Chap 017

Chapter 17
The Foreign Exchange Market
Multiple Choice Questions
1. Which of the following refers to foreign exchange?
A. The act of trading different nations'

moneys.
B. The holdings of foreign
assets.
C. The act of exchanging goods and services
internationally.
D. The adoption of foreign trade
policies.
2. If the price of British pounds in terms of the U.S. dollars is $1.80 per pound, then the
price of U.S. dollars in terms of British pounds is:
A. 1.80 per
dollar.
B. 0.555 per
dollar.
C. 0.90 per
dollar.
D. 3.60 per
dollar.
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3. Suppose the yen per dollar exchange rate is 100. The dollar price of a Japanese stereo
system of worth 60,000 yen is:
A. $1,66
7.
B. $60
0.
C. $6,00
0.
D. $10
0.
4. Suppose that a Korean television set that costs 600 won in Korea costs $400 in the
United States. Which of the following correctly indicates the implied won per dollar
exchange rate?
A. 1.5 won per

dollar
B. 0.67 won per
dollar
C. $1.50 per
won
D. $2.40 per
won
5. The exchange rate set for an immediate trade is often referred to as a:
A. managed exchange
rate.
B. pegged exchange
rate.
C. forward exchange
rate.
D. spot exchange
rate.
6. When the exchange rate is set now for a currency trade that will take place sometime
more than a few days in the future is often referred to as a:
A. spot exchange
rate.
B. forward exchange
rate.
C. pegged exchange
rate.
D. managed exchange
rate.
7. The retail part of the foreign exchange market does not include traders at banks
trading with:
A. national
governments.
B. stock brokers who trade in the assets of the firms in
different nations.
C. traders at other
banks.
D. nonfinancial companies that sometimes want to buy and sell different
currencies.
8. Which of the following is true of foreign exchange markets?
A. The foreign exchange market is a single gathering place where traders shout buy
and sell orders at each other.
B. Individuals' exchanges of currencies comprise the largest portion of overall foreign
exchange trading.
C. The laws of demand and supply are not applicable in a foreign
exchange market.
D. Most foreign exchange trading involves the exchange of U.S. dollars for other
currencies.
9. The U.S. dollar is called a _____ because it is often used as an intermediary to
accomplish trading between two other currencies.
A. vehicle
currency
B. main
currency
C. common
currency
D. primary
currency
10. Suppose the dollar per pound exchange rate is $2 per pound while the dollar per
Swiss franc exchange rate is 50 cents per franc. From the given information we can
conclude that the Swiss franc per pound exchange rate is:
A. 1 franc per
pound.
B. too
low.
C. too
high.
D. 4 francs per
pound.
11. Which of the following is NOT a function of the interbank part of the foreign exchange
market?
A. Provides a bank with a continuous stream of information on conditions in the

foreign exchange market
B. Provides a bank the means to readjust its own position quickly and at low cost when
it separately conducts a large trade with a customer
C. Permits a bank to take on a position in a foreign currency quickly if the bank and its
traders want to speculate on exchange-rate movements in the near future
D. Provides clearing services for organizations that prefer to use different
currencies
12. The 2004-2010 rapid growth in global foreign exchange trading can be explained by:
A. large increases in trading by hedge funds, pension funds, and other financial
institutions.
B. increases in volume of global trade in the
recent years.
C. volatility in U.S. long term government bond
yields.
D. increase in the number of nations adopting floating exchange
rate system.
13. Interbank trading is conducted directly between _____ or through the use of _____ that
provide anonymity until the trade is complete and reduce search costs.
A. traders;
brokers
B. brokers;
traders
C. individual consumers; the
government
D. individual consumers;
brokers
14. A country's demand for foreign currency is derived from:
A. international transactions entering the debit side of its balance of

payments accounts.
B. international transactions entering the credit column of its balance of
payments accounts.
C. the government's attempt to revalue domestic
currency.
D. an increase in foreign capital inflows in the domestic
country.
15. Rapid increases in the U.S. exports of goods and services will result in a(n) _____
foreign currency and a(n) _____ the U.S. dollars in the foreign exchange market.
A. increase in the demand for; increase in the

supply of
B. increase in the supply of; increase in the
demand for
C. shortage of;
surplus of
D. decrease in the supply of; decrease in the
demand for
16. An increase in the U.S. imports of goods and services from the EU countries will result
in a(n) _____ euro and a(n) _____ the U.S. dollars in the foreign exchange market.
A. increase in the supply of; increase in the

demand for
B. decrease in the demand for; decrease in the
supply of
C. surplus of;
shortage of
D. increase in the demand for; increase in the
supply of
17. An increase in capital inflows in the United States will result in a(n) _____ foreign
currency and a(n) _____ the U.S. dollars in the foreign exchange market.

