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Chapter 1ÑMultinational Financial Management: An Overview 10. Due to the risks involved in international business, firms should:
a. only consider international business in major countries.
b. maintain international business to no more than 20% of total business.
MULTIPLE CHOICE c. maintain international business to no more than 35% of total business.
d. none of the above
1. The commonly accepted goal of the MNC is to:
ANS: D PTS: 1
a. maximize short-term earnings.
b. maximize shareholder wealth. 11. A product cycle is the process by which a firm provides a specialized sales or service strategy, support assistance, and possibly an initial
c. minimize risk. investment in the franchise in exchange for periodic fees.
d. A and C. a. true.
e. maximize international sales. b. false.
ANS: B PTS: 1 ANS: B PTS: 1
2. With regard to corporate goals, an MNC is mostly concerned with maximizing ____, and a purely domestic firm is mostly concerned with 12. Licensing is the process by which a firm provides its technology (copyrights, patents, trademarks, or trade names) in exchange for fees or some
maximizing ____. other specified benefits.
a. shareholder wealth; short-term earnings a. true.
b. shareholder wealth; shareholder wealth b. false.
c. short-term earnings; sales volume
d. short-term earnings; shareholder wealth ANS: A PTS: 1
ANS: B PTS: 1 13. The agency costs of an MNC are likely to be lower if it:
a. scatters its subsidiaries across many foreign countries.
3. For the MNC, agency costs are typically: b. increases its volume of international business.
a. non-existent. c. uses a centralized management style.
b. larger than agency costs of a small purely domestic firm. d. A and B.
c. smaller than agency costs of a small purely domestic firm.
d. the same as agency costs of a small purely domestic firm. ANS: C PTS: 1
ANS: B PTS: 1 14. An indirect benefit to the MNC of following a worldwide code of ethics is:
a. it allows them to receive special tax breaks in less developed countries.
4. Which of the following is not a form of corporate control that could reduce agency problems for an MNC? b. it puts them at a competitive advantage in foreign markets.
a. stock options c. the worldwide credibility associated with maintaining such standards can increase global
b. hostile takeover threat demand for the MNC's products.
c. investor monitoring d. A and B.
d. all of the above are forms of corporate control that could reduce agency problems for an
MNC ANS: C PTS: 1
ANS: D PTS: 1 15. The term privatization is typically used to describe:
a. firms that are purchased by their managers.
5. A recent study by McKinsey & Co. found that investors assign a higher value to firms that exhibit ____ corporate governance standards and b. firms that are purchased by the government.
are likely to ____ ethical constraints. c. firms that are bought out by other firms.
a. high; not obey d. government operations that are purchased by corporations and other investors.
b. high; obey
c. low; not obey ANS: D PTS: 1
d. low; obey
16. According to the text, products and services are generally becoming ____ standardized across countries, which tends to ____ the globalization
ANS: B PTS: 1 of business.
a. more; encourage
6. Which of the following theories identifies specialization as a reason for international business? b. more; discourage
a. theory of comparative advantage c. less; discourage
b. imperfect markets theory d. less; encourage
c. product cycle theory
d. none of the above ANS: A PTS: 1
ANS: A PTS: 1 17. Franchising is the process by which national governments sell state owned operations to corporations and other investors .
a. true.
7. Which of the following theories identifies the non-transferability of resources as a reason for international business? b. false.
a. theory of comparative advantage
b. imperfect markets theory ANS: B PTS: 1
d. none of the above 18. Which of the following is not a major event that increased international business opportunities in Europe?
a. the Single European Act.
ANS: B PTS: 1 b. the removal of the Berlin Wall.
c. the inception of the euro.
8. Which of the following theories suggests that firms seek to penetrate new markets over time? d. the reduction in the number of countries participating in the European Union.
a. theory of comparative advantage
b. imperfect markets theory ANS: D PTS: 1
d. none of the above 19. The Single European Act of 1987 was primarily intended to:
a. create more trade barriers between European countries.
ANS: C PTS: 1 b. unify East Germany and West Germany.
c. provide financial support for Eastern Europe.
9. Which of the following industries would most likely take advantage of lower costs in some less developed foreign countries? d. make regulations more uniform across industrialized countries in Europe.
a. assembly line production
b. specialized professional services ANS: D PTS: 1
c. nuclear missile planning
d. planning for more sophisticated computer technology 20. The Single European Act of 1987:
a. reduced competition in most industries.
ANS: A PTS: 1 b. eliminated competition in many industries.
c. reduced efficiency in most industries.
d. increased competition in most industries.
ANS: D PTS: 1
1 2
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21. In comparing exporting to direct foreign investment (FDI), an exporting operation will likely incur ____ fixed production costs and ____ 32. Which of the following is not a way in which agency problems can be reduced through corporate control?
transportation costs than DFI. a. executive compensation.
a. higher; higher b. threat of hostile takeover.
b. higher; lower c. acquisition of a foreign subsidiary.
c. lower; lower d. monitoring by large shareholders.
d. lower; higher
ANS: C PTS: 1
ANS: D PTS: 1
33. The goal of a multinational corporation (MNC) is the maximization of shareholder wealth.
22. Which of the following is an example of direct foreign investment? a. true.
a. exporting to a country. b. false.
b. establishing licensing arrangements in a country.
c. purchasing existing companies in a country. ANS: A PTS: 1
d. investing directly (without brokers) in foreign stocks.
34. A centralized management style, where major decisions about a foreign subsidiary are made by the parent company, results in an increase in
ANS: C PTS: 1 agency costs.
a. true.
23. According to the text, a disadvantage of licensing is that: b. false.
a. it prevents a firm from importing.
b. it is difficult to ensure quality control of the production process. ANS: B PTS: 1
c. it prevents a firm from exporting.
d. none of the above 35. In some countries, bribes are commonplace. If a MNC decides to adhere to a strict code of ethics and not pay bribes, its subsidiary may be at a
competitive disadvantage in the foreign country.
ANS: B PTS: 1 a. true.
b. false.
24. ____ are most commonly classified as a direct foreign investment.
a. Foreign acquisitions ANS: A PTS: 1
b. Purchases of international stocks
c. Licensing agreements 36. Due to the larger opportunity set of funding sources around the world from which an MNC can choose, an MNC may be able to obtain capital
d. Exporting transactions at a lower cost than a purely domestic firm.
a. true.
ANS: A PTS: 1 b. false.
25. Imperfect markets represent conditions under which factors of production are immobile. ANS: A PTS: 1
a. true.
b. false. 37. The Single European Act of 1987 made regulations more uniform among European countries. However, the cost of achieving this goal resulted
in the imposition of additional taxes on goods traded between these countries.
b. false.
26. Privatization is a venture that is jointly owned and operated by two or more firms.
a. true. ANS: B PTS: 1
b. false.
38. The North American Free Trade Agreement (NAFTA) of 1993 eliminated trade barriers between the United States and Mexico.
b. false.
27. The main provision of the North American Free Trade Agreement (NAFTA) was that:
a. the Mexican peso's value be tied to the Canadian dollar. ANS: A PTS: 1
b. Mexico be allowed to privatize its business.
c. Mexico must impose a minimum wage that is similar to the minimum wage in the U.S. 39. Although MNCs may need to convert currencies occasionally, they do not face any exchange rate risk, as exchange rates are stable over time.
d. none of the above a. true.
b. false.
ANS: D PTS: 1
ANS: B PTS: 1
28. Which of the following is not mentioned in the text as a constraint interfering with the MNC goal?
a. economic constraints. 40. One of the most prevalent factors conflicting with the realization of the goal of an MNC is the existence of agency prob lems.
b. environmental constraints. a. true.
c. regulatory constraints. b. false.
d. ethical constraints. ANS: A PTS: 1
ANS: A PTS: 1
41. A centralized management style for an MNC results in relatively high agency costs.
29. Which of the following is not a provision or result of the Single European Act of 1987? a. true.
a. increased regulatory uniformity among European countries. b. false.
b. the phasing in of a common currency for all European countries by 1992. ANS: B PTS: 1
c. the removal of many taxes on goods traded between European countries.
d. firms' ability to achieve economies of scale. 42. The imperfect markets theory states that factors of production are somewhat immobile, allowing firms to capitalize on a foreign country's
e. all of the above resources.
a. true.
ANS: B PTS: 1
b. false.
30. Which of the following is not mentioned in the text as an additional risk resulting from international business? ANS: A PTS: 1
a. exchange rate fluctuations.
b. political risk.
c. interest rate risk.
d. exposure to foreign economies.
ANS: C PTS: 1
31. Licensing obliges a firm to provide ____, while franchising obligates a firm to provide ____.
a. a specialized sales or service strategy; its technology
b. its technology; a specialized sales or service strategy
c. its technology; its technology
d. a specialized sales or service strategy; a specialized sales or service strategy
e. its technology; an initial investment
ANS: B PTS: 1
3 4
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Chapter 24International Flow of Funds

7. The International Financial Corporation was established to:
a. enhance development solely in Asia through grants.
1. Recently, the U.S. experienced an annual balance of trade representing a ____. b. enhance economic development through non-subsidized loans (at market interest rates).
a. large surplus (exceeding $100 billion) c. enhance economic development through low-interest rate loans (below-market rates).
b. small surplus d. enhance economic development of the private sector through investment in stock of
c. level of zero corporations.
d. deficit
ANS: D PTS: 1
ANS: D PTS: 1
8. The World Bank was established to:
2. A high home inflation rate relative to other countries would ____ the home country's current account a. enhance development solely in Asia through grants.
balance, other things equal. A high growth in the home income level relative to other countries would b. enhance economic development through non-subsidized loans (at market interest rates).
____ the home country's current account balance, other things equal. c. enhance economic development through low-interest rate loans (below-market rates).
a. increase; increase d. enhance economic development of the private sector through investment in stock of
b. increase; decrease corporations.
c. decrease; decrease
d. decrease; increase ANS: B PTS: 1
ANS: C PTS: 1 9. The International Development Association was established to:
a. enhance development solely in Asia through grants.
3. If a country's government imposes a tariff on imported goods, that country's current account balance b. enhance economic development through non-subsidized loans (at market interest rates).
will likely ____ (assuming no retaliation by other governments). c. enhance economic development through low-interest rate loans (below-market rates).
a. decrease d. enhance economic development of the private sector through investment in stock of
b. increase corporations.
c. remain unaffected
d. either A or C are possible ANS: C PTS: 1
ANS: B PTS: 1 10. Which of the following would likely have the least direct influence on a country's current account?
a. inflation.
4. ____ purchases more U.S. exports than the other countries listed here. b. national income.
a. Italy c. exchange rates.
b. Spain d. tariffs.
c. Mexico e. a tax on income earned from foreign stocks.
d. Canada
ANS: E PTS: 1
ANS: D PTS: 1
11. The "J curve" effect describes:
5. An increase in the current account deficit will place ____ pressure on the home currency value, other a. the continuous long-term inverse relationship between a country's current account balance
things equal. and the country's growth in gross national product.
a. upward b. the short-run tendency for a country's balance of trade to deteriorate even while its
b. downward currency is depreciating.
c. no c. the tendency for exporters to initially reduce the price of goods when their own currency
d. upward or downward (depending on the size of the deficit) appreciates.
ANS: B PTS: 1 d. the reaction of a country's currency to initially depreciate after the country's inflation rate
declines.
6. If the home currency begins to appreciate against other currencies, this should ____ the current ANS: B PTS: 1
account balance, other things equal (assume that substitutes are readily available in the countries, and
that the prices charged by firms remain the same). 12. An increase in the use of quotas is expected to:
a. increase a. reduce the country's current account balance, if other governments do not retaliate.
b. have no impact on b. increase the country's current account balance, if other governments do not retaliate.
c. reduce c. have no impact on the country's current account balance unless other governments
d. all of the above are equally possible retaliate.
ANS: C PTS: 1 d. increase the volume of a country's trade with other countries.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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ANS: B PTS: 1 d. none of the above
13. The U.S. typically has a balance of trade surplus in its trade with ____. ANS: B PTS: 1
a. China
b. Japan 20. Over the last several years, international trade has generally:
c. A and B a. increased for most major countries.
d. none of the above b. decreased for most major countries.
c. stayed about constant for most major countries.
ANS: D PTS: 1 d. increased for about half the major countries and decreased for the others.
14. The North American Free Trade Agreement (NAFTA) increased restrictions on: ANS: A PTS: 1
a. trade between Canada and Mexico.
b. trade between Canada and the U.S. 21. Which is not a concern about the North American Free Trade Agreement (NAFTA)?
c. direct foreign investment in Mexico by U.S. firms. a. its impact on U.S. inflation.
d. none of the above. b. its impact on U.S. unemployment.
c. lower environmental standards in Mexico.
ANS: D PTS: 1 d. different health laws for workers in Mexico.
15. According to the text, international trade (exports plus imports combined) as a percentage of GDP is: ANS: A PTS: 1
a. higher in the U.S. than in European countries.
b. lower in the U.S. than in European countries. 22. A General Agreement on Tariffs and Trade (GATT) accord in 1993 called for:
c. higher in the U.S. than in about half the European countries, and lower in the U.S. than the a. increased trade restrictions outside of North America.
others. b. lower trade restrictions around the world.
d. about the same in the U.S. as in European countries. c. uniform environmental standards around the world.
d. uniform worker health laws.
ANS: B PTS: 1
ANS: B PTS: 1
16. The direct foreign investment positions by U.S. firms have generally ____ over time. Restrictions by
governments on direct foreign investment have generally ___ over time. 23. Which of the following is mentioned in the text as a possible means by which the government may
a. increased; increased attempt to improve its balance of trade position (increase its exports or reduce its imports).
b. increased; decreased a. It could attempt to reduce its home currency's value.
c. decreased; decreased b. The government could require firms to engage in outsourcing.
d. decreased; increased c. The government could require that its local firms pursue outsourcing.
d. All of the above are mentioned.
ANS: B PTS: 1
ANS: A PTS: 1
17. Which of the following countries purchases the largest amount of exports by U.S. firms?
a. Mexico 24. The demand for U.S. exports tends to increase when:
b. Japan a. economic growth in foreign countries decreases.
c. Canada b. the currencies of foreign countries strengthen against the dollar.
d. France c. U.S. inflation rises.
d. none of the above.
ANS: C PTS: 1
ANS: B PTS: 1
18. The primary component of the current account is the:
a. balance of trade. 25. "Dumping" is used in the text to represent the:
b. balance of money market flows. a. exporting of goods that do not meet quality standards.
c. balance of capital market flows. b. sales of junk bonds to foreign countries.
d. unilateral transfers. c. removal of foreign subsidiaries by the host government.
d. exporting of goods at prices below cost.
ANS: A PTS: 1
ANS: D PTS: 1
19. As a result of the European Union, restrictions on exports between ____ were reduced or eliminated.
a. member countries and the U.S. 26. ____ is (are) income received by investors on foreign investments in financial assets (securities).
b. member countries a. Portfolio income
c. member countries and European non-members b. Direct foreign income

