eAchange rates
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&1. 'or developing countries such as ,eAico and Bra0il> severe economic problems in the 1;9<s were
caused by"
a
.
fall in the world demand for products produced by developing countries
b
.
Cigh prices of basic raw materials and other commodities
c
.
1ow real interest rates in the )nited States
d
.
Cigh levels of income and imports for the )nited States
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&&. +n response to the international debt problem> the )nited States set up a special fund in 1;95 to help
make up for lost oil revenues. )nder the plan> the )nited States would make more money available as
world oil prices fell. %his plan was designed to help"
a
.
rgentina
b
.
Saudi rabia
c
.
,eAico
d
.
Bra0il
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&*. Which indicator of international debt burden schedules interest and principal payments on long2term
debt as a percent of eAport earnings?
a
.
#ebt service ratio
b
.
#ebt2to2eAport ratio
c
.
(atio of eAternal debt to gross domestic product
d
.
(atio of eAternal debt to gross national product
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&-. Which term best describes the process in which the +nternational ,onetary 'und provides loans to
countries facing balance2of2payments difficulties provided that they initiate programs holding promise
of correcting these difficulties?
a
.
6onditionality
b
.
#ebt service
c
.
(eciprocal currency arrangement
d
.
Swap agreement
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&3. ll of the following are maBor goals of the +nternational ,onetary 'und eAcept"
a
.
$romoting international cooperation among member countries
b
.
'ostering a multilateral system of international payments
c
.
,aking long2term development and reconstruction loans
d
.
$romoting eAchange2rate stability and the elimination of eAchange restrictions
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&5. Which international reserve asset was officially phased out of the international monetary system by the
)nited States in the early 1;7<s?
a
.
Special drawing rights
b
.
Swap agreements
c
.
:eneral arrangements to borrow
d
.
:old
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&7. Bilateral agreements between central banks> which provide for an eAchange of currencies to help
finance temporary balance2of2payments disequilibriums> are referred to as"
a
.
+,' drawings
b
.
Special drawing rights
c
.
Buffer stock facility
d
.
Swap agreements
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&9. Which organi0ation is largely intended to make long2term reconstruction loans to developing nations?
a
.
/Aport2+mport Bank
b
.
World Bank
c
.
+nternational ,onetary 'und
d
.
)nited !ations
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&;. 8Owned8 international reserves consist of"
a
.
Special drawing rights
b
.
Oil facility
c
.
+,' drawings
d
.
(eciprocal currency arrangements
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*<. 8Borrowed8 international reserves consist of"
a
.
+,' drawings
b
.
'oreign currencies
c
.
:old
d
.
Special drawing rights
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*1. 6oncerning international lending risk of commercial banks> DDDD refers to the probability that partEall
of the interestEprincipal of a loan will not be repaid.
a
.
6ountry risk
b
.
6redit risk
c
.
6urrency risk
d
.
$residential risk
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*&. 6oncerning international lending risk of commercial banks> DDDD is closely related to political
developments in a borrowing country> especially the government.s views concerning international
investments and loans.
a
.
/conomic risk
b
.
6redit risk
c
.
6ountry risk
d
.
6urrency risk
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**. 6oncerning international lending risk of commercial banks> DDDD is associated with possible changes
in the eAchange value of a nation.s currency.
a
.
$olitical risk
b
.
6ountry risk
c
.
6redit risk
d
.
6urrency risk
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*-. %o reduce their eAposure to developing country debt> lending commercial banks have practiced all of
the following eAcept"
a
.
,aking outright loan sales to other commercial banks
b
.
(educing their capital base as a cushion against losses
c
.
#ealing in debt2for2debt swaps with foreign governments
d
.
#ealing in debtEequity swaps with foreign governments
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*3. %o reduce losses on developing country loans> commercial banks sometimes sell their loans> at a
discount> to a developing country government for local currency which is then used to finance
purchases of ownership shares in developing country industries. %his practice is known as"
a
.
#ebt forgiveness
b
.
#ebt buyback
c
.
#ebt2for2debt swap
d
.
#ebtEequity swap
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*5. 6oncerning international debt> DDDD refers to a negotiated reduction in the contractual obligations of
the debtor country and includes schemes such as markdowns and write2offs of debt.
a
.
#ebtEequity swap
b
.
#ebt2for2debt swap
c
.
#ebt forgiveness
d
.
#ebt sales
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*7. %he eAchange of borrowing country debt for an ownership position in the borrowing country is known
as"
a
.
#ebt forgiveness
b
.
#ebt2for2debt swap
c
.