supply of
demand for
C. shortage of;
surplus of
demand for
18. In the foreign exchange market, what could be a possible consequence of an increase
in the purchase of stocks of Toyota, a Japanese automobile firm, by the U.S.
residents?
A. Demand for dollar will

increase
B. Yen will
depreciate
C. Dollar will
depreciate
D. Supply curve for dollar will shift to
the left
19. A decrease in German residents' willingness to invest in dollar-denominated assets will

shift the demand curve for:
A. Euros to the
right.
B. Euros to the
left.
C. Dollars to the
right.
D. Dollars to the
left.
20. In a floating exchange rate system, the dollar per pound exchange rate is determined
by:
A. the American
government.
B. the British
government.
C. the interaction of the demand and supply of pounds in the foreign
exchange market.
D. the interaction of the demand for and supply of dollar-denominated assets in the
stock market.
21. As the value of the yen falls relative to the U.S. dollar in the foreign exchange market:
A. Japanese goods become more expensive to the U.S.

consumers.
B. the supply of dollars will
fall.
C. the demand for Japanese goods will increase in the U.S.
market.
D. U.S. goods become less expensive to Japanese
consumers.
22. An increase in the dollar per euro exchange rate will result in:
A. a decline in the quantity demanded

for euro.
B. a decline in the quantity demanded for
dollar.
C. an inward shift of the supply curve of
euro.
D. an outward shift of the demand curve for
dollar.
23. Shifts in demand away from French products and toward the U.S. products (caused by
forces other than changes in the exchange rate) would result in extra attempts to:
A. buy both euros and

dollars.
B. sell both euros and
dollars.
C. sell euros and buy
dollars.
D. buy euros and sell
dollars.
24. Other things remaining unchanged, if American exports to Japan increase and
American imports from Japan decrease, then under a floating exchange rate system,
we would expect:
A. the U.S. dollar to

appreciate.
B. the yen value of a U.S. dollar to be higher in Tokyo than in
New York.
C. the demand for Japanese yen to increase in the foreign
exchange market.
D. the supply curve of Japanese yen to shift
inward.
The figure given above illustrates the market for British pounds. D and S are the
demand and supply curves of the British pounds respectively.
25. In Figure 17.1, a downward movement along the vertical axis would correspond to
a(n) _____ of the U.S. dollar.
A. arbitra
ge
B. swa
p
C. appreciati
on
D. depreciati
on
26. In Figure 17.1, at an exchange rate of $2.50 per pound, there is an:
A. excess demand for 1 million

pounds.
B. excess supply of 1 million
pounds.
C. excess demand for 0.5 million
pounds.
D. excess supply of 0.5 million
pounds.
27. In Figure 17.1, if the British government wants to peg the dollar per pound exchange
rate at $2.50 per pound, what action would British monetary authorities have to
undertake?
A. Sell 1 million pounds and buy 2.5 million

dollars
B. Buy 1 million pounds and sell 1 million
dollars
C. Buy 1 million pounds and sell 2.5 million
dollars
D. Buy 6 million pounds and sell 12 million
dollars
28. In Figure 17.1, if the exchange rate is pegged at $2.50 per pound:
A. the pound will be

overvalued.
B. the pound will be
undervalued.
C. the British goods will become cheap in U.S.
markets.
D. the demand for the American goods will fall in British
markets.
29. Refer to Figure 17.1. Who among the following groups will most likely benefit if the
exchange rate is pegged at $2.50 per pound?
A. The U.S.
importers
B. The British
importers
C. The British
exporters
D. The import-competing producers in
the U.K.
30. Refer to Figure 17.1. Suppose initially the exchange rate is pegged at $2.50 per
pound. If the governments allow the pound to float, the pound will experience a(n):
A. surplu
s.
B. buoyant
period.
C. appreciatio
n.
D. depreciatio
n.
31. Refer to Figure 17.1, if the U.S. Federal Reserve uses a contractionary monetary
policy, the _____ curve would shift right and the pound would tend to ____.
A. S;
appreciate
B. D;
depreciate
C. S;
depreciate
D. D;
appreciate
32. In a _____ exchange rate system the government or central bankers intervene to keep
the exchange rate virtually steady.
A. fixe
d
B. market
driven
C. managed
float
D. forwar
d
33. Under the floating exchange rate system, a fall in the market price of a currency is
called:
A. devaluatio
n.
B. depreciatio
n.
C. appreciatio
n.
D. revaluatio
n.
34. Which of the following best characterizes the current U.S. exchange rate policy?
A. An adjustable pegged exchange