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c. capital outflow
d. trade outflow
ANS: A PTS: 1
33. A balance of trade surplus indicates an excess of imports over exports.

a. True
b. False
ANS: F PTS: 1
34. A weakening of the U.S. dollar with respect to the British pound would likely reduce the U.S. exports
to Britain and increase U.S. imports from Britain over time.
a. True
b. False
ANS: F PTS: 1
35. The World Bank extends loans only to developed nations, while the International Development
Association (IDA) extends loans only to developing nations.
a. True
b. False
ANS: F PTS: 1
36. The World Bank frequently enters into cofinancing agreements. Under these agreements, financing is
provided by the World Bank and/or official aid agencies, export credit agencies, or commercial banks.
a. True
b. False
ANS: T PTS: 1
37. The balance of payments is a measurement of all transactions between domestic and foreign residents
over a specified period of time.
a. True
b. False
ANS: T PTS: 1
38. Changes in country ownership of long-term and short-term assets are measured in the balance of
payments with the capital account.
a. True
b. False
ANS: T PTS: 1
39. Portfolio investment represents transactions involving long-term financial assets (such as stocks and
bonds) between countries that do not affect the transfer of control.
a. True
b. False
ANS: T PTS: 1
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40. The current account represents the investment in fixed assets in foreign countries that can be used to 48. The sale of patent rights by a U.S. firm to a Russian firm reflects a credit to the U.S. balance of
conduct business operations. payments account.
a. True a. True
b. False b. False
ANS: F PTS: 1 ANS: T PTS: 1
41. Exporting of products by one country to other countries at prices below cost is called elasticity. 49. A U.S. purchase of patent rights from a firm in Mexico reflects a credit to the U.S. balance of
a. True payments account.
b. False a. True
b. False
ANS: F PTS: 1
ANS: F PTS: 1
42. Direct foreign investment by U.S.-based MNCs occurs primarily in the Bahamas and Brazil.
a. True 50. Regarding the U.S. balance of payments, capital account items are relatively minor compared to the
b. False financial account items.
a. True
ANS: F PTS: 1 b. False
43. The J curve effect is the initial worsening of the U.S. trade balance due to a weakening dollar because ANS: T PTS: 1
of established trade relationships that are not easily changed; as the dollar weakens, the dollar value of
imports initially rises before the U.S. trade balance is improved. 51. In recent years, the U.S. has had a relatively (compared to other countries) ____ balance of trade ____
a. True with China.
b. False a. small; surplus
b. large; surplus
ANS: T PTS: 1 c. small; deficit
d. large; deficit
44. Portfolio investments represent transactions involving long-term financial assets (such as stocks and
bonds) between countries that do not affect the transfer of control. ANS: D PTS: 1
a. True
b. False 52. The Central American Trade Agreement (CAFTA) is intended to raise tariffs and regulations between
the U.S., the Dominican Republic, and Central American countries.
ANS: T PTS: 1 a. True
b. False
45. Intracompany trade represents the exporting of products by one country to other countries below cost.
a. True ANS: F PTS: 1
b. False
53. U.S. government officials would likely prefer that China devalue the yuan against the dollar.
ANS: F PTS: 1 a. True
b. False
46. A tariff is a maximum limit on imports.
b. False
54. Assume that some U.S. firms will purchase supplies from either China or from U.S. firms. If the
ANS: F PTS: 1 Chinese yuan appreciates against the dollar, it should reduce the U.S. balance of trade deficit with
China.
47. A country's net outflow of funds ____ affect its interest rates, and ____ affect its economic conditions. a. True
a. does; does b. False
b. does; does not
c. does not; does not ANS: T PTS: 1
d. does not; does
55. Assume the U.S. has a balance of trade surplus with the country of Thor. When individuals in Thor
ANS: A PTS: 1 manufacture CDs and DVDs that look almost exactly like the original product produced in the U.S.
and other countries, they ____ the U.S. balance of trade surplus with Thor. This activity is called ____.

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a. reduce; flipping
b. reduce; pirating 63. Outsourcing allows some MNCs to reduce costs but shifts jobs to other countries.
c. increase; pirating a. True
d. increase; flipping b. False
ANS: B PTS: 1 ANS: T PTS: 1
56. Japan's annual interest rate has been relatively ____ compared to other countries for several years, 64. A weakening of the U.S. dollar with respect to the British pound would likely reduce U.S. exports to
because the supply of funds in its credit market has been very ____. the U.K. and increase U.S. imports from the U.K.
a. low; small a. True
b. high; small b. False
c. low; large
d. high; large ANS: F PTS: 1
ANS: C PTS: 1
65. The World Bank extends loans only to developed nations, while the International Development
57. Without the international capital flows, there would be ____ funding available in the U.S. across all Association (IDA) extends loans only to developing nations.
risk levels, and the cost of funding would be ____ regardless of the firm's risk level. a. True
a. more; lower b. False
b. more; higher
c. less; lower ANS: F PTS: 1
d. less; higher
66. The ____ is the difference between exports and imports.
ANS: D PTS: 1 a. balance of trade
b. balance on goods and services
58. The primary component of the capital account is the balance of trade. c. balance of payments
a. True d. current account
b. False e. capital account
ANS: F PTS: 1 ANS: A PTS: 1
59. A balance of trade surplus indicates an excess of merchandise imports over merchandise exports. 67. Which of the following will probably not result in an increase in a country's current account balance
a. True (assuming everything else constant)?
b. False a. A decrease in the country's rate of inflation
b. A decrease in the country's national income level
ANS: F PTS: 1 c. An increase in government restrictions in the form of tariffs or quotas
d. An appreciation of the country's currency
60. An American tourist visiting Germany and spending money there (for lodging, food, etc.) will reduce e. All of the above will result in an increased current account balance.
the U.S. current account deficit and reduce Germany's current account balance. ANS: D PTS: 1
a. True
b. False 68. Which of the following factors probably does not directly affect a country's capital account and its
components?
ANS: F PTS: 1 a. Inflation
b. Interest rates
61. A balance of trade deficit indicates an excess of imports over exports. c. Withholding taxes on foreign income
a. True d. Exchange rate movements
b. False e. All of the above will directly affect a country's capital account.
ANS: T PTS: 1 ANS: A PTS: 1
62. The capital account reflects changes in country ownership of long-term (but not short-term) assets. 69. The ____, an accord among 117 nations, called for lower tariffs around the world.
a. True a. General Agreement on Tariffs and Trade (GATT)
b. False b. North American Free Trade Agreement (NAFTA)
c. Single European Act of 1987
ANS: F PTS: 1 d. European Union Accord

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e. None of the above

75. According to the "J curve effect," a weakening of the U.S. dollar relative to its trading partners'
ANS: A PTS: 1 currencies would result in an initial ____ in the current account balance, followed by a subsequent
____ in the current account balance.
70. Which of the following is not likely to represent a strategy by the government of Country X to reduce a. decrease; increase
its balance of trade deficit with Country Y? b. increase; decrease
a. The government of Country X eliminates environmental restrictions. c. decrease; decrease
b. The government of Country X subsidizes firms in its country to facilitate dumping. d. increase; increase
c. The government of Country X provides tax breaks to firms in specific industries.
d. The government of Country X removes a tariff on goods imported from Country Y. ANS: A PTS: 1
ANS: D PTS: 1
71. Which of the following statements is not true?

a. Exporters commonly complain that they are being mistreated because the currency of their
country is too weak.
b. Outsourcing affects the balance of trade because it means that a service is purchased in
another country.
c. Sometimes, trade policies are used to punish countries for various actions.
d. Tariffs imposed by the EU have caused some friction between EU countries that
commonly import products and other EU countries.
e. All of the above are true.
ANS: A PTS: 1
72. Which of the following would increase the current account of Country X? Country Y is Country X's
sole trading partner.
a. Inflation increases in countries X and Y by comparable amounts.
b. Country X's and Country Y's currencies depreciate by the same amount.
c. Country X imposes tariffs on imports from Country Y, and Country Y retaliates by
imposing an identical tax on X's exports.
d. The central banks of Country X and Country Y reduce the money supply to increase
interest rates.
e. Country X imposes a quota on imports, and Country Y retaliates by imposing an identical
quota on X's exports.
ANS: D PTS: 1
73. ____ represent aid, grants, and gifts from one country to another.
a. Transfer payments
b. Factor income
c. The balance of trade
d. The balance of payments
e. The capital account
ANS: A PTS: 1
74. Which of the following is not a goal of the International Monetary Fund (IMF)?
a. To promote cooperation among countries on international monetary issues
b. To promote stability in exchange rates
c. To enhance a country's long-term economic growth via the extension of structural
adjustment loans
d. To promote free trade
e. To promote free mobility of capital funds across countries
ANS: C PTS: 1

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If a U.S. firm desires to avoid the risk from exchange rateChapter 34International Financial .
Markets c 10 to 15
.
1. Assume that a bank's bid rate on Swiss francs is $.45 and its ask rate is $.47. Its bid-ask d .5 to 1
percentage spread is: .
a about 4.44%.
.
b about 4.26%. ANS: A PTS: 1
.
c about 4.03%. 4. ____ is not a factor that affects the bid/ask spread.
. a Order costs
d about 4.17%. .
. b Inventory costs
.
c Volume
ANS: B .
SOLUTIO Bid-ask percentage spread = ($.47 2 $.45)/$.47 = 4.26% d All of the above factors affect the bid/ask spread
N: .
PTS: 1 ANS: D PTS: 1
2. Assume that a bank's bid rate on Japanese yen is $.0041 and its ask rate is $.0043. Its bid- 7. According to the text, the forward rate is commonly used for:
ask percentage spread is: a hedging.
a about 4.99%. .
. b immediate transactions.
b about 4.88%. .
. c previous transactions.
c about 4.65%. .
. d bond transactions.
d about 4.43%. .
.
ANS: A PTS: 1
ANS: C
SOLUTIO Bid-ask percentage spread = ($.0043 2 $.0041)/$.0043 = 4.65% 8. If a U.S. firm desires to avoid the risk from exchange rate fluctuations, and it is receiving
N: 100,000 in 90 days, it could:
a obtain a 90-day forward purchase contract on euros.
.
PTS: 1 b obtain a 90-day forward sale contract on euros.
.
3. The bid/ask spread for small retail transactions is commonly in the range of ____ percent. c purchase euros 90 days from now at the spot rate.
a 3 to 7 .
. d sell euros 90 days from now at the spot rate.
b .01 to .03 .

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. currency at a reasonable exchange rate.
ANS: B PTS: 1
ANS: D PTS: 1
9. If a U.S. firm desires to avoid the risk from exchange rate fluctuations, and it will need
C$200,000 in 90 days to make payment on imports from Canada, it could: 12. Forward markets for currencies of developing countries are:
a obtain a 90-day forward purchase contract on Canadian dollars. a prohibited.
. .
b obtain a 90-day forward sale contract on Canadian dollars. b less liquid than markets for developed countries.
. .
c purchase Canadian dollars 90 days from now at the spot rate. c more liquid than markets for developed countries.
. .
d sell Canadian dollars 90 days from now at the spot rate. d only available for use by government agencies.
. .
ANS: A PTS: 1 ANS: B PTS: 1
10. Assume the Canadian dollar is equal to $.88 and the Peruvian Sol is equal to $.35. The 13. A forward contract can be used to lock in the ____ of a specified currency for a future
value of the Peruvian Sol in Canadian dollars is: point in time.
a about .3621 Canadian dollars. a purchase price
. .
b about .3977 Canadian dollars. b sale price
. .
c about 2.36 Canadian dollars. c A or B
. .
d about 2.51 Canadian dollars. d none of the above
. .
ANS: B ANS: C PTS: 1

SOLUTIO $.35/$.88 = .3977
N: 14. The forward market:
a for euros is very illiquid.
.
PTS: 1 b for Eastern European countries is very liquid.
.
11. Which of the following is not true with respect to spot market liquidity? c does not exist for some currencies.
a The more willing buyers and sellers there are, the more liquid a market is. .
. d none of the above
b The spot markets for heavily traded currencies such as the Japanese yen are .
. very liquid.
c A currency's liquidity affects the ease with which an MNC can obtain or
. sell that currency. ANS: C PTS: 1
d If a currency is illiquid, an MNC is typically able to quickly purchase that

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15. ____ is not a bank characteristic important to customers in need of foreign exchange. .
a Quote competitiveness b medium-term lending.
. .
b Speed of execution c long-term lending.
. .
c Forecasting advice d providing an exchange of foreign currencies for firms who need them.
. .
d Advice about current market conditions e placing newly issued stock in foreign markets.
. .
e All of the above are important bank characteristics to customers in need of
. foreign exchange.
ANS: B PTS: 1
ANS: E PTS: 1 19. The main participants in the international money market are:
a consumers.
16. The Basel II accord is focused on eliminating inconsistencies in ____ across countries. .
a capital requirements b small firms.
. .
b deposit rates c large corporations.
. .
c deposit insurance d small European firms needing European currencies for international trade.
. .
d bank failure policies
.
ANS: C PTS: 1
ANS: A PTS: 1 20. LIBOR is:

a the interest rate commonly charged for loans between banks.
17. The international money market primarily concentrates on: .
a short-term lending (one year or less). b the average inflation rate in European countries.
. .
b medium-term lending. c the maximum loan rate ceiling on loans in the international money market.
. .
c long-term lending. d the maximum deposit rate ceiling on deposits in the international money
. . market.
d placing bonds with investors. e the maximum interest rate offered on bonds that are issued in London.
. .
e placing newly issued stock in foreign markets.
.
ANS: A PTS: 1
ANS: A PTS: 1 21. A syndicated loan:

a represents a loan by a single bank to a syndicate of corporations.
18. The international credit market primarily concentrates on: .
a short-term lending (less than one year). b represents a loan by a single bank to a syndicate of country governments.