#ebt reduction
d
.
#ebtEequity swap
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*9. 86ountry risk8 analysis is concerned with all of the following eAcept"
a
.
#epreciation of the borrowing country.s currency
b
.
$olitical instability in the borrowing country
c
.
/conomic growth in the borrowing country
d
.
/Aternal debt of the borrowing country
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*;. #ebt reduction
a
.
(efers to any voluntary scheme that lessens the burden on the debtor nation
b
.
,ay be accomplished through debt rescheduling
c
.
,ay be achieved through debtEequity swaps
d
.
ll of the above
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-<. ,ost analysts feel that the financial difficulties in /ast sia were triggered by
a
.
,isallocation of investment
b
.
)navailability of cheap foreign labor
c
.
1ack of alignment of the eAchange rate with the dollar
d
.
Surpluses in the trade accounts of the sian countries
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-1. nation may eAperience debt2servicing problems because of
a
.
$ursuit of improper macroeconomic policies
b
.
+nadequate borrowing
c
.
dverse economic events
d
.
Both a and c
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-&. Swap arrangements
a
.
re agreements between governments
b
.
(equire repayment within a stipulated period
c
.
re usually multilateral agreements
d
.
re never initiated by telephone
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TRUE/FALSE
1. )nder a system of fiAed eAchange rates> international reserves are needed to bridge the gap between
monetary receipts and monetary payments.
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&. +nternational reserves allow a country to finance disequilibria in its balance2of2payments position.
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*. n advantage of international reserves is that they allow countries to sustain temporary balance2of2
payments deficits until acceptable adBustment measures can operate to correct the disequilibrium.
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-. With floating eAchange rates> countries require si0able amounts of international reserves for the
stabili0ation of eAchange rates.
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3. When eAchange rates are fiAed by central bankers> the need for international reserves disappears.
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5. When eAchange rates are fiAed by central bankers> international reserves are necessary for financing
payments imbalances and the stabili0ation of eAchange rates.
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7. %here eAists a direct relationship between the degree of eAchange rate fleAibility and the need for
international reserves.
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9. With floating eAchange rates> payments imbalances tend to be corrected by market2induced
fluctuations in the eAchange rate> and the need for eAchange2rate stabili0ation and international
reserves disappears.
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The diagram below represents the exchange market position of the United States in trade with the
United Kingdom. Starting at the equilibrium exchange rate of $3 per pound, suppose the demand for
pounds rises from ! to ".
Figur 17!1 F"rig# E$%&'#g M'r()
;. (efer to 'igure 17.1. )nder a fiAed eAchange rate system> ).S. monetary authorities would have to
supply 9 million pounds in eAchange for dollars to keep the eAchange rate at F* per pound.
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1<. (efer to 'igure 17.1. +f the eAchange rate was allowed to rise to F- per pound> ).S. monetary
authorities would have to supply 5 million pounds to the foreign eAchange market in eAchange for
dollars to maintain this rate.
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11. (efer to 'igure 17.1. )nder a floating eAchange rate system> the eAchange rate would rise to F- and
).S. monetary authorities would have to supply - million pounds to the foreign eAchange market in
eAchange for dollars to maintain this rate.
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1&. %o the eAtent that adBustments in prices> interest rates> and income levels promote balance2of2payments
equilibrium> the demand for international reserves decreases.
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1*. %he greater a nation.s propensity to apply tariffs and quotas to key sectors> the greater will be the need
for international reserves.
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1-. %he demand for international reserves is negatively related to the level of world prices and income.
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13. %he demand for international reserves tend to increase with the level of world income and trade
activity.
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15. +f a nation with a balance2of2payments deficit is willing and able to initiate quick actions to increase
eAport receipts and decrease import payments> the amount of international reserves needed will be
relatively large.
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17. %he supply of international reserves consists of owned reserves and borrowed reserves.
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19. 'oreign currencies constitute the smallest component of the world.s international reserves.
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1;. :old constitutes the largest component of the world.s international reserves.
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&<. %he ).S. dollar has been considered a reserve ?key@ currency because trading nations have been
willing to hold it as an international reserve asset.
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&1. %he ).S. dollar> 4apanese yen> British pound> and ,eAican peso are the maBor reserve currencies of the
international monetary system.
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&&. By the 1;;<s> the British pound had replaced the ).S. dollar as the world.s key currency.
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&*. goal of the +nternational ,onetary 'und is to make short2term loans to member nations so as to
allow them to correct balance of payments disequilibriums without resorting to measures that would
destroy national prosperity.