rate
B. A crawling pegged exchange
rate
C. A freely floating exchange
rate
D. A fixed exchange
rate
35. Under a floating exchange rate system, everything remaining constant, an increase in
European exports to Japan is most likely to result in:
A. a decrease in the demand for euro in the foreign exchange

market.
B. a decrease in the supply of euro in the foreign exchange
market.
C. an appreciation of the Japanese yen vis--vis
the euro.
D. an appreciation of the euro vis--vis the
Japanese yen.
36. Which of the following groups is most likely to benefit from a strengthening of the U.S.
dollar against other major currencies?
A. U.S.
exporters
B. The U.S.
government
C. U.S.
consumers
D. Foreign
consumers
37. Under a fixed exchange rate system, a fall in the market price (the exchange rate
value) of a currency is called a(n) _____ of that currency.
A. revaluati
on
B. devaluati
on
C. appreciati
on
D. depreciati
on
38. Under the system of pegged exchange rates, when the domestic currency's value
presses against the top of its official price range, officials must:
A. sell foreign currency and buy domestic

currency.
B. buy foreign currency and sell domestic
currency.
C. let the exchange rate change and refrain from intervention in the foreign
exchange market.
D. guide the exchange rate to reach the
equilibrium rate.
39. Exchange rates are equalized in different locations due to:
A. arbitrag
e.
B. government intervention in foreign exchange
markets.
C. free trade in goods and
services.
D. the actions of importers and
exporters.
40. How can one profit through arbitrage if the dollar per euro exchange rate in London is
$2 per pound while in New York is $1.95 per pound?
A. Buy dollars in New York and sell them in

London
B. Buy pounds in London and sell them in
New York
C. Buy pounds in New York and sell them in
London
D. Buy dollars in London and sell pounds in
New York
41. Under a floating exchange rate system, the value of the dollar per euro exchange rate
rises when:
A. The U.S. trade deficit with the euro-area countries

increases.
B. European demand for U.S. products
increases.
C. The U.S. government raises personal income tax
rates.
D. The inflation rate in the U.S. is much lower than the inflation rate in the
euro-area.
42. Under a floating exchange rate system, an increase in the international demand for
electronic appliances manufactured in Japan will result in:
A. Deflation in the Japanese

economy.
B. An increase in Japan's trade deficit with other
countries.
C. An appreciation of the yen vis--vis other
currencies.
D. A depletion of international reserves held by the central bank
of Japan.
True / False Questions
43. The greater part of the money assets traded in foreign exchange markets is demand
deposits in banks.
Difficulty Level: 1
True False
44. The spot exchange rate is the current price for an exchange that will take place a
month or more in the future.
Difficulty Level: 1
True False
45. Most foreign exchange trading is done among the banks themselves in the retail part
of the foreign exchange market.
Difficulty Level: 1
True False
46. Greece was among the 11 EU countries deemed to meet the five criteria in early
1998.
Difficulty Level: 1
True False
47. The euro was introduced in the foreign exchange market on January 1, 1990.
Difficulty Level: 1
True False
48. The Maastricht Treaty adopted by the EU countries set a process for establishing a
monetary union and a single union wide currency.
Difficulty Level: 1
True False
49. French imports of goods and services will create a demand for foreign currency and a
supply of euros.
Difficulty Level: 2
True False
50. From 2004 to 2010, global foreign exchange trading more than doubled.
Difficulty Level: 1
True False
51. Most interbank trading occurs through electronic brokering systems, with only a small
remaining role for voice brokers.
Difficulty Level: 1
True False
52. In the floating exchange rate system, government officials must intervene in the
foreign exchange market to keep the exchange rate from fluctuating.
Difficulty Level: 1
True False
53. Government officials wanting to defend a fixed exchange rate may not have sufficient
reserves of foreign currency to keep the price fixed indefinitely.
Difficulty Level: 2
True False
54. Assuming the Japanese have a floating exchange rate, an increase in Japanese
exports of goods and services will tend to cause the value of the yen to appreciate.
Difficulty Level: 1
True False
55. To maintain an undervalued currency, the country's monetary authorities must