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. d nonexistent; that is currencies were not exchanged, but gold was used to
c represents a direct loan by a syndicate of oil-producing exporters to a less . pay for all foreign transactions.
. developed country.
d represents a loan by a group of banks to a borrower.
. ANS: A PTS: 1
e A and B
. 26. As a result of the Smithsonian Agreement, the U.S. dollar was:
a the currency to be used by all countries as a medium of exchange for
. international trade.
ANS: D PTS: 1 b forced to be freely floating relative to all currencies without any
. boundaries.
22. The international money market is primarily served by: c devalued relative to major currencies.
a the governments of European countries, which directly intervene in foreign .
. currency markets. d revalued (upward) relative to major currencies.
b government agencies such as the International Monetary Fund that enhance .
. development of countries.
c several large banks that accept deposits and provide loans in various
. currencies. ANS: C PTS: 1
d small banks that convert foreign currency for tourists and business visitors.
. 27. According to the text, the average foreign exchange trading around the world ____ per
day.
a equals about $200 billion
ANS: C PTS: 1 .
b equals about $400 billion
23. International money market transactions normally represent: .
a the equivalent of $1 million or more. c equals about $700 billion
. .
b the equivalent of $1,000 to $10,000. d exceeds $1 trillion
. .
c the equivalent of between $10,000 and $100,000.
.
d the equivalent of between $100,000 and $200,000. ANS: D PTS: 1
.
28. Assume a Japanese firm invoices exports to the U.S. in U.S. dollars. Assume that the
forward rate and spot rate of the Japanese yen are equal. If the Japanese firm expects the
ANS: A PTS: 1 U.S. dollar to ____ against the yen, it would likely wish to hedge. It could hedge by ____
dollars forward.
a depreciate; buying
25. From 1944 to 1971, the exchange rate between any two currencies was typically: .
a fixed within narrow boundaries. b depreciate; selling
. .
b floating, but subject to central bank intervention. c appreciate; selling
. .
c floating, and not subject to central bank intervention. d appreciate; buying
. .

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. regulations in the U.S.

b U.S. firms may desire to issue bonds in the U.S. due to less regulations in
ANS: B PTS: 1 . the U.S.
c U.S. firms may desire to issue bonds in the non-U.S. markets due to less
29. The bid-ask spread on an exchange rate can be used to directly determine: . regulations in non-U.S. countries.
a how an exchange rate will change. d A and B
. .
b the transaction cost of foreign exchange.
.
c the forward premium. ANS: C PTS: 1
.
d the currency option premium. 33. Eurobonds:
. a can be issued only by European firms.
.
b can be sold only to European investors.
ANS: B PTS: 1 .
c A and B
30. Futures contracts are typically ____; forward contracts are typically ____. .
a sold on an exchange; sold on an exchange d none of the above
. .
b offered by commercial banks; sold on an exchange
.
c sold on an exchange; offered by commercial banks ANS: D PTS: 1
.
d offered by commercial banks; offered by commercial banks 34. Which currency is used the most to denominate Eurobonds?
. a the British pound.
.
b the Japanese yen.
ANS: C PTS: 1 .
c the U.S. dollar.
31. Eurobonds: .
a are usually issued in bearer form. d the Swiss franc.
. .
b typically carry several protective covenants.
.
c cannot contain call provisions. ANS: C PTS: 1
.
d A and B 35. When the foreign exchange market opens in the U.S. each morning, the opening
. exchange rate quotations will be based on the:
a closing prices in the U.S. during the previous day.
.
ANS: A PTS: 1 b closing prices in Canada during the previous day.
.
32. Which of the following is true? c prevailing prices in locations where the foreign exchange markets have
a Non-U.S. firms may desire to issue bonds in the U.S. due to less . been open.

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d officially set by central banks before the U.S. market opens. e none of the above
. .
ANS: C PTS: 1 ANS: D

SOLUTIO ($.008/$.59) = F$.014/¥
36. The U.S. dollar is not ever used as a medium of exchange in: N:
a industrialized countries outside the U.S.
.
b in any Latin American countries. PTS: 1
.
c in Eastern European countries where foreign exchange restrictions exist.
. 51. A share of the ADR of a Dutch firm represents one share of that firm's stock that is traded
d none of the above on a Dutch stock exchange. The share price of the firm was 15 euros when the Dutch
. market closed. As the U.S. market opens, the euro is worth $1.10. Thus, the price of the
ADR should be ____.
a $13.64
ANS: D PTS: 1 .
b $15.00
37. Which of the following is not true regarding the Bretton Woods Agreement? .
a It called for fixed exchange rates between currencies. c $16.50
. .
b Governments intervened to prevent exchange rates from moving more than d 16.50 euros
. 1 percent above or below their initially established levels. .
c The agreement lasted from 1944 until 1971. e none of the above
. .
d Each country used gold to back its currency.
.
e All of the above are true regarding the Bretton Woods Agreement. ANS: C
. SOLUTIO 15 × $1.10 = $16.50
N:
ANS: D PTS: 1
PTS: 1
38. A Japanese yen is worth $.0080, and a Fijian dollar (F$) is worth $.5900. What is the
value of the yen in Fijian dollars (i.e., how many Fijian dollars do you need to buy a 52. The ADR of a British firm is convertible into 3 shares of stock. The share price of the
yen)? firm was 30 pounds when the British market closed. When the U.S. market opens, the
a 73.75. pound is worth $1.63. The price of this ADR should be $____.
. a 48.90
b 125. .
. b 146.70
c 1.69. .
. c 55.21
d 0.014 .
. d none of the above

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. c 793,651
.
d 12,900
ANS: B .
SOLUTIO 3 × 30 × $1.63 = $146.70
N:
ANS: C PTS: 1
PTS: 1
75. An obligation to purchase a specific amount of currency at a future point in time is called
a:
69. In general, stock markets allow for more price efficiency and attract more investors when a call option
they have all of the following except: .
a more voting rights for shareholders. b spot contract
. .
b more legal protection. c put option
. .
c more enforcement of the laws. d forward contract
. .
d less stringent accounting requirements. e both B and D
. .
ANS: D PTS: 1 ANS: D PTS: 1
71. If companies can rely on stock markets to obtain funds, they will have to rely more 76. Which of the following is not a method that can be used to invest internationally?
heavily on the ____ market to raise long-term funds. a Investment in MNC stocks
a derivative .
. b American depository receipts (ADRs)
b long-term credit .
. c World Equity benchmark Shares (WEBS)
c money .
. d International mutual funds
d foreign exchange .
. e All of the above are methods that can be used to invest internationally.
.
ANS: B PTS: 1
ANS: E PTS: 1
73. Assume that the bank's bid quote of Mexican peso is $.126 and ask price is $.129. If you
have Mexican pesos, what is the amount of pesos that you need to purchase $100,000? 77. The interest rate in developing countries is usually very low.
a 12,600 a. True
. b. False
b 775,194
. ANS: F PTS: 1

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c The loans are provided by a group of banks to a borrower.

78. Assume that $1 is equal to .85 Euros and 98 yen. The value of yen in euros is .
a .01 d The loans are usually formed in 6 weeks or less.
. .
b 118
.
c 1.18 ANS: B PTS: 1
.
d .0087 0.85/98 82. The interest rate on the syndicated loan depends on the:
. a currency denominating the loan.
.
b maturity of the loan.
ANS: D PTS: 1 .
c creditworthiness of the borrower.
79. When obtaining a loan, the risk premium paid above LIBOR depends on the: .
a risk-free interest rate of the borrower. d interbank lending rate.
. .
b credit risk of the borrower. e all of the above.
. .
c borrower's stock price.
.
d lender's stock price. ANS: E PTS: 1
.
83. Assume a U.S. firm has to pay for Korean imports in 60 days. It expects that Korean won
will depreciate, but it still wants to hedge its risk. What type of hedging is more
ANS: B PTS: 1 appropriate in this situation:
a Buy dollars forward
80. The largest global exchange is: .
a NASDAQ b Sell dollars forward
. .
b Tokyo Stock Exchange c Purchase call option
. .
c NYSE Euronext d Purchase put option
. .
d London Stock Exchange
.
ANS: C PTS: 1
ANS: C PTS: 1 84. Certificates representing bundles of stock of non-U.S. firms are called:
a Eurobonds
81. Which of the following is not true about syndicated loans? .
a A borrower that receives a syndicated loan incurs various fees besides the b ADRs
. interest rate. .
b The loans are only denominated in U.S. dollars. c FRNs
. .

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d Eurobor .
.
ANS: C PTS: 1
ANS: B PTS: 1
95. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide
85. Assume that the spot rate of the Singapore dollar is $.664. The ADR of a Singapore firm to hedge your position by selling Japanese yen forward. The current spot rate of the yen
is convertible into 3 shares of stock. The price of an ADR is $20. What is the share price is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be
of the firm in Singapore dollars? $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now if
a 10 you sell yen forward?
. a $44,500
b 13.28 .
. b $45,000
c 30.12 .
. c $526 million
d 39.84 .
. d $47,500
.
e $556 million
ANS: A PTS: 1 .
86. Which of the following is not true regarding ADRs?

a ADRs are denominated in the currency of the stock's home country. ANS: D PTS: 1
.
b ADRs enable U.S. investors to avoid cross-border transactions 96. Which of the following is probably not an example of the use of forward contracts by an
. MNC?
c ADRs allow non-U.S. firms to tap into U.S. market for funds. a Hedging pound payables by selling pounds forward
. .
d ADRs sometimes allow for arbitrage opportunities. b Hedging peso receivables by selling pesos forward
. .
c Hedging yen payables by purchasing yen forward
.
ANS: A PTS: 1 d Hedging peso payables by purchasing pesos forward
.
e All of the above are examples of using forward contracts.
94. Which of the following is not a possible bid/ask quotation for the Barbados dollar? .
a $.50/$.51
.
b $.49/$.50 ANS: A PTS: 1
.
c $.52/$.51 97. A quotation representing the value of a foreign currency in dollars is referred to as a(n)
. ____ quotation; a quotation representing the number of units of a foreign currency per
d $.51/$.52 dollar is referred to as a(n) ____ quotation.
. a direct; indirect
e All of the above are possible bid/ask quotations. .

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b indirect; direct exposure to British pound payables?

. a Purchase pounds forward
c direct; direct .
. b Buy a pound futures contract
d indirect; indirect .
. c Buy a pound put option
e cannot be answered without more information .
. d Buy a pound call option
.
ANS: A PTS: 1
ANS: C PTS: 1
98. You observe a quotation of the Japanese yen (¥) of $0.007. You are, however, interested
in the number of yen per dollar. Thus, you calculate the ____ quotation of ____ ¥/$. 101. Futures contracts are sold on exchanges and are consequently ____ than forward
a direct; 142.86 contracts, which can be ____ to satisfy an MNC's needs.
. a more standardized; standardized
b indirect; 142.86 .
. b more standardized; custom-tailored
c indirect; 150 .
. c more custom-tailored; standardized
d direct; 150 .
. d more custom-tailored; custom-tailored
e indirect; 0 .
. e less standardized; custom-tailored
.
ANS: B PTS: 1
ANS: B PTS: 1
99. Which of the following is not true regarding electronic communications networks
(ECNs)? 102. An MNC's short-term financing decisions are satisfied in the ____ market, while its
a They have a visible trading floor. medium debt financing decisions are satisfied in the ____ market.
. a international money; international credit
b Trades are executed by a computer network. .
. b international money; international bond
c They have been created in many countries to match orders between buyers .
. and sellers. c international credit; international money
d They allow investors to place orders on their computers. .
. d international bond; international credit
e All of the above are true. .
. e international money; international stock
.
ANS: A PTS: 1
ANS: A PTS: 1
100. Which of the following is probably not appropriate for an MNC wishing to reduce its