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&-. When granting loans to financially troubled nations> the +nternational ,onetary 'und requires some
degree of conditionality> meaning that the borrowing nation must agree to implement economic
policies as mandated by the +,'.
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&3. %he +nternational ,onetary 'und has sometimes demanded that financially2troubled nations> that
borrow from the +,'> undergo austerity programs including slashing of public spending and private
consumption.
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&5. %he main purpose of the +nternational ,onetary 'und is to grant long2term loans to developing nations
to help them finance the development of infrastructure such as roads> dams> and bridges.
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&7. :old is currently the most widely used asset in the international monetary system.
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&9. +n 1;7- the )nited States revoked a -12year ban on ).S. citi0en.s ownership of gold.
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&;. +n 1;73 the official price of gold was abolished as the unit of account for the international monetary
system. s a result> gold was demoneti0ed as an international reserve asset.
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*<. +n the 1;7<s> the maBor industrial countries abandoned the managed2floating eAchange rate system and
adopted a system of fiAed eAchange rates tied to the price of gold.
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*1. 6reated by the +nternational ,onetary 'und> special drawing rights ?S#(s@ are unconditional rights to
draw currencies of other nations> thus enabling countries to finance their current2account deficits.
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*&. %he value of the S#( is tied to a currency basket consisting of the ).S. dollar> :erman mark> 4apanese
yen> 'rench franc> and British pound.
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**. %he S#( has replaced the dollar> yen> and mark as the key asset of the international financial system.
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*-. Because the value of the S#( is tied directly to the value of the ).S. dollar> a 1< percent dollar
depreciation would result in a 1< percent decrease in the S#(.s value.
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*3. main purpose of the +nternational ,onetary 'und is to make loans of foreign currencies to member
countries which are eAperiencing current2account surpluses.
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*5. When a deficit nation borrows from the +nternational ,onetary 'und> it purchases with its currency
the foreign currency required to help finance the payments deficit.
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*7. %he so2called :eneral rrangements to Borrow provide a permanent increase in the supply of
international reserves.
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*9. Swap arrangements are bilateral agreements between central banks to allow countries to temporarily
borrow funds to ease current2account deficits and discourage speculative capital flows.
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*;. +,' drawings> swap arrangements> buffer stock facility> and compensatory financing for eAports are
classified as owned reserves rather than borrowed reserves.
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-<. 6oncerning international lending risk> credit risk refers to the probability that part or all of the interest
rate or principal of a loan will not be repaid.
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-1. 6oncerning international lending risk> country risk refers to the risk that part or all of the interest or
principal of a loan will not be repaid.
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-&. 6oncerning international lending risk> currency risk is the risk of asset losses due to changing currency
values.
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-*. country with a high debtEeAport ratio and a high debt serviceEeAport ratio would likely be considered
as an attractive place in which to invest by foreign residents.
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--. debt buyback is a debt2reduction technique in which a government of a debtor nation buys loans
from commercial banks at a discount.
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-3. )nder a debt2for2debt swap> a commercial bank sells its loans at a discount to a developing country
government for local currency which it then uses to finance an equity investment in the debtor country.
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-5. debt2equity swap results in a trade surplus nation forgiving the loans made to a trade2deficit nation.
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-7. /urocurrencies are deposits> denominated and payable in dollars and other foreign currencies> in banks
outside the )nited States> primarily in 1ondon> the market.s center.
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SHORT ANS*ER
1. Why do countries hold international reserves?
!S"
%he purpose of international reserves is to permit nations to bridge the gap between monetary receipts
and payments.
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&. Cow can a bank reduce its eAposure to the debt of developing nations?
!S"
+t can reduce eAposure through outright loan sales in the secondary market> debt buybacks> debt2for2
debt swaps> and debtEequity swaps.
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ESSA+
1. #escribe the eurocurrency market.
!S"
/urocurrencies are deposits> denominated and payable in dollars and other foreign currencies> such as
Swiss franc> in banks outside the )nited States> primarily in 1ondon> the market.s center. ,ost
eurocurrency trading occurs in non2/uropean centers> such as Cong =ong> and Singapore. #ollar
deposits located in banks outside the )nited States are known as eurodollars> and banks that conduct
trading in the markets for eurocurrencies are designated eurobanks.
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&. re international reserve needs different for different eAchange rate regimes?
!S"
%he need for international reserves tends to become less acute under a system of floating rates than
under a system of fiAed rates. %he more efficient the international adBustment mechanism and the
greater the eAtent of international policy coordination> the smaller the need for international reserves.
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