intervene in the foreign exchange market to buy its currency in the foreign exchange
market.
Difficulty Level: 1
True False
56. Arbitrage ensures that the spot price of the currency will equal the forward price of
the currency.
Difficulty Level: 2
True False
57. Triangular arbitrage does not cause the cross rate between two foreign currencies to
be consistent with the dollar exchange rates of these two currencies.
Difficulty Level: 1
True False
Essay Questions
58. A retailer in Mexico wants to buy $100,000 worth of Apple computers from the United
States. The Mexican retailer has pesos while the seller in the United States wants to
be paid in U.S. dollars. Explain how this transaction is completed with particular
emphasis on the foreign exchange market and banks in the United States and
Mexico.
59. How does interbank foreign exchange trading work? What is being traded in the
interbank part of the foreign exchange markets? What functions does it serve?
For each of the cases given below, indicate what the numerical change means, and
state whether the euro has appreciated or depreciated.
60. The spot exchange rate changes from 450 euros per Mexican peso to 440 euros per
Mexican peso.
61. The spot exchange rate changes from 0.011 Mexican pesos per euro to 0.006 Mexican
pesos per euro.
62. The spot exchange rate changes from 1.48 euros per British pound to 1.51 euros per
British pound.
63. The spot exchange rate changes from 0.73 British pounds per euro to 0.75 British
pounds per euro.
Explain how the following factors affect the value of dollar vis--vis other currencies
under a floating exchange rate system.
64. Tariffs and quotas are placed by the U.S. government on all imports into the country.
65. Demand by foreign consumers for the U.S. exports falls and the U.S. demand for
imports rises.
66. Rising interest rates in the United States relative to interest rates in Europe.
67. Rising U.S. fiscal deficits reduce investor confidence and lead to capital outflows.
Briefly explain each of the following terms:
68. Forward exchange rate
69. Foreign exchange swap
70. Arbitrage
71. Triangular arbitrage
Suppose $1 = 0.85 euros in New York, 1 euro = 150 yen in Paris, and 1 yen = $0.008
in Tokyo.
72. If you begin by holding $1, how could you profit from these exchange rates? What is
your arbitrage profit per dollar initially traded?
73. Identify the forces at work that will make the exchange rates consistent with each
other in this situation. That is, what forces will lead to a situation in which no
profitable arbitrage is possible?
Chapter 17 The Foreign Exchange Market Answer Key
Multiple Choice Questions
1. Which of the following refers to foreign exchange?
A. The act of trading different nations'

moneys.
B. The holdings of foreign
assets.
C. The act of exchanging goods and services
internationally.
D. The adoption of foreign trade
policies.
2. If the price of British pounds in terms of the U.S. dollars is $1.80 per pound, then
the price of U.S. dollars in terms of British pounds is:
A. 1.80 per
dollar.
B. 0.555 per
dollar.
C. 0.90 per
dollar.
D. 3.60 per
dollar.
3. Suppose the yen per dollar exchange rate is 100. The dollar price of a Japanese
stereo system of worth 60,000 yen is:
A. $1,66
7.
B. $60
0.
C. $6,00
0.
D. $10
0.
4. Suppose that a Korean television set that costs 600 won in Korea costs $400 in the
United States. Which of the following correctly indicates the implied won per dollar
exchange rate?
A. 1.5 won per

dollar
B. 0.67 won per
dollar
C. $1.50 per
won
D. $2.40 per
won
5. The exchange rate set for an immediate trade is often referred to as a:
A. managed exchange
rate.
B. pegged exchange
rate.
C. forward exchange
rate.
D. spot exchange
rate.
6. When the exchange rate is set now for a currency trade that will take place
sometime more than a few days in the future is often referred to as a:
A. spot exchange
rate.
B. forward exchange
rate.
C. pegged exchange
rate.
D. managed exchange
rate.
7. The retail part of the foreign exchange market does not include traders at banks
trading with:
A. national
governments.
B. stock brokers who trade in the assets of the firms in
different nations.
C. traders at other
banks.
D. nonfinancial companies that sometimes want to buy and sell different
currencies.
8. Which of the following is true of foreign exchange markets?
A. The foreign exchange market is a single gathering place where traders shout
buy and sell orders at each other.
B. Individuals' exchanges of currencies comprise the largest portion of overall
foreign exchange trading.
C. The laws of demand and supply are not applicable in a foreign
exchange market.
D. Most foreign exchange trading involves the exchange of U.S. dollars for other
currencies.
9. The U.S. dollar is called a _____ because it is often used as an intermediary to

accomplish trading between two other currencies.
A. vehicle
currency
B. main
currency
C. common
currency
D. primary
currency
10. Suppose the dollar per pound exchange rate is $2 per pound while the dollar per
Swiss franc exchange rate is 50 cents per franc. From the given information we can
conclude that the Swiss franc per pound exchange rate is:
A. 1 franc per
pound.
B. too
low.
C. too
high.
D. 4 francs per
pound.
11. Which of the following is NOT a function of the interbank part of the foreign
exchange market?
A. Provides a bank with a continuous stream of information on conditions in the