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Chapter 4: Exchange Rate Determination 415
5. An increase in U.S. interest rates relative to German interest rates would likely _______ the U.S.
Chapter 4 demand for euros and _______ the supply of euros for sale.
A) reduce; increase
B) increase; reduce
C) reduce; reduce
Exchange Rate Determination D) increase; increase
https://alcoholfan.wordpress.com/2014/04/16/7/ ANSWER: A
1. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian 6. Investors from Germany, the United States, and Britain frequently invest in each other based on
dollar was $0.69. The Australian dollar _______ by _______%. prevailing interest rates. If British interest rates increase, German investors are likely to buy
A) depreciated; 5.80 _______ dollar-denominated securities, and the euro is likely to _______ relative to the dollar.
B) depreciated; 4.00 A) fewer; depreciate
C) appreciated; 5.80 B) fewer; appreciate
D) appreciated; 4.00 C) more; depreciate
D) more; appreciate
ANSWER: C
ANSWER: A
SOLUTION: ($0.73 3 $0.69)/$0.69 = 5.80%
7. When the <real= interest rate is relatively low in a given country, then the currency of that country
2. If a currency9s spot rate market is _______, its exchange rate is likely to be _______ to a single is typically expected to be:
large purchase or sale transaction. A) weak, since the country9s quoted interest rate would be high relative to the inflation rate.
A) liquid; highly sensitive B) strong, since the country9s quoted interest rate would be low relative to the inflation rate.
B) illiquid; insensitive C) strong, since the country9s quoted interest rate would be high relative to the inflation rate.
C) illiquid; highly sensitive D) weak, since the country9s quoted interest rate would be low relative to the inflation rate.
D) none of these
ANSWER: D
ANSWER: C
8. Assume that the inflation rate becomes much higher in the U.K. relative to the U.S. This will place
3. _______ is not a factor that causes currency supply and demand schedules to change. _______ pressure on the value of the British pound. Also, assume that interest rates in the U.K.
A) Relative inflation rates begin to rise relative to interest rates in the U.S. The change in interest rates will place _______
B) Relative interest rates pressure on the value of the British pound.
C) Relative income levels A) upward; downward
D) Expectations B) upward; upward
E) All of these are factors that cause currency supply and demand schedules to change. C) downward; upward
D) downward; downward
ANSWER: E
ANSWER: C
4. A large increase in the income level in Mexico along with no growth in the U.S. income level is
normally expected to cause (assuming no change in interest rates or other factors) a(n) _______ in
Mexican demand for U.S. goods, and the Mexican peso should _______.
A) increase; appreciate
B) increase; depreciate
C) decrease; depreciate
D) decrease; appreciate
ANSWER: B
414

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416 International Financial Management Chapter 4: Exchange Rate Determination 417
9. Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to 10. Assume the following information regarding U.S. and European annualized interest rates:
$.50. The following annual interest rates apply:
Currency Lending Rate Borrowing Rate
Currency Lending Rate Borrowing Rate U.S. Dollar ($) 6.73% 7.20%
Dollars 7.10% 7.50% Euro (¬) 6.80% 7.28%
New Zealand dollar (NZ$) 6.80% 7.25%
Trensor Bank can borrow either $20 million or ¬20 million. The current spot rate of the euro is
Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank9s $1.13. Furthermore, Trensor Bank expects the spot rate of the euro to be $1.10 in 90 days. What is
forecast if correct, what will its dollar profit be from speculation over the five-day period Trensor Bank9s dollar profit from speculating if the spot rate of the euro is indeed $1.10 in 90
(assuming it does not use any of its existing consumer deposits to capitalize on its expectations)? days?
A) $521,325. A) $579,845.
B) $500,520. B) $583,800.
C) $104,262. C) $588,200.
D) $413,419. D) $584,245.
E) $208,044. E) $980,245.
ANSWER: E ANSWER: A
SOLUTION: SOLUTION:
1. Borrow $5 million. 1. Borrow ¬20 million.
2. Convert to NZ$: $5,000,000/$.48 = NZ$10,416,667. 2. Convert the ¬20 million to ¬20,000,000 × $1.13 = $22,600,000.
3. Invest the NZ$ at an annualized rate of 6.80% over five days. 3. Invest the $22,600,000 at an annualized rate of 6.73% for 90 days.
NZ$10,416,667 × [1 + 6.80% (5/360)] $22,600,000 × [1 + 6.73% (90/360)]
= NZ$10,426,505 = $22,980,245
4. Convert the NZ$ back to dollars: 4. Determine euros owed:
NZ$10,426,505 × $.50 = $5,213,252 ¬20,000,000 × [1 + 7.28% (90/360)] = ¬20,364,000.
5. Repay the dollars borrowed. The repayment amount is: 5. Determine dollars needed to repay euro loan:
$5,000,000 × [1 + 7.5% (5/360)] ¬20,364,000 × $1.10 = $22,400,400.
= $5,000,000 × [1.00104] 6. The dollar profit is:
= $5,005,208 $22,980,245 3 $22,400,400 = $579,845.
6. After repaying the loan, the remaining dollar profit is:
$5,213,252 3 $5,005,208 = $208,044

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11. The equilibrium exchange rate of pounds is $1.70. At an exchange rate of $1.72 per pound: 15. If inflation in New Zealand suddenly increased while U.S. inflation stayed the same, there would
A) U.S. demand for pounds would exceed the supply of pounds for sale and there would be a be:
shortage of pounds in the foreign exchange market. A) an inward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for
B) U.S. demand for pounds would be less than the supply of pounds for sale and there would be a NZ$.
shortage of pounds in the foreign exchange market. B) an outward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for
C) U.S. demand for pounds would exceed the supply of pounds for sale and there would be a NZ$.
surplus of pounds in the foreign exchange market. C) an outward shift in the demand schedule for NZ$ and an outward shift in the supply schedule
D) U.S. demand for pounds would be less than the supply of pounds for sale and there would be a for NZ$.
surplus of pounds in the foreign exchange market. D) an inward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for
E) U.S. demand for pounds would be equal to the supply of pounds for sale and there would be a NZ$.
shortage of pounds in the foreign exchange market.
ANSWER: A
ANSWER: D
16. If the U.S. and Japan engage in substantial financial flows but little trade, _______ directly
12. Assume that Swiss investors have francs available to invest in securities, and they initially view influence their exchange rate the most. If the U.S. and Switzerland engage in much trade but little
U.S. and British interest rates as equally attractive. Now assume that U.S. interest rates increase financial flows, _______ directly influence their exchange rate the most.
while British interest rates stay the same. This would likely cause: A) interest rate differentials; interest rate differentials
A) the Swiss demand for dollars to decrease and the dollar will depreciate against the pound. B) inflation and interest rate differentials; interest rate differentials
B) the Swiss demand for dollars to increase and the dollar will depreciate against the Swiss franc. C) income and interest rate differentials; inflation differentials
C) the Swiss demand for dollars to increase and the dollar will appreciate against the Swiss D) interest rate differentials; inflation and income differentials
franc. E) inflation and income differentials; interest rate differentials
D) the Swiss demand for dollars to decrease and the dollar will appreciate against the pound.
ANSWER: D
ANSWER: C
17. If inflation increases substantially in Australia while U.S. inflation remains unchanged, this is
13. The real interest rate adjusts the nominal interest rate for: expected to place _______ pressure on the value of the Australian dollar with respect to the U.S.
A) exchange rate movements. dollar.
B) income growth. A) upward
C) inflation. B) downward
D) government controls. C) either upward or downward (depending on the degree of the increase in Australian inflation)
E) none of these. D) none of these; there will be no impact
ANSWER: C ANSWER: B
14. If U.S. inflation suddenly increased while European inflation stayed the same, there would be: 18. Assume that British corporations begin to purchase more supplies from the U.S. as a result of
A) an increased U.S. demand for euros and an increased supply of euros for sale. several labor strikes by British suppliers. This action reflects:
B) a decreased U.S. demand for euros and an increased supply of euros for sale. A) an increased demand for British pounds.
C) a decreased U.S. demand for euros and a decreased supply of euros for sale. B) a decrease in the demand for British pounds.
D) an increased U.S. demand for euros and a decreased supply of euros for sale. C) an increase in the supply of British pounds for sale.
D) a decrease in the supply of British pounds for sale.
ANSWER: D
ANSWER: C
19. The phrase <the dollar was mixed in trading= means that:
A) the dollar was strong in some periods and weak in other periods over the last month.
B) the volume of trading was very high in some periods and low in other periods.
C) the dollar was involved in some currency transactions, but not others.
D) the dollar strengthened against some currencies and weakened against others.
ANSWER: D

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20. Assume that the U.S. places a strict quota on goods imported from Chile and that Chile does not 25. Assume that the U.S. experiences a significant decline in income, while Japan9s income remains
retaliate. Holding other factors constant, this event should immediately cause the U.S. demand for steady. This event should place _______ pressure on the value of the Japanese yen, other things
Chilean pesos to _______ and the value of the peso to _______. being equal. (Assume that interest rates and other factors are not affected.)
A) increase; increase A) upward
B) increase; decline B) downward
C) decline; decline C) no
D) decline; increase D) upward and downward (offsetting)
ANSWER: C ANSWER: B
21. Any event that increases the U.S. demand for euros should result in a(n) _______ in the value of 26. News of a potential surge in U.S. inflation and zero Chilean inflation places _______ pressure on
the euro with respect to _______, other things being equal. the value of the Chilean peso. The pressure will occur _______.
A) increase; U.S. dollar A) upward; only after the U.S. inflation surges
B) increase; nondollar currencies B) downward; only after the U.S. inflation surges
C) decrease; nondollar currencies C) upward; immediately
D) decrease; U.S. dollar D) downward; immediately
ANSWER: A ANSWER: C
22. Any event that reduces the U.S. demand for Japanese yen should result in a(n) _______ in the 27. Assume that Canada places a strict quota on goods imported from the U.S. and that the U.S. does
value of the Japanese yen with respect to _______, other things being equal. not retaliate. Holding other factors constant, this event should immediately cause the supply of
A) increase; U.S. dollar Canadian dollars to be exchanged for U.S. dollars to _______ and the value of the Canadian dollar
B) increase; nondollar currencies to _______.
C) decrease; nondollar currencies A) increase; increase
D) decrease; U.S. dollar B) increase; decline
C) decline; decline
ANSWER: D D) decline; increase
23. Any event that increases the supply of British pounds to be exchanged for U.S. dollars should ANSWER: D
result in a(n) _______ in the value of the British pound with respect to _______, other things
being equal. 28. Assume that Japan places a strict quota on goods imported from the U.S. and the U.S. places a
A) increase; U.S. dollar strict quota on goods imported from Japan. This event should immediately cause the U.S. demand
B) increase; nondollar currencies for Japanese yen to _______, and the supply of Japanese yen to be exchanged for U.S. dollars to
C) decrease; nondollar currencies _______.
D) decrease; U.S. dollar A) increase; increase
B) increase; decline
ANSWER: D C) decline; decline
D) decline; increase
24. Any event that reduces the supply of Swiss francs to be exchanged for U.S. dollars should result in
a(n) _______ in the value of the Swiss franc with respect to _______, other things being equal. ANSWER: C
A) increase; U.S. dollar
B) increase; nondollar currencies 29. Which of the following is not mentioned in the text as a factor affecting exchange rates?
C) decrease; nondollar currencies A) relative interest rates.
D) decrease; U.S. dollar B) relative inflation rates.
C) government controls.
ANSWER: A D) expectations.
E) All of these are mentioned in the text as factors affecting exchange rates.
ANSWER: E

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30. If a country experiences high inflation relative to the U.S., its exports to the U.S. should _______,
its imports should _______, and there is _______ pressure on its currency9s equilibrium value. 36. Since supply and demand for a currency are constant (primarily due to government intervention),
A) decrease; increase; upward currency values seldom fluctuate.
B) decrease; decrease; upward A) true.
C) increase; decrease; downward B) false.
D) decrease; increase; downward
E) increase; decrease; upward ANSWER: B
ANSWER: C 37. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a
reduction in the demand for yen.
31. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of A) true.
U.S. funds to purchase its securities should _______, the outflow of its funds to purchase U.S. B) false.
securities should _______, and there is _______ pressure on its currency9s equilibrium value.
A) increase; decrease; downward ANSWER: A
B) decrease; increase; upward
C) increase; decrease; upward 38. The main effect of interest rate movements on exchange rates is through their effect on
D) decrease; increase; downward international trade.
E) increase; increase; upward A) true.
B) false.
ANSWER: C
ANSWER: B
32. In general, when speculating on exchange rate movements, the speculator will borrow the
currency that is expected to appreciate and invest in the country whose currency is expected to 39. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country
depreciate. Y frequently engages in capital flows with the U.S. (such as financial investments). Everything
A) true. else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X9s
B) false. currency more than the exchange rate of Country Y9s currency.
A) true.
ANSWER: B B) false.
33. The exchange rates of smaller countries are very stable because the market for their currency is ANSWER: B
very liquid.
A) true. 40. Increases in relative income in one country vs. another result in an increase in that country9s
B) false. currency value.
A) true.
ANSWER: B B) false.
34. An increase in U.S. inflation relative to Singapore inflation places upward pressure on the ANSWER: B
Singapore dollar.
A) true. 41. Trade-related foreign exchange transactions are more responsive to news than financial flow
B) false. transactions.
A) true.
ANSWER: A B) false.
35. When expecting a foreign currency to depreciate, a possible way to speculate on this movement is ANSWER: B
to borrow dollars, convert the proceeds to the foreign currency, lend in the foreign country, and
use the proceeds from this investment to repay the dollar loan.
A) true.
B) false.
ANSWER: B

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424 International Financial Management Chapter 54Currency Derivatives
1. Kalons, Inc. is a U.S.-based MNC that frequently imports raw materials from Canada. Kalons is typically
42. Signals regarding future actions of market participants in the foreign exchange market sometimes invoiced for these goods in Canadian dollars and is concerned that the Canadian dollar will appreciate in
result in overreactions. the near future. Which of the following is not an appropriate hedging technique under these
A) true. circumstances?
B) false. a. purchase Canadian dollars forward.
b. purchase Canadian dollar futures contracts.
ANSWER: A c. purchase Canadian dollar put options.
d. purchase Canadian dollar call options.
43. The markets that have a smaller amount of foreign exchange trading for speculatory purposes than
for trade purposes will likely experience more volatility than those where trade flows play a larger
role.
ANS: C PTS: 1
A) true.
B) false.
2. Graylon, Inc., based in Washington, exports products to a German firm and will receive payment of
ANSWER: A ¬200,000 in three months. On June 1, the spot rate of the euro was $1.12, and the 3-month forward rate
was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell ¬200,000 forward in
three months. The spot rate of the euro on September 1 is $1.15. Graylon will receive $____ for the euros.
44. Liquidity of a currency can affect the extent to which speculation can impact the currency9s value.
A) true. a. 224,000
B) false. b. 220,000
c. 200,000
ANSWER: A d. 230,000
45. Forecasting a currency9s future value is difficult, because it is difficult to identify how the factors
affecting the currency value will change, and how they will interact to impact the currency9s ANS: B
value. SOLUTION: ¬200,000 ×$1.10 = $220,000
A) true.
B) false.
PTS: 1
ANSWER: A
3. The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is
46. The standard deviation should be applied to values rather than percentage movements when quoted at $1.63. The forward ____ is ____ percent.
comparing volatility among currencies. a. discount; 1.9
A) true. b. discount; 1.8
B) false.
c. premium; 1.9
d. premium; 1.8
ANSWER: B
47. Movements of foreign currencies tend to be more volatile for shorter time horizons.
A) true. ANS: B
B) false. SOLUTION: (F/S) − 1 = ($1.60/$1.63) − 1 = −1.8 percent.
ANSWER: B
PTS: 1
4. The 90-day forward rate for the euro is $1.07, while the current spot rate of the euro is $1.05. What is the
annualized forward premium or discount of the euro?
a. 1.9 percent discount.
b. 1.9 percent premium.
c. 7.6 percent premium.
d. 7.6 percent discount.