foreign exchange market
B. Provides a bank the means to readjust its own position quickly and at low cost
when it separately conducts a large trade with a customer
C. Permits a bank to take on a position in a foreign currency quickly if the bank and
its traders want to speculate on exchange-rate movements in the near future
D. Provides clearing services for organizations that prefer to use different
currencies
12. The 2004-2010 rapid growth in global foreign exchange trading can be explained
by:
A. large increases in trading by hedge funds, pension funds, and other financial
institutions.
B. increases in volume of global trade in the
recent years.
C. volatility in U.S. long term government bond
yields.
D. increase in the number of nations adopting floating exchange
rate system.
13. Interbank trading is conducted directly between _____ or through the use of _____
that provide anonymity until the trade is complete and reduce search costs.
A. traders;
brokers
B. brokers;
traders
C. individual consumers; the
government
D. individual consumers;
brokers
14. A country's demand for foreign currency is derived from:
A. international transactions entering the debit side of its balance of

payments accounts.
B. international transactions entering the credit column of its balance of
payments accounts.
C. the government's attempt to revalue domestic
currency.
D. an increase in foreign capital inflows in the domestic
country.
15. Rapid increases in the U.S. exports of goods and services will result in a(n) _____
foreign currency and a(n) _____ the U.S. dollars in the foreign exchange market.

supply of
demand for
C. shortage of;
surplus of
demand for
16. An increase in the U.S. imports of goods and services from the EU countries will
result in a(n) _____ euro and a(n) _____ the U.S. dollars in the foreign exchange
market.
A. increase in the supply of; increase in the

demand for
B. decrease in the demand for; decrease in the
supply of
C. surplus of;
shortage of
D. increase in the demand for; increase in the
supply of
17. An increase in capital inflows in the United States will result in a(n) _____ foreign
currency and a(n) _____ the U.S. dollars in the foreign exchange market.

supply of
demand for
C. shortage of;
surplus of
demand for
18. In the foreign exchange market, what could be a possible consequence of an

increase in the purchase of stocks of Toyota, a Japanese automobile firm, by the
U.S. residents?
A. Demand for dollar will

increase
B. Yen will
depreciate
C. Dollar will
depreciate
D. Supply curve for dollar will shift to
the left
19. A decrease in German residents' willingness to invest in dollar-denominated assets
will shift the demand curve for:
A. Euros to the
right.
B. Euros to the
left.
C. Dollars to the
right.
D. Dollars to the
left.
20. In a floating exchange rate system, the dollar per pound exchange rate is
determined by:
A. the American
government.
B. the British
government.
C. the interaction of the demand and supply of pounds in the foreign
exchange market.
D. the interaction of the demand for and supply of dollar-denominated assets in the
stock market.
21. As the value of the yen falls relative to the U.S. dollar in the foreign exchange
market:
A. Japanese goods become more expensive to the U.S.

consumers.
B. the supply of dollars will
fall.
C. the demand for Japanese goods will increase in the U.S.
market.
D. U.S. goods become less expensive to Japanese
consumers.
22. An increase in the dollar per euro exchange rate will result in:
A. a decline in the quantity demanded

for euro.
B. a decline in the quantity demanded for
dollar.
C. an inward shift of the supply curve of
euro.
D. an outward shift of the demand curve for
dollar.
23. Shifts in demand away from French products and toward the U.S. products (caused
by forces other than changes in the exchange rate) would result in extra attempts
to:
A. buy both euros and

dollars.
B. sell both euros and
dollars.
C. sell euros and buy
dollars.
D. buy euros and sell
dollars.
24. Other things remaining unchanged, if American exports to Japan increase and
American imports from Japan decrease, then under a floating exchange rate
system, we would expect:
A. the U.S. dollar to

appreciate.
B. the yen value of a U.S. dollar to be higher in Tokyo than in
New York.
C. the demand for Japanese yen to increase in the foreign
exchange market.
D. the supply curve of Japanese yen to shift
inward.
The figure given above illustrates the market for British pounds. D and S are the
demand and supply curves of the British pounds respectively.
25. In Figure 17.1, a downward movement along the vertical axis would correspond to
a(n) _____ of the U.S. dollar.
A. arbitra
ge
B. swa
p
C. appreciati
on
D. depreciati
on
26. In Figure 17.1, at an exchange rate of $2.50 per pound, there is an:
A. excess demand for 1 million

pounds.
B. excess supply of 1 million
pounds.
C. excess demand for 0.5 million
pounds.
D. excess supply of 0.5 million
pounds.
27. In Figure 17.1, if the British government wants to peg the dollar per pound
exchange rate at $2.50 per pound, what action would British monetary authorities
have to undertake?
A. Sell 1 million pounds and buy 2.5 million

dollars
B. Buy 1 million pounds and sell 1 million
dollars
C. Buy 1 million pounds and sell 2.5 million
dollars
D. Buy 6 million pounds and sell 12 million
dollars
28. In Figure 17.1, if the exchange rate is pegged at $2.50 per pound:
A. the pound will be

overvalued.
B. the pound will be
undervalued.
C. the British goods will become cheap in U.S.
markets.
D. the demand for the American goods will fall in British
markets.
29. Refer to Figure 17.1. Who among the following groups will most likely benefit if the
exchange rate is pegged at $2.50 per pound?
A. The U.S.
importers
B. The British
importers
C. The British
exporters
D. The import-competing producers in
the U.K.
30. Refer to Figure 17.1. Suppose initially the exchange rate is pegged at $2.50 per
pound. If the governments allow the pound to float, the pound will experience a(n):
A. surplu
s.
B. buoyant
period.
C. appreciatio
n.
D. depreciatio
n.
31. Refer to Figure 17.1, if the U.S. Federal Reserve uses a contractionary monetary
policy, the _____ curve would shift right and the pound would tend to ____.
A. S;
appreciate
B. D;
depreciate
C. S;
depreciate
D. D;
appreciate
32. In a _____ exchange rate system the government or central bankers intervene to
keep the exchange rate virtually steady.
A. fixe
d
B. market
driven
C. managed
float
D. forwar
d
33. Under the floating exchange rate system, a fall in the market price of a currency is
called:
A. devaluatio
n.
B. depreciatio
n.
C. appreciatio
n.
D. revaluatio
n.
34. Which of the following best characterizes the current U.S. exchange rate policy?
A. An adjustable pegged exchange

rate
B. A crawling pegged exchange
rate
C. A freely floating exchange
rate
D. A fixed exchange
rate
35. Under a floating exchange rate system, everything remaining constant, an increase
in European exports to Japan is most likely to result in:
A. a decrease in the demand for euro in the foreign exchange

market.
B. a decrease in the supply of euro in the foreign exchange
market.
C. an appreciation of the Japanese yen vis--vis
the euro.
D. an appreciation of the euro vis--vis the
Japanese yen.
36. Which of the following groups is most likely to benefit from a strengthening of the
U.S. dollar against other major currencies?
A. U.S.
exporters
B. The U.S.
government
C. U.S.
consumers
D. Foreign
consumers
37. Under a fixed exchange rate system, a fall in the market price (the exchange rate
value) of a currency is called a(n) _____ of that currency.
A. revaluati
on
B. devaluati
on
C. appreciati
on
D. depreciati
on
38. Under the system of pegged exchange rates, when the domestic currency's value
presses against the top of its official price range, officials must:
A. sell foreign currency and buy domestic

currency.
B. buy foreign currency and sell domestic
currency.
C. let the exchange rate change and refrain from intervention in the foreign
exchange market.
D. guide the exchange rate to reach the
equilibrium rate.
39. Exchange rates are equalized in different locations due to:
A. arbitrag
e.
B. government intervention in foreign exchange
markets.
C. free trade in goods and
services.
D. the actions of importers and
exporters.
40. How can one profit through arbitrage if the dollar per euro exchange rate in London
is $2 per pound while in New York is $1.95 per pound?
A. Buy dollars in New York and sell them in

London
B. Buy pounds in London and sell them in
New York
C. Buy pounds in New York and sell them in
London
D. Buy dollars in London and sell pounds in
New York
41. Under a floating exchange rate system, the value of the dollar per euro exchange
rate rises when:
A. The U.S. trade deficit with the euro-area countries

increases.
B. European demand for U.S. products
increases.
C. The U.S. government raises personal income tax
rates.
D. The inflation rate in the U.S. is much lower than the inflation rate in the
euro-area.
42. Under a floating exchange rate system, an increase in the international demand for
electronic appliances manufactured in Japan will result in:
A. Deflation in the Japanese

economy.
B. An increase in Japan's trade deficit with other
countries.
C. An appreciation of the yen vis--vis other
currencies.
D. A depletion of international reserves held by the central bank
of Japan.
True / False Questions
43. The greater part of the money assets traded in foreign exchange markets is
demand deposits in banks.
Difficulty Level: 1
TRUE
44. The spot exchange rate is the current price for an exchange that will take place a
month or more in the future.
Difficulty Level: 1
FALSE
45. Most foreign exchange trading is done among the banks themselves in the retail
part of the foreign exchange market.
Difficulty Level: 1
FALSE
46. Greece was among the 11 EU countries deemed to meet the five criteria in early
1998.
Difficulty Level: 1
FALSE
47. The euro was introduced in the foreign exchange market on January 1, 1990.
Difficulty Level: 1
FALSE
48. The Maastricht Treaty adopted by the EU countries set a process for establishing a
monetary union and a single union wide currency.
Difficulty Level: 1
TRUE
49. French imports of goods and services will create a demand for foreign currency and
a supply of euros.
Difficulty Level: 2
TRUE
50. From 2004 to 2010, global foreign exchange trading more than doubled.
Difficulty Level: 1
TRUE
51. Most interbank trading occurs through electronic brokering systems, with only a
small remaining role for voice brokers.
Difficulty Level: 1
TRUE
52. In the floating exchange rate system, government officials must intervene in the
foreign exchange market to keep the exchange rate from fluctuating.
Difficulty Level: 1
FALSE
53. Government officials wanting to defend a fixed exchange rate may not have
sufficient reserves of foreign currency to keep the price fixed indefinitely.
Difficulty Level: 2
TRUE
54. Assuming the Japanese have a floating exchange rate, an increase in Japanese
exports of goods and services will tend to cause the value of the yen to appreciate.
Difficulty Level: 1
TRUE
55. To maintain an undervalued currency, the country's monetary authorities must