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a. robot
ANS: C b. Euro
SOLUTION: [(F/S) − 1] ×360/90 = 7.6 percent. c. GLOBEX
d. Scope
PTS: 1
ANS: C PTS: 1
5. Thornton, Inc. needs to invest five million Nepalese rupees in its Nepalese subsidiary to support local
operations. Thornton would like its subsidiary to repay the rupees in one year. Thornton would like to 10. Forward contracts:
engage in a swap transaction. Thus, Thornton would: a. contain a commitment to the owner, and are standardized.
a. convert the rupees to dollars in the spot market today and convert rupees to dollars in one b. contain a commitment to the owner, and can be tailored to the desire of the owner.
year at today's forward rate. c. contain a right but not a commitment to the owner, and can be tailored to the desire of the
b. convert the dollars to rupees in the spot market today and convert dollars to rupees in one owner.
year at the prevailing spot rate. d. contain a right but not a commitment to the owner, and are standardized.
c. convert the dollars to rupees in the spot market today and convert rupees to dollars in one
year at today's forward rate.
d. convert the dollars to rupees in the spot market today and convert rupees to dollars in one ANS: B PTS: 1
year at the prevailing spot rate.
11. Which of the following is the most likely strategy for a U.S. firm that will be receiving Swiss francs in the
future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?
ANS: C PTS: 1 a. purchase a call option on francs.
b. sell a futures contract on francs.
6. In the U.S., the typical currency futures contract is based on a currency value in terms of: c. obtain a forward contract to purchase francs forward.
a. euros. d. all of the above are appropriate strategies for the scenario described.
b. U.S. dollars.
c. British pounds.
d. Canadian dollars. ANS: B PTS: 1
12. Which of the following is the most unlikely strategy for a U.S. firm that will be purchasing Swiss francs
ANS: B PTS: 1 in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?
a. purchase a call option on francs.
7. Currency futures contracts sold on an exchange: b. obtain a forward contract to purchase francs forward.
a. contain a commitment to the owner, and are standardized. c. sell a futures contract on francs.
b. contain a commitment to the owner, and can be tailored to the desire of the owner. d. all of the above are appropriate strategies for the scenario described.
c. contain a right but not a commitment to the owner, and can be tailored to the desire of the
owner.
d. contain a right but not a commitment to the owner, and are standardized. ANS: C PTS: 1
13. If your firm expects the euro to substantially depreciate, it could speculate by ____ euro call options or
ANS: A PTS: 1 ____ euros forward in the forward exchange market.
a. selling; selling
8. Currency options sold through an options exchange: b. selling; purchasing
a. contain a commitment to the owner, and are standardized. c. purchasing; purchasing
b. contain a commitment to the owner, and can be tailored to the desire of the owner. d. purchasing; selling
c. contain a right but not a commitment to the owner, and can be tailored to the desire of the
owner.
d. contain a right but not a commitment to the owner, and are standardized. ANS: A PTS: 1
14. When you own ____, there is no obligation on your part; however, when you own ____, there is an
ANS: D PTS: 1 obligation on your part.
a. call options; put options
9. Currency options are commonly traded through the ____ system.

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b. futures contracts; call options

c. forward contracts; futures contracts PTS: 1
d. put options; forward contracts
19. Which of the following is true?
a. The futures market is primarily used by speculators while the forward market is primarily
ANS: D PTS: 1 used for hedging.
b. The futures market is primarily used for hedging while the forward market is primarily
15. The greater the variability of a currency, the ____ will be the premium of a call option on this currency, used for speculating.
and the ____ will be the premium of a put option on this currency, other things equal. c. The futures market and the forward market are primarily used for speculating.
a. greater; lower d. The futures market and the forward market are primarily used for hedging.
b. greater; greater
c. lower; greater
d. lower; lower ANS: A PTS: 1

ANS: B PTS: 1 a. Most forward contracts between firms and banks are for speculative purposes.
b. Most future contracts represent a conservative approach by firms to hedge foreign trade.
16. When currency options are not standardized and traded over-the-counter, there is ____ liquidity and a c. The forward contracts offered by banks have maturities for only four possible dates in the
____ bid/ask spread. future.
a. less; narrower d. none of the above
b. more; narrower
c. more; wider
d. less; wider ANS: D PTS: 1
21. If you expect the euro to depreciate, it would be appropriate to ____ for speculative purposes.
ANS: D PTS: 1 a. buy a euro call and buy a euro put
b. buy a euro call and sell a euro put
17. The shorter the time to the expiration date for a currency, the ____ will be the premium of a call option, c. sell a euro call and sell a euro put
and the ____ will be the premium of a put option, other things equal. d. sell a euro call and buy a euro put
a. greater; greater
b. greater; lower
c. lower; lower ANS: D PTS: 1
d. lower; greater
22. If you expect the British pound to appreciate, you could speculate by ____ pound call options or ____
pound put options.
ANS: C PTS: 1 a. purchasing; selling
b. purchasing; purchasing
18. Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 c. selling; selling
per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of d. selling; purchasing
the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for
the speculator based on the information above is:
a. $1,562.50. ANS: A PTS: 1
b. 2$1,562.50.
c. 2$1,250.00. 23. Which of the following is correct?
d. 2$625.00. a. The longer the time to maturity, the less the value of a currency call option, other things
equal.
b. The longer the time to maturity, the less the value of a currency put option, other things
ANS: B equal.
SOLUTION: The premium of the option is $.05 ×(31,250 units) = $1,562.50. Since the c. The higher the spot rate relative to the exercise price, the greater the value of a currency
option will not be exercised, the net profit is 2$1,562.50. put option, other things equal.
d. The lower the exercise price relative to the spot rate, the greater the value of a currency
call option, other things equal.

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ANS: D PTS: 1 ANS: C PTS: 1
24. Research has found that the options market is: 29. A U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if the bid is
a. efficient before controlling for transaction costs. accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid
b. efficient after controlling for transaction costs. by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against
c. highly inefficient. exchange rate exposure by:
d. none of the above a. selling futures in francs.
b. buying futures in francs.
c. buying franc put options.
ANS: B PTS: 1 d. buying franc call options.
25. Assume no transactions costs exist for any futures or forward contracts. The price of British pound futures
with a settlement date 180 days from now will: ANS: D PTS: 1
a. definitely be above the 180-day forward rate.
b. definitely be below the 180-day forward rate. 30. A firm wants to use an option to hedge 12.5 million in receivables from New Zealand firms. The premium
c. be about the same as the 180-day forward rate. is $.03. The exercise price is $.55. If the option is exercised, what is the total amount of dollars received
d. none of the above; there is no relation between the futures and forward prices. (after accounting for the premium paid)?
a. $6,875,000.
b. $7,250,000.
ANS: C PTS: 1 c. $7,000,000.
d. $6,500,000.
26. Assume that a currency's spot and future prices are the same, and the currency's interest rate is higher than e. none of the above
the U.S. rate. The actions of U.S. investors to lock in this higher foreign return would ____ the currency's
spot rate and ____ the currency's futures price.
a. put upward pressure on; put upward pressure on ANS: D
b. put downward pressure on; put upward pressure on SOLUTION: Dollars received from exercising option = NZ$12.5 million ×$.55 =
c. put upward pressure on; put downward pressure on $6,875,000. Premium paid for options = NZ$12.5 million ×$.03 = $375,000.
d. put downward pressure on; put downward pressure on Amount of dollars received minus premium = $6,500,000.
ANS: C PTS: 1 PTS: 1
27. A firm sells a currency futures contract, and then decides before the settlement date that it no longer wants 31. If you purchase a straddle on euros, this implies that you:
to maintain such a position. It can close out its position by: a. finance the purchase of a call option by selling a put option in the euros.
a. buying an identical futures contract. b. finance the purchase of a call option by selling a call option in the euros.
b. selling an identical futures contract. c. finance the purchase of a put option by selling a put option in the euros.
c. buying a futures contract with a different settlement date. d. finance the purchase of a put option by selling a call option in the euros.
d. selling a futures contract for a different amount of currency. e. none of the above
e. purchasing a put option contract in the same currency.
ANS: E PTS: 1
ANS: A PTS: 1
32. The premium on a pound put option is $.03 per unit. The exercise price is $1.60. The break-even point is
28. If the spot rate of the euro increased substantially over a one-month period, the futures price on euros ____ for the buyer of the put, and ____ for the seller of the put. (Assume zero transactions costs and that
would likely ____ over that same period. the buyer and seller of the put option are speculators.)
a. increase slightly a. $1.63; $1.63
b. decrease substantially b. $1.63; $1.60
c. increase substantially c. $1.63; $1.57
d. stay the same d. $1.57; $1.63

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e. none of the above
ANS: E
ANS: E SOLUTION: Net profit per unit = $.61 2 $.58 2 $.02 = $.01.
SOLUTION: Break-even point on put option to both the buyer and seller is $1.60 2 $.03 =
$1.57.
PTS: 1
PTS: 1 36. You are a speculator who sells a call option on Swiss francs for a premium of $.06, with an exercise price
of $.64. The option will not be exercised until the expiration date, if at all. If the spot rate of the Swiss
33. The existing spot rate of the Canadian dollar is $.82. The premium on a Canadian dollar call option is franc is $.69 on the expiration date, your net profit per unit, assuming that you have to buy Swiss francs in
$.04. The exercise price is $.81. The option will be exercised on the expiration date if at all. If the spot the market to fulfill your obligation, is:
rate on the expiration date is $.87, the profit as a percent of the initial investment (the premium paid) is: a. 2$.02.
a. 0 percent. b. 2$.01.
b. 25 percent. c. $.01.
c. 50 percent. d. $.02.
d. 150 percent. e. none of the above
ANS: C
ANS: C SOLUTION: Net profit per unit = $.64 + $.06 2 $.69 = $.01.
SOLUTION: The net profit per unit is: $.87 2 $.81 2 $.04 = $.02. The net profit per unit as a
percent of the initial investment per unit is: $.02/$.04 = 50%.
PTS: 1
PTS: 1 37. You are a speculator who sells a put option on Canadian dollars for a premium of $.03 per unit, with an
exercise price of $.86. The option will not be exercised until the expiration date, if at all. If the spot rate of
34. You purchase a call option on pounds for a premium of $.03 per unit, with an exercise price of $1.64; the the Canadian dollar is $.78 on the expiration date, your net profit per unit is:
option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is a. 2$.08.
$1.65, your net profit per unit is: b. 2$.03.
a. 2$.03. c. $.05.
b. 2$.02. d. $.08.
c. 2$.01. e. none of the above
d. $.02.
ANS: E
SOLUTION: Net profit = $.78 + $.03 2 $.86 = 2$.05.
ANS: B
SOLUTION: Net profit per unit = $1.65 2 $1.64 2 $.03 = 2$.02.
PTS: 1
PTS: 1 38. European currency options can be exercised ____; American currency options can be exercised ____.
a. any time up to the expiration date; any time up to the expiration date
35. You purchase a put option on Swiss francs for a premium of $.02, with an exercise price of $.61. The b. any time up to the expiration date; only on the expiration date
option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is c. only on the expiration date; only on the expiration date
$.58, your net profit per unit is: d. only on the expiration date; any time up to the expiration date
a. 2$.03.
b. 2$.02.
c. 2$.01. ANS: D PTS: 1
d. $.02.
e. none of the above 39. Macomb Corporation is a U.S. firm that invoices some of its exports in Japanese yen. If it expects the yen
to weaken, it could ____ to hedge the exchange rate risk on those exports.