intervene in the foreign exchange market to buy its currency in the foreign
exchange market.
Difficulty Level: 1
FALSE
56. Arbitrage ensures that the spot price of the currency will equal the forward price of
the currency.
Difficulty Level: 2
FALSE
57. Triangular arbitrage does not cause the cross rate between two foreign currencies
to be consistent with the dollar exchange rates of these two currencies.
Difficulty Level: 1
FALSE
Essay Questions
58. A retailer in Mexico wants to buy $100,000 worth of Apple computers from the
United States. The Mexican retailer has pesos while the seller in the United States
wants to be paid in U.S. dollars. Explain how this transaction is completed with
particular emphasis on the foreign exchange market and banks in the United States
and Mexico.
The Mexican buyer has to sell pesos to obtain dollars to pay the U.S. exporter. The
Mexican firm contacts its bank and requests a quotation of the exchange rate for
selling pesos and acquiring $100,000. If the rate is acceptable, the Mexican firm
instructs its bank to take pesos from its checking account, convert into $100,000
and transfer the dollars to the U.S. producer. The Mexican bank holds the dollar
denominated deposits in the United States, at its correspondent bank in New York.
The Mexican bank instructs its correspondent bank in New York to take dollars from
its checking account and transfer the dollars to the U.S. producer. This completes
the international payment for computers.
Difficulty Level: 1
59. How does interbank foreign exchange trading work? What is being traded in the
interbank part of the foreign exchange markets? What functions does it serve?
A little less than 40% of foreign exchange trading is among banks themselves.
Demand deposits denominated in different currencies are being traded where each
deal is between one foreign exchange trader and a trader at a different bank, not a
trade with an "outside" customer. It serves several functions. Participation in the
interbank part of the market provides a bank with continuous stream of information
on conditions of the foreign exchange market. Interbank trading allows the bank to
readjust its position quickly and at a low cost. It allows the bank to take on a
speculative position quickly. Quoted interbank rates are for amounts of $1 million or
more.
Difficulty Level: 1
For each of the cases given below, indicate what the numerical change means, and
state whether the euro has appreciated or depreciated.
60. The spot exchange rate changes from 450 euros per Mexican peso to 440 euros per
Mexican peso.
The value of the Mexican peso decreases, so the euro has appreciated.
Difficulty Level: 1
61. The spot exchange rate changes from 0.011 Mexican pesos per euro to 0.006
Mexican pesos per euro.
The value of the euro decreases, so the euro has depreciated.

Difficulty Level: 1
62. The spot exchange rate changes from 1.48 euros per British pound to 1.51 euros
per British pound.
The value of the pound increases, so the euro has depreciated.

Difficulty Level: 1
63. The spot exchange rate changes from 0.73 British pounds per euro to 0.75 British
pounds per euro.
The value of the euro increases, so the euro has appreciated.