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a. sell yen put options foreign currency, invest it in the foreign country, and ____ futures in the foreign currency.
b. buy yen call options a. buy; buy
c. buy futures contracts on yen b. sell; buy
d. sell futures contracts on yen c. buy; sell
d. buy; buy
ANS: D PTS: 1
ANS: C PTS: 1
40. A call option on Australian dollars has a strike (exercise) price of $.56. The present exchange rate is $.59.
This call option can be referred to as: 45. Which of the following would result in a profit of a euro futures contract when the euro depreciates?
a. in the money. a. buy a euro futures contract; sell a futures contract after the euro has depreciated.
b. out of the money. b. sell a euro futures contract; buy a futures contract after the euro has depreciated.
c. at the money. c. buy a euro futures contract; buy an additional futures contract after the euro has
d. at a discount. depreciated.
d. none of the above would result in a profit when the euro depreciates.
ANS: A PTS: 1
ANS: B PTS: 1
41. A put option on British pounds has a strike (exercise) price of $1.48. The present exchange rate is $1.55.
This put option can be referred to as: 46. Which of the following is not true regarding options?
a. in the money. a. Options are traded on exchanges, never over-the-counter.
b. out of the money. b. Similar to futures contracts, margin requirements are normally imposed on option traders.
c. at the money. c. Although commissions for options are fixed per transaction, multiple contracts may be
d. at a discount. involved in a transaction, thus lowering the commission per contract.
d. Currency options can be classified as either put or call options.
e. All of the above are true.
ANS: B PTS: 1
42. Which of the following is not an instrument used by U.S.-based MNCs to cover their foreign currency ANS: A PTS: 1
positions?
a. forward contracts. 47. A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$)
b. futures contracts. receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of
c. non-deliverable forward contracts. maturity is $.85, what is the net amount received by the corporation if it acts rationally?
d. options. a. $74,000.
e. all of the above are instruments used to cover foreign currency positions. b. $84,000.
c. $75,000.
d. $85,000.
ANS: E PTS: 1
43. When the futures price on euros is below the forward rate on euros for the same settlement date, astute ANS: B
investors may attempt to simultaneously ____ euros forward and ____ euro futures. SOLUTION: Dollars received from selling Canadian dollars in the spot market = C$100,000
a. sell; sell ×$.85 = $85,000. Premium paid for options = C$100,000 ×$.01 = $1,000.
b. buy; sell Amount of dollars received less premium = $84,000.
c. sell; buy
d. buy; buy
PTS: 1
ANS: B PTS: 1 48. A U.S. corporation has purchased currency call options to hedge a 70,000 pound payable. The premium is
$.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the
44. When the futures price is equal to the spot rate of a given currency, and the foreign country exhibits a total amount paid by the corporation if it acts rationally?
higher interest rate than the U.S. interest rate, astute investors may attempt to simultaneously ____ the a. $33,600.

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b. $46,900. b. be paid; 20,000

c. $44,100. c. pay; 2,000
d. $36,400. d. be paid; 2,000
ANS: D
SOLUTION: Dollars paid when exercising the option = £70,000 ×$.50 = $35,000. Premium ANS: B
paid for options = £70,000 ×$.02 = $1,400. Amount of dollars paid = $35,000 SOLUTION: Amount received per unit = $.022 2 $.02 = $.002 ×THB10,000,0000 =
+ $1,400 = $36,400. $20,000.
PTS: 1 PTS: 1
49. Frank is an option speculator. He anticipates the Danish kroner to appreciate from its current level of $.19 52. If the observed put option premium is less than what is suggested by the put-call parity equation, astute
to $.21. Currently, kroner call options are available with an exercise price of $.18 and a premium of $.02. arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying
Should Frank attempt to buy this option? If the future spot rate of the Danish kroner is indeed $.21, what currency.
is his profit or loss per unit? a. selling; buying; buying
a. no; 2$0.01. b. buying; selling; buying
b. yes; $0.01. c. selling; buying; selling
c. yes; 2$0.01. d. buying; buying; buying
d. yes; $0.03.
ANS: B PTS: 1
ANS: B
SOLUTION: The net profit per unit is: $.21 2 $.18 2 $.02 = $.01. 53. A put option premium has a lower bound that is equal to the greater of zero and the difference between
the underlying ____ prices. The upper bound of a call option premium is the ____ price.
a. spot and exercise; exercise
PTS: 1 b. spot and exercise; spot
c. exercise and spot; exercise
50. Carl is an option writer. In anticipation of a depreciation of the British pound from its current level of d. exercise and spot; spot
$1.50 to $1.45, he has written a call option with an exercise price of $1.51 and a premium of $.02. If the
spot rate at the option's maturity turns out to be $1.54, what is Carl's profit or loss per unit (assuming the
buyer of the option acts rationally)? ANS: C PTS: 1
a. 2$0.01.
b. $0.01. 54. A call option premium has a lower bound that is equal to the greater of zero and the difference between
c. 2$0.04. the underlying ____ prices. The upper bound of a call option premium is the ____ price.
d. $0.04. a. spot and exercise; exercise
e. 2$0.03. b. spot and exercise; spot
c. exercise and spot; exercise
d. exercise and spot; spot
ANS: A
SOLUTION: The net profit per unit is $1.51 + $.02 2 $1.54 = 2$.01.
ANS: B PTS: 1
PTS: 1 55. Assume the spot rate of the Swiss franc is $.62 and the one-year forward rate is $.66. The forward rate
exhibits a ____ of ____.
51. Johnson, Inc., a U.S.-based MNC, will need 10 million Thai baht on August 1. It is now May 1. Johnson a. premium; about 6%
has negotiated a non-deliverable forward contract with its bank. The reference rate is the baht's closing b. discount; about 6%
exchange rate (in $) quoted by Thailand's central bank in 90 days. The baht's spot rate today is $.02. If the c. discount; about 6.45%
rate quoted by Thailand's central bank on August 1 is $.022, Johnson will ____ $____. d. premium; about 6.45%
a. pay; 20,000

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a. the volatility of the underlying asset goes up.

ANS: D b. the time to maturity goes up.
SOLUTION: Premium = (Forward rate 2 Spot rate)/Spot rate = ($.66 2 $.62)/$.62 = 6.45% c. the spot rate declines.
PTS: 1
ANS: D PTS: 1
56. Assume the spot rate of a currency is $.37 and the 90-day forward rate is $.36. The forward rate of this
currency exhibits a ____ of ____ on an annualized basis. 61. Which of the following is true of options?
a. discount; 11.11% a. The writer decides whether the option will be exercised.
b. premium; 11.11% b. The writer pays the buyer the option premium.
c. premium; 10.81% c. The buyer decides if the option will be exercised.
d. discount; 10.81% d. More than one of these.
ANS: D ANS: C PTS: 1

SOLUTION: Discount = [(FR 2 SR)/SR] ×(360/90)
= [($.36 2 $.37)/$.37] ×(360/90) 62. The purchase of a currency put option would be appropriate for which of the following?
= 210.81% (Discount) a. Investors who expect to buy a foreign bond in one month.
b. Corporations who expect to buy foreign currency to finance foreign subsidiaries.
c. Corporations who expect to collect on a foreign account receivable in one month.
PTS: 1 d. all of the above
57. Which of the following are most commonly traded on an exchange?

a. forward contracts. ANS: B PTS: 1
b. futures contracts.
c. currencies 63. If you have bought the right to sell, you are a:
d. none of the above a. call writer.
b. put buyer.
c. futures buyer.
ANS: B PTS: 1 d. put writer.
58. Conditional currency options are:

a. options that do not require premiums. ANS: B PTS: 1
b. options where the premiums are canceled if a trigger level is reached.
c. options that allow the buyer to decide what currency the option will be settled in. 64. If you have a position where you might be obligated to buy Euros, you are:
d. none of the above a. a call writer.
b. a put writer.
c. a put buyer.
ANS: B PTS: 1 d. a futures seller.
59. Which of the following is true regarding the options markets?

a. Hedgers and speculators both attempt to lower risk. ANS: C PTS: 1
b. Hedgers attempt to lower risk, while speculators attempt to make riskless profits.
c. Hedgers and speculators are both necessary in order for the market to be liquid. 65. Which of the following is true for futures, but not for forwards?
d. all of the above a. actual delivery.
b. no transactions costs.
c. self regulation.
ANS: C PTS: 1 d. none of the above
60. The premium of a currency put option will increase if:

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ANS: D PTS: 1
71. Forward contracts are usually liquidated by actual delivery of the currency, while futures contracts are
66. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your usually liquidated by offsetting transactions.
position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward a. True
rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for b. False
the 5,000,000 yen 60 days from now?
a. $44,500. ANS: T PTS: 1
b. $45,000.
c. $526 million. 72. If an investor who previously sold futures contracts wishes to liquidate his position, he could sell futures
d. $47,500. contracts with the same maturity date.
a. True
b. False
ANS: D
ANS: F PTS: 1
SOLUTION: ¥5,000,000 ×$.0095/¥ = $47,500
73. Since futures contracts are traded on an exchange, the exchange will always take the "other side" of the
transaction in terms of accepting the credit risk.
PTS: 1 a. True
b. False
67. The spot rate for the Singapore dollar is $.588. The 30-day forward rate is $.590. The forward rate
contains an annualized ____ of ____%. ANS: T PTS: 1
a. discount; 24.07
b. premium; 4.07 74. Currency options are only traded on exchanges. That is, there is no over-the-counter market for options.
c. discount; 24.08 a. True
d. premium; 4.08 b. False
e. premium; 3.40
ANS: F PTS: 1
ANS: D 75. Both call and put option premiums are affected by the level of the existing spot price relative to the strike
SOLUTION: ($.59 2 $.588)/$.588 ×(360/30) = 4.08% price; for example, a high spot price relative to the strike price will result in a relatively high premium for
a call option but a relatively low premium for a put option.
a. True
b. False
PTS: 1
ANS: T PTS: 1
68. Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets.
a. True
76. The writer of a call option is obligated to sell the underlying currency to the buyer of the option if the
b. False
option is exercised.
a. True
ANS: T PTS: 1
b. False
69. The price of a futures contract will generally vary significantly from that of a forward contract.
ANS: T PTS: 1
a. True
b. False
77. The lower bound of the call option premium is the greater of zero and the difference between the spot rate
and the exercise price; the upper bound of a currency call option is the spot rate.
ANS: F PTS: 1
a. True
b. False
70. If the futures rate is lower than the forward rate, astute investors would attempt to simultaneously buy
futures and sell forward. Such actions would place downward pressure on the futures price and upward
ANS: T PTS: 1
pressure on the forward rate.
a. True
78. The lower bound of a put option premium is the greater of zero and the difference between the exercise
b. False
price and the spot rate; the upper bound of a currency put option is the exercise price.
a. True
ANS: F PTS: 1
b. False

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b. False
ANS: T PTS: 1
ANS: F PTS: 1
79. Due to put-call parity, we can use the same formula to price calls and puts.
a. True 87. A straddle is a speculative strategy that represents the purchase of both a call and a put.
b. False a. True
b. False
ANS: F PTS: 1
ANS: T PTS: 1
80. If an actual put option premium is less than what is suggested by the put-call parity relationship, arbitrage
can be conducted. 88. A currency put option is a contract specifying a standard volume of a particular currency to be exchanged
a. True on a specific settlement date.
b. False a. True
b. False
ANS: T PTS: 1
ANS: F PTS: 1
81. If the futures rate is above the forward rate, actions by rational investors would put upward pressure on
the forward rate and downward pressure on the futures rate. 89. An option writer is the seller of a call or a put option.
a. True a. True
b. False b. False
ANS: T PTS: 1 ANS: T PTS: 1
82. Futures contracts are standardized with respect to delivery date and the futures price specified for the 90. The forward premium is the price specified in a call or put option.
settlement date. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: F PTS: 1
91. An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign receivables.
83. If an investor who has previously purchased a futures contract wishes to liquidate her position, she would To do so, the MNC can either sell the foreign currency forward or sell futures.
sell an identical futures contract with the same settlement date. a. True
a. True b. False
b. False
ANS: T PTS: 1
ANS: T PTS: 1
92. Hedgers should buy puts if they are hedging an expected inflow of foreign currency.
84. Margin requirements are deposits placed by investors in futures contracts with their respective brokerage a. True
firms when they take their position. They are intended to minimize credit risk associated with futures b. False
contracts.
a. True ANS: T PTS: 1
b. False
93. Forward contracts are the best technique for managing exposure arising from project bidding.
ANS: T PTS: 1 a. True
b. False
85. A European option can only be exercised at the expiration date, while an American option can be
exercised any time prior to the expiration date. ANS: F PTS: 1
a. True
b. False 94. The currency futures markets are regulated by the International Monetary Fund.
a. True
ANS: T PTS: 1 b. False
86. The highest amount a buyer of a call or a put option can lose is the exercise price. ANS: F PTS: 1
a. True

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95. It is possible to have an opportunity loss when using futures to hedge.

a. True
b. False ANS: A PTS: 1
ANS: T PTS: 1 104. Managers of MNCs are typically expected to use currency derivatives for speculation in order to improve
profits.
96. Margin is used in the forward market to mitigate default risk. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: F PTS: 1
105. The 180-day forward rate for the euro is $1.34, while the current spot rate of the euro is $1.29. What is
97. There are no transactions costs associated with trading futures or options. the annualized forward premium or discount of the euro?
a. True a. 7.46% premium
b. False b. 7.46% discount
c. 7.75% premium
ANS: F PTS: 1 d. 7.75% discount
98. Futures and options are available for crossrates.
a. True ANS: C
b. False
SOLUTION: [(F/S) 2 1] ×360/180 = [($1.34/$1.29) 2 1] ×360/180 = 7.75%
ANS: T PTS: 1
99. Options can be traded on an exchange or over the counter. PTS: 1

a. True
b. False 106. The annualized forward premium on the euro is 7%. What is the 90-day forward rate on the euro if the
spot rate today is $1.25?
ANS: T PTS: 1 a. $1.27
b. $1.34
100. The writer of an uncovered call can experience a loss limited to the option premium. c. $1.16
a. True d. $1.23
b. False
ANS: F PTS: 1 ANS: A

SOLUTION: $1.25 ×[1 + 7%/(360/90)] = $1.27
101. American style options can be exercised any time up to maturity.
a. True
b. False PTS: 1
ANS: F PTS: 1 107. The one-year forward rate of the Japanese yen is quoted at $.013, and the spot rate of Japanese yen is
quoted at $.011. The forward ____ is ____ percent.
102. If a currency put option is out of the money, then the present exchange rate is less than the strike price.
a. discount; 18.18
a. True
b. premium; 18.18
b. False
c. discount; 15.38
ANS: F PTS: 1 d. premium; 15.38
103. As mentioned in the text, the most common maturities for forward rates are:
a. one, three, six, and twelve months. ANS: B
b. one, three, six, and twelve years. SOLUTION: (F/S) 2 1 = ($.013/$.011) 2 1 = 18.18%
c. two, three, and five years.
d. two, three, and five weeks.
PTS: 1

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108. The spot rate of British pound is quoted at $1.49. The 90-day forward rate exhibits a 2% discount. What is ANS: A PTS: 1
the 90-day forward rate of the pound?
a. $1.52 112. If you have bought a right to buy foreign currency, you are:
b. $1.61 a. a call writer.
c. $1.37 b. a call buyer.
d. $1.46 c. a put writer.
d. a put buyer.
ANS: D
SOLUTION: $1.49 ×(1 2 .02) = $1.46 ANS: B PTS: 1
113. The premium on a pound put option is $.04. The spot rate and the exercise price is $1.52. The spot rate at
PTS: 1 the time of this option expiration is expected to be $1.51. The speculators could profit by:
a. writing a put option.
109. The spot rate of euro is quoted at $1.29. The annualized forward premium on the euro is 10%. What is the b. buying a put option.
30-day forward rate of the euro? c. buying a call option
a. $1.28 d. writing a call option and buying a call option simultaneously.
b. $1.30
c. $1.42
d. $1.16 ANS: D PTS: 1
114. A call option on Japanese yen has a strike (exercise) price of $.012. The present exchange rate is $.011.
ANS: B This call option can be referred to as:
SOLUTION: $1.29 ×[1+ 0.10/(360/30)] = $1.30 a. in the money.
b. out of the money.
c. at the money.
PTS: 1 d. at a discount.
110. The premium on a euro call option is $.02. The exercise price is $1.32. The break-even point is ____ for
the buyer of the call, and ____ for the seller of the call. (Assume zero transactions costs and that the buyer ANS: B PTS: 1
and seller of the put option are speculators.)
a. $1.30; $1.30 115. A put option on Swiss franc has a strike (exercise) price of $.92. The present exchange rate is $.89. This
b. $1.34; $1.30 put option can be referred to as:
c. $1.30; $1.34 a. in the money.
d. $1.34; $1.34 b. out of the money.
c. at the money.
d. at a discount.
ANS: D
SOLUTION: Break-even point on call option to both the buyer and seller is $1.32 + $.02 =
$1.34. ANS: A PTS: 1
116. Crown Co. is expecting to receive 100,000 British pounds in one year. Crown expects the spot rate of
PTS: 1 British pound to be $1.49 in a year, so it decides to avoid exchange rate risk by hedging its receivables.
The spot rate of the pound is quoted at $1.51. The strike price of put and call options are $1.54 and $1.53
111. If you have a position where you might be obligated to sell pounds, you are: respectively. The premium on both options is $.03. The one-year forward rate exhibits a 2.65% premium.
a. a call writer. Assume there are no transaction costs. What is the best possible hedging strategy and how many U.S.
dollars Crown Co. will receive under this strategy?
b. a call buyer.
a. buy a put option and receive $150,000.
c. a put writer.
b. sell pounds forward and receive $155,000.
d. a put buyer.
c. sell a call option and receive $156,000.
d. sell a put option and receive $157,000.

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of April 1st and the profit/loss generated from this transaction is a ____ U.S. dollars.
a. sell yen; gain of $60,000
ANS: B b. sell yen; loss of $60,000
SOLUTION: There are only two feasible choices for hedging in these circumstances: selling c. buy yen; gain of $30,000
pounds forward or buying a put option. d. to buy yen; loss of $30,000
Sell pounds forward:

One-year forward rate = $1.51 ×(1 + .0265) = $1.55 ANS: B
Dollars received = 100,000 ×$1.55 = $155,000 SOLUTION: 2-month forward rate = $.0087 ×(1 2 .03) = $.0084
Profit/loss from transaction = (100,000,000 ×$.0084) 2 (100,000,000 ×.009) =
Buy put option: $60,000 loss.
Amount received per unit = $1.54 2 $.03 = $1.51
Total amount of receivables in U.S.$ = 100,000 ×$1.51 = $151,000
PTS: 1
PTS: 1 121. Assume that a speculator received news that makes her believe that the yen will appreciate or depreciate
substantially in the near future, but she is not certain of the direction. Also assume that exercise price of
117. J&L Co. is a U.S.-based MNC that frequently exports computers to Italy. J&L typically invoices these call and put options are the same. The most appropriate method for speculation is ____and it may be
goods in euros and is concerned that the euro will depreciate in the near future. Which of the following is achieved by ____.
not an appropriate technique under these circumstances? a. straddle; purchase put option and purchase call option.
a. purchase euro put options. b. strangle; purchase put option and sell call option.
b. sell euros forward. c. strangle; sell put option and sell put option.
c. sell euro futures contracts. d. straddle; sell put option and buy call option.
d. sell euro put options.
ANS: A PTS: 1
ANS: D PTS: 1
122. Which of the following does not represent the risk from using forward contracts?
118. The ____ the existing spot price relative to the strike price, the ____ valuable the call options will be. a. if a forward contract is used to hedge receivables, and the spot exchange rate at the
a. higher; less expiration of contract exceeds the contract price.
b. higher; more b. if a forward contract is used to hedge receivables, and the spot exchange rate at the time of
c. lower; less expiration of contract is lower than the contract price.
d. lower; more c. if a forward contract is used to hedge payables, and the spot exchange rate at the time of
expiration of contract is lower than the contract price.
d. if a forward contract is used to hedge payables or receivables and the amount to be
ANS: A PTS: 1 received or paid is cancelled.
119. The ____ the existing spot price relative to the strike price, the ____ valuable the put options will be.
a. higher; less ANS: B PTS: 1
b. higher; more
123. The writer of a put option has a right, but not obligation, to buy the underlying currency from the option
c. lower; less
buyer.
d. lower; more a. True
b. False
ANS: D PTS: 1 ANS: F PTS: 1
st
120. On January 1 , Madison Co. ordered raw material from Japan and agreed to pay 100 million yen for this 124. A straddle can only be achieved if the exercise prices of put and call options are the same.
order on April 1st. It negotiated a 3-month forward contract to obtain 100 million Japanese yen on that a. True
date at $.009. On February 1st, the Japanese firm informed Madison Co. that it won't be able to fulfill that b. False
order. The Japanese yen spot rate on February 1st is $.0087 and 2-month forward rate exhibits 3%
discount. To offset its existing contract Madison Co. will negotiate a forward contract to ____ for the date ANS: T PTS: 1

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a. True
125. An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign payables. To b. False
do so, the MNC can either sell the foreign currency forward or sell futures.
b. False
134. Since corporations have specialized needs, they usually prefer futures contracts to forward contracts for
ANS: F PTS: 1 hedging purposes.
a. True
126. Hedgers should buy calls if they are hedging an expected outflow of foreign currency. b. False
a. True
b. False ANS: F PTS: 1
ANS: T PTS: 1 135. A speculator in futures contracts expecting the value of a foreign currency to depreciate would likely sell
futures contracts.
127. If a currency's forward rate exhibits a discount, the currency is forced to appreciate. a. True
a. True b. False
b. False
ANS: T PTS: 1
ANS: F PTS: 1
136. Currency options are only traded on exchanges. That is, there is no over-the-counter market for options.
128. If a currency's forward rate exhibits a premium, that currency is forced to depreciate. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: F PTS: 1
137. A currency call option grants the right to sell a specific currency at a designated price within a specific
129. If a currency call option is in the money, then the present exchange rate exceeds the strike price. time period.
a. True a. True
b. False b. False
ANS: T PTS: 1 ANS: F PTS: 1
130. If the forward rate for a currency is less than the spot rate for that currency, the forward rate is said to 138. Currency call options allow the purchaser to lock in the price paid for a currency. Therefore, they are
exhibit a premium. often used by MNCs to hedge foreign currency payables.
a. True a. True
b. False b. False
ANS: F PTS: 1 ANS: T PTS: 1
131. If an MNC desires to offset a forward contract that it previously created, it can simply ignore its 139. When the current exchange rate is less than the strike price, a call option with that strike price will be in
obligation. the money and a put option with that strike price will be out of the money.
a. True a. True
b. False b. False
ANS: F PTS: 1 ANS: F PTS: 1
132. Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets. 140. Both call and put option premiums are affected by the level of the existing spot price relative to the strike
a. True price; for example, a high spot price relative to the strike price will result in a relatively high premium for
b. False a call option but a relatively low premium for a put option.
a. True
133. Forward contracts are usually negotiated with a commercial bank, while futures contracts are traded on an ANS: T PTS: 1
organized exchange.

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141. Both call and put option premiums are affected by the level of the existing spot rate relative to the strike
price, the length of time before the expiration date, and the potential variability of the currency. 149. With a bull spread, the spreader believes that the underlying currency will appreciate substantially, even
a. True more so than with a strangle.
b. False a. True
b. False
ANS: T PTS: 1
ANS: F PTS: 1
142. A straddle represents the purchase of either two call or two put options at the same exercise price.
a. True 150. A forward rate for a currency is said to exhibit a discount if
b. False a. the forward rate exceeds the existing spot rate.
b. the forward rate is less than the existing spot rate.
ANS: F PTS: 1 c. the forward rate exceeds the expected future spot rate.
d. the forward rate is less than the expected future spot rate.
143. A European option can be exercised at any time prior to maturity, while an American option can only be e. none of the above
exercised at maturity.
a. True
b. False
ANS: B PTS: 1
ANS: F PTS: 1
151. If the spot rate of the British pound is $1.50, and the one-year forward rate has a discount of 3 percent, the
one-year forward rate is $____.
144. The lower bound of the call option premium is the greater of zero and the difference between the spot rate
a. 1.50
and the exercise price; the upper bound of a currency call option is the spot rate.
a. True b. 1.47
b. False c. 1.55
d. 1.46
ANS: T PTS: 1 e. None of the above
145. The lower bound of a put option premium is the greater of zero and the difference between the exercise
price and the spot rate; the upper bound of a currency put option is the exercise price. ANS: D PTS: 1
a. True
b. False 152. Which of the following is not true regarding futures contracts?
a. Unlike forward contracts, they are generally traded on an exchange.
ANS: T PTS: 1 b. Futures contracts are standardized with respect to delivery date and size of the contract.
c. There is an active over-the-counter market for currency futures contracts.
146. If an actual put option premium is less than what is suggested by the put-call parity relationship, arbitrage d. Currency futures can be used by speculators who attempt to profit from exchange rate
can be conducted. movements.
a. True
b. False
ANS: C PTS: 1
ANS: T PTS: 1
153. When the futures price is above the forward rate, astute investors may attempt to simultaneously buy a
147. An advantage of a short straddle is that it provides the option writer with income from two separate currency forward and sell futures in that currency. These actions would place ____ pressure on the
sources. forward rate and ____ pressure on the futures rate.
a. True a. upward; downward
b. False
b. upward; upward
ANS: T PTS: 1 c. downward; upward
d. downward; downward
148. The disadvantage of a long strangle relative to a long straddle is that the underlying currency has to
fluctuate more prior to expiration.
a. True ANS: A PTS: 1
b. False
154. Assume that the British pound (£) futures price for September is $1.60. Given that 62,500 units are in a
ANS: T PTS: 1 British pound futures contract, the seller of British pound futures will receive $____ on the delivery date.

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a. 39,062.50 159. When a currency call option is classified as "in the money," this indicates that
b. 100,000 a. the spot rate of the currency is less than the exercise price of the option.
c. 48,000 b. the spot rate of the currency is greater than the exercise price of the option.
d. 87,062.50 c. the buyer of the option would generate a profit; that is, the spot rate would exceed the sum
of the exercise price and the premium paid.
d. the buyer of the option would generate a profit; that is, the exercise price would exceed
ANS: B PTS: 1 the sum of the spot rate and the premium paid.
155. Which of the following would result in a profit of a futures contract when the underlying currency
depreciates? ANS: B PTS: 1
a. Buy a futures contract; sell a futures contract after the currency has depreciated
b. Sell a futures contract; buy a futures contract after the currency has depreciated 160. A U.S. corporation has purchased currency call options to hedge a 70,000 pound (£) payable. The
c. Buy a futures contract; buy an additional futures contract after the currency has premium is $0.02 and the exercise price of the option is $0.50. If the spot rate at the time of maturity is
depreciated $0.65, what is the total amount paid by the corporation if it acts rationally?
d. None of the above would result in a profit when the underlying currency of the futures a. $33,600
contract depreciates. b. $46,900
c. $44,100
d. $36,400
ANS: B PTS: 1
156. Currency futures can be used by MNCs to hedge payables. That is, an MNC would ____ futures to hedge ANS: D PTS: 1
a foreign payable position. Also, currency futures can be used for speculation. For example, a speculator
expecting a currency to appreciate would ____ futures. 161. Andrea is an option speculator. She anticipates the Canadian dollar to depreciate from its current level of
a. buy; buy $0.90 to $0.85. Currently, Canadian dollar call options are available with an exercise price of $0.91 and a
b. sell; sell premium of $0.02. Also, Canadian dollar put options are available with an exercise price of $0.88 and a
c. buy; sell premium of $0.02. If the future spot rate of the Canadian dollar is $0.85, what is Andrea's profit or loss
d. sell; buy per unit?
a. $0.03
b. $0.05
ANS: A PTS: 1 c. $0.01
d. $0.04
157. Which of the following is not true regarding options?
a. Options are traded on exchanges, never over-the-counter.
b. Similar to futures contracts, margin requirements are normally imposed on option traders. ANS: C PTS: 1
c. Although commissions for options are fixed per transaction, multiple contracts may be
involved in a transaction, thus lowering the commission per contract. 162. Which of the following is not true regarding options?
d. Currency options can be classified as either put or call options. a. The buyer of a call option has the right to buy the currency at the strike price.
e. All of the above are true. b. The writer of a call option has the obligation to sell the currency to the buyer if the option
if exercised.
c. The buyer of a put option has the right to sell the currency at the strike price.
ANS: A PTS: 1 d. The writer of a put option has the obligation to sell the currency to the buyer if the option
is exercised.
158. When the existing spot rate exceeds the exercise price, a call option is ____, and a put option is ____.
a. out of the money; in the money
b. out of the money; out of the money ANS: D PTS: 1
c. in the money; in the money
d. in the money; out of the money 163. If the observed put option premium is less than what is suggested by the put-call parity equation, astute
arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying
currency.
ANS: D PTS: 1 a. selling; buying; buying
b. buying; selling; buying
c. selling; buying; selling