Difficulty Level: 1
Explain how the following factors affect the value of dollar vis--vis other currencies
under a floating exchange rate system.
64. Tariffs and quotas are placed by the U.S. government on all imports into the
country.
Tariffs and quotas placed by the U.S. on all imports into the country would decrease
U.S. imports and thus decrease the demand for foreign currency. This, in turn,
would lead to an appreciation of the dollar vis--vis other currencies.
Difficulty Level: 1
65. Demand by foreign consumers for the U.S. exports falls and the U.S. demand for
imports rises.
By itself, decreased demand by foreign consumers for the U.S. exports would
decrease demand for U.S. dollars and lead to a depreciation of the dollar vis--vis
other currencies. By itself, an increased U.S. demand for import would increase
demand for foreign currency, so, the foreign currency would appreciate and the
dollar would depreciate. The two changes together therefore would depreciate the
dollar.
Difficulty Level: 1
66. Rising interest rates in the United States relative to interest rates in Europe.
Rising interest rates in the United States relative to interest rates in Europe leads to
capital inflows. To invest in the United States foreign investors would first have to
purchase dollars in the foreign exchange market. This would increase the demand
for dollars, thus appreciating the dollar vis--vis other currencies.
Difficulty Level: 1
67. Rising U.S. fiscal deficits reduce investor confidence and lead to capital outflows.
The capital outflows affect the foreign exchange market. Investors would have to
sell dollars to buy foreign currency; thus, the supply of dollars would increase and
the demand for foreign currencies would increase. The dollar, as a result, would
depreciate vis--vis other currencies.
Difficulty Level: 1
Briefly explain each of the following terms:
68. Forward exchange rate
It is the price agreed now for a currency exchange that will occur sometime in the
future.
Difficulty Level: 1
69. Foreign exchange swap
It is a package trade that includes both a spot exchange of two currencies and an
agreement to the reverse forward exchange of the two currencies. It is useful when
the parties to the trade have only a temporary need for the currency.
Difficulty Level: 1
70. Arbitrage
It the process of buying and selling to make a riskless (or nearly riskless) profit.
Difficulty Level: 1
71. Triangular arbitrage
It is the arbitrage taking place through the exchange rates of three different
currencies.
Difficulty Level: 1
Suppose $1 = 0.85 euros in New York, 1 euro = 150 yen in Paris, and 1 yen =
$0.008 in Tokyo.
72. If you begin by holding $1, how could you profit from these exchange rates? What
is your arbitrage profit per dollar initially traded?
With $1, one should buy 0.85 euros in New York. Then 0.85 euros should be
exchanged for 127.5 yen in Paris. Then convert 127.5 yen back to dollars in Tokyo,
which makes $1.02, yielding a profit of $0.02.
Difficulty Level: 2
73. Identify the forces at work that will make the exchange rates consistent with each
other in this situation. That is, what forces will lead to a situation in which no
profitable arbitrage is possible?
The forces of demand and supply will eliminate the arbitrage opportunity. For
instance, given the other two exchange rates, this could happen if the extra supply
of euros (and extra demand for yen) in Paris drives the euro in Paris to depreciate,
so that the yen per euro exchange rate settles at 147 yen per euro.
Difficulty Level: 2

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Chapter 17

The Foreign Exchange Market

Multiple Choice Questions

1. Which of the following refers to foreign exchange?

A. The act of trading different nations'

A. 1.5 won per

5. The exchange rate set for an immediate trade is often referred to as a:

8. Which of the following is true of foreign exchange markets?

A. Provides a bank with a continuous stream of information on conditions in the

14. A country's demand for foreign currency is derived from:

A. international transactions entering the debit side of its balance of

A. increase in the demand for; increase in the

A. increase in the supply of; increase in the

A. increase in the demand for; increase in the

A. Demand for dollar will

19. A decrease in German residents' willingness to invest in dollar-denominated assets will

A. Japanese goods become more expensive to the U.S.

A. a decline in the quantity demanded

A. buy both euros and

A. the U.S. dollar to

A. excess demand for 1 million

A. Sell 1 million pounds and buy 2.5 million

A. the pound will be

A. An adjustable pegged exchange

A. a decrease in the demand for euro in the foreign exchange

A. sell foreign currency and buy domestic

39. Exchange rates are equalized in different locations due to:

A. Buy dollars in New York and sell them in

A. The U.S. trade deficit with the euro-area countries

A. Deflation in the Japanese

True / False Questions

55. To maintain an undervalued currency, the country's monetary authorities must

Briefly explain each of the following terms:

68. Forward exchange rate

69. Foreign exchange swap

71. Triangular arbitrage

Multiple Choice Questions

1. Which of the following refers to foreign exchange?

A. The act of trading different nations'

A. 1.5 won per

5. The exchange rate set for an immediate trade is often referred to as a:

8. Which of the following is true of foreign exchange markets?

9. The U.S. dollar is called a _____ because it is often used as an intermediary to

A. Provides a bank with a continuous stream of information on conditions in the

14. A country's demand for foreign currency is derived from:

A. international transactions entering the debit side of its balance of

A. increase in the demand for; increase in the

A. increase in the supply of; increase in the

A. increase in the demand for; increase in the

18. In the foreign exchange market, what could be a possible consequence of an

A. Demand for dollar will

A. Japanese goods become more expensive to the U.S.

A. a decline in the quantity demanded

A. buy both euros and

A. the U.S. dollar to

A. excess demand for 1 million

A. Sell 1 million pounds and buy 2.5 million

A. the pound will be

A. An adjustable pegged exchange

A. a decrease in the demand for euro in the foreign exchange

A. sell foreign currency and buy domestic

39. Exchange rates are equalized in different locations due to:

A. Buy dollars in New York and sell them in

A. The U.S. trade deficit with the euro-area countries