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d. buying; buying; buying

26. ANS: C
ANS: B PTS: 1 27. ANS: A

ANS: B
28. ANS: D
2. ANS: B
29. ANS: A
3. ANS: A
30. ANS: B
4. ANS: A
31. ANS: B
5. ANS: B
32. ANS: D
6. ANS: D
33. ANS: B
7. ANS: C
34. ANS: E
8. ANS: A
35. ANS: C
9. ANS: C
36. ANS: C
10. ANS: B
37. ANS: D
11. ANS: C
38. ANS: C
12. ANS: B
39. ANS: B
13. ANS: B
14. ANS: A
15. ANS: B
16. ANS: B
17. ANS: B
18. ANS: B
19. ANS: B
20. ANS: B
21. ANS: A
22. ANS: B
23. ANS: B
24. ANS: A
25. ANS: B

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Chapter 64International Arbitrage and Interest Rate Parity

7. When using ____, funds are typically tied up for a significant period of time.
a. covered interest arbitrage
1. Due to ____, market forces should realign the relationship between the interest rate differential of two b. locational arbitrage
currencies and the forward premium (or discount) on the forward exchange rate between the two c. triangular arbitrage
currencies. d. B and C
a. forward realignment arbitrage
b. triangular arbitrage ANS: A PTS: 1
c. covered interest arbitrage
d. locational arbitrage 8. Assume that the interest rate in the home country of Currency X is a much higher interest rate than the
U.S. interest rate. According to interest rate parity, the forward rate of Currency X:
ANS: C PTS: 1 a. should exhibit a discount.
b. should exhibit a premium.
2. Due to ____, market forces should realign the spot rate of a currency among banks. c. should be zero (i.e., it should equal its spot rate).
a. forward realignment arbitrage d. B or C
b. triangular arbitrage
c. covered interest arbitrage ANS: A PTS: 1
d. locational arbitrage
9. If the interest rate is higher in the U.S. than in the United Kingdom, and if the forward rate of the
ANS: D PTS: 1 British pound (in U.S. dollars) is the same as the pound's spot rate, then:
a. U.S. investors could possibly benefit from covered interest arbitrage.
3. Due to ____, market forces should realign the cross exchange rate between two foreign currencies b. British investors could possibly benefit from covered interest arbitrage.
based on the spot exchange rates of the two currencies against the U.S. dollar. c. neither U.S. nor British investors could benefit from covered interest arbitrage.
a. forward realignment arbitrage d. A and B
b. triangular arbitrage
c. covered interest arbitrage ANS: B PTS: 1
d. locational arbitrage
10. If the interest rate is lower in the U.S. than in the United Kingdom, and if the forward rate of the
ANS: B PTS: 1 British pound is the same as its spot rate:
a. U.S. investors could possibly benefit from covered interest arbitrage.
4. If interest rate parity exists, then ____ is not feasible. b. British investors could possibly benefit from covered interest arbitrage.
a. forward realignment arbitrage c. neither U.S. nor British investors could benefit from covered interest arbitrage.
b. triangular arbitrage d. A and B
c. covered interest arbitrage
d. locational arbitrage ANS: A PTS: 1
ANS: C PTS: 1 11. Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest rates
on euros. Which of the following forces should result from the act of this covered interest arbitrage?
5. In which case will locational arbitrage most likely be feasible? a. downward pressure on the euro's spot rate.
a. One bank's ask price for a currency is greater than another bank's bid price for the b. downward pressure on the euro's forward rate.
currency. c. downward pressure on the U.S. interest rate.
b. One bank's bid price for a currency is greater than another bank's ask price for the d. upward pressure on the euro's interest rate.
currency.
c. One bank's ask price for a currency is less than another bank's ask price for the currency. ANS: B PTS: 1
d. One bank's bid price for a currency is less than another bank's bid price for the currency.
12. Assume that Swiss investors are benefiting from covered interest arbitrage due to a high U.S. interest
ANS: B PTS: 1 rate. Which of the following forces results from the act of this covered interest arbitrage?
a. upward pressure on the Swiss franc's spot rate.
6. When using ____, funds are not tied up for any length of time. b. upward pressure on the U.S. interest rate.
a. covered interest arbitrage c. downward pressure on the Swiss interest rate.
b. locational arbitrage d. upward pressure on the Swiss franc's forward rate.
c. triangular arbitrage
d. B and C ANS: D PTS: 1
ANS: D PTS: 1

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13. Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in Mexico at PTS: 1
14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms
attempt to use covered interest arbitrage, what forces should occur? 17. Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity
a. spot rate of peso increases; forward rate of peso decreases. exists, then:
b. spot rate of peso decreases; forward rate of peso increases. a. British investors who invest in the United Kingdom will achieve the same return as U.S.
c. spot rate of peso decreases; forward rate of peso decreases. investors who invest in the U.S.
d. spot rate of peso increases; forward rate of peso increases. b. U.S. investors will earn a higher rate of return when using covered interest arbitrage than
what they would earn in the U.S.
ANS: A PTS: 1 c. U.S. investors will earn 15% whether they use covered interest arbitrage or invest in the
U.S.
14. Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the d. U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the
bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. Given this information, U.S.
what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much
will you end up with over and above the $1,000,000 you started with? ANS: D PTS: 1
a. $15,385.
b. $15,625. 18. Assume the following information:
c. $22,136.
d. $31,250. U.S. investors have $1,000,000 to invest:
1-year deposit rate offered on U.S. dollars = 12%
ANS: A 1-year deposit rate offered on Singapore dollars = 10%
SOLUTION: $1,000,000/$.325 = NZ$3,076,923 ô $.33 = $1,015,385. Thus, the profit is 1-year forward rate of Singapore dollars = $.412
$15,385. Spot rate of Singapore dollar = $.400
PTS: 1 Given this information:

a. interest rate parity exists and covered interest arbitrage by U.S. investors results in the
15. Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. same yield as investing domestically.
interest rate, the: b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a
a. larger will be the forward discount of the foreign currency. yield above what is possible domestically.
b. larger will be the forward premium of the foreign currency. c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield
c. smaller will be the forward premium of the foreign currency. above what is possible domestically.
d. smaller will be the forward discount of the foreign currency. d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a
yield below what is possible domestically.
ANS: A PTS: 1
ANS: B
16. Assume the following information: SOLUTION: $1,000,000/$.400 = S$2,500,000 ô (1.1)
= S$2,750,000 ô $.412 = $1,133,000
You have $1,000,000 to invest: Yield = ($1,133,000 2 $1,000,000)/$1,000,000 = 13.3%
Current spot rate of pound = $1.30 This yield exceeds what is possible domestically.
90-day forward rate of pound = $1.28
3-month deposit rate in U.S. = 3%
PTS: 1
3-month deposit rate in Great Britain = 4%
19. Assume the following information:
If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars
you will have after 90 days?
Current spot rate of New Zealand dollar = $.41
a. $1,024,000.
Forecasted spot rate of New Zealand dollar 1 year from now = $.43
b. $1,030,000.
One-year forward rate of the New Zealand dollar = $.42
c. $1,040,000.
Annual interest rate on New Zealand dollars = 8%
d. $1,034,000.
Annual interest rate on U.S. dollars = 9%
ANS: A Given the information in this question, the return from covered interest arbitrage by U.S. investors
SOLUTION: $1,000,000/$1.30 = 769,231 pounds ô (1.04) = 800,000 pounds ô 1.28 = with $500,000 to invest is ____%.
$1,024,000 a. about 11.97
b. about 9.63

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c. about 11.12 23. Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this
d. about 11.64 information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand
e. about 10.63 dollar (NZ) with respect to the U.S. dollar should ____, and the exchange rate of the Mexican peso
(MXP) with respect to the U.S. dollar should ____.
ANS: E a. appreciate; depreciate
SOLUTION: $500,000/$.41 = NZ$1,219,512 ô (1.08) b. depreciate; appreciate
= NZ$1,317,073 ô .42 = $553,171 c. depreciate; depreciate
Yield = ($553,171 2 $500,000)/$500,000 = 10.63% d. appreciate; appreciate
e. remain stable; appreciate
PTS: 1
ANS: A PTS: 1
20. Assume the following bid and ask rates of the pound for two banks as shown below:
Bid Ask
Bank A $1.41 $1.42 Spot rate today of Swiss franc = $.60
Bank B $1.39 $1.40 1-year forward rate as of today for Swiss franc = $.63
Expected spot rate 1 year from now = $.64
As locational arbitrage occurs: Rate on 1-year deposits denominated in Swiss francs = 7%
a. the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will Rate on 1-year deposits denominated in U.S. dollars = 9%
increase.
b. the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate
decrease. of return of ____%.
c. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will a. 5.00
decrease. b. 12.35
d. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will c. 15.50
increase. d. 14.13
e. 11.22
ANS: D PTS: 1
ANS: B
21. Assume the bid rate of a Singapore dollar is $.40 while the ask rate is $.41 at Bank X. Assume the bid SOLUTION: $1,000,000/$.60 = SF1,666,667 ô (1.07)
rate of a Singapore dollar is $.42 while the ask rate is $.425 at Bank Z. Given this information, what = SF1,783,333 ô $.63 = $1,123,500
would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will Yield = ($1,123,500 2 $1,000,000)/$1,000,000 = 12.35%
you end up with over and above the $1,000,000 you started with?
a. $11,764. PTS: 1
b. 2$11,964.
c. $36,585. 25. Assume the following information for a bank quoting on spot exchange rates:
d. $24,390.
e. $18,219. Exchange rate of Singapore dollar in U.S. $ = $.32
Exchange rate of pound in U.S. $ = $1.50
ANS: D Exchange rate of pound in Singapore dollars = S$4.50
SOLUTION: $1,000,000/$.41 = S2,439,024 ô $.42 = $1,024,390
Based on the information given, as you and others perform triangular arbitrage, what should logically
PTS: 1 happen to the spot exchange rates?
a. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S.
22. Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign dollars should appreciate, and the pound value in Singapore dollars should depreciate.
interest rate, the: b. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S.
a. larger will be the forward discount of the foreign currency. dollars should appreciate, and the pound value in Singapore dollars should depreciate.
b. larger will be the forward premium of the foreign currency. c. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S.
c. smaller will be the forward premium of the foreign currency. dollars should appreciate, and the pound value in Singapore dollars should appreciate.
d. smaller will be the forward discount of the foreign currency. d. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S.
dollars should depreciate, and the pound value in Singapore dollars should appreciate.
ANS: B PTS: 1
ANS: D PTS: 1

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c. premium; increase
26. Assume the British pound is worth $1.60, and the Canadian dollar is worth $.80. What is the value of d. premium; decrease
the Canadian dollar in pounds?
a. 2.0. ANS: D PTS: 1
b. 2.40.
c. .80. 31. Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate
d. .50. of the Swiss franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would
e. none of the above be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end
up with over and above the $1,000,000 you started with?
ANS: D a. $7,067.
SOLUTION: $.80/$1.60 = 0.50 b. $8,556.
c. $10,114.
PTS: 1 d. $12,238.
ANS: A
27. Assume that the euro's interest rates are higher than U.S. interest rates, and that interest rate parity
exists. Which of the following is true?
SOLUTION: $1,000,000/$.566 = SF1,766,784 ô $.57 = $1,007,067. Thus, the profit is
a. Americans using covered interest arbitrage earn the same rate of return as Germans who $7,067.
attempt covered interest arbitrage.
b. Americans who invest in the U.S. earn the same rate of return as Germans who attempt PTS: 1
covered interest arbitrage.
c. Americans who invest in the U.S. earn the same rate of return as Germans who invest in 32. Assume the following information:
Germany
d. A and B You have $1,000,000 to invest:
e. None of the above Current spot rate of pound = $1.60
90-day forward rate of pound = $1.57
ANS: E PTS: 1 3-month deposit rate in U.S. = 3%
3-month deposit rate in U.K. = 4%
28. Assume the U.S. interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss franc
has a 4% premium. Given this information: If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars
a. Swiss investors who attempt covered interest arbitrage earn the same rate of return as if you will have after 90 days?
they invested in Switzerland. a. $1,020,500.
b. U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if b. $1,045,600.
they invested in the U.S. c. $1,073,330.
c. A and B d. $1,094,230.
d. none of the above e. $1,116,250.
ANS: B PTS: 1 ANS: A
SOLUTION: $1,000,000/$1.60 = 625,000 pounds ô (1.04) = 650,000 pounds ô 1.57 =
29. Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward $1,020,500
rate. Covered interest arbitrage puts ____ pressure on the pound's spot rate, and ____ pressure on the
pound's forward rate. PTS: 1
a. downward; downward
b. downward; upward 33. Assume the following information:
c. upward; downward
d. upward; upward U.S. investors have $1,000,000 to invest:
ANS: C PTS: 1 1-year deposit rate offered by U.S. banks = 12%
1-year deposit rate offered on Swiss francs = 10%
30. Assume that interest rate parity holds, and the euro's interest rate is 9% while the U.S. interest rate is 1-year forward rate of Swiss francs = $.62
12%. Then the euro's interest rate increases to 11% while the U.S. interest rate remains the same. As a Spot rate of Swiss franc = $.60
result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to
maintain interest rate parity. Given this information:
a. discount; increase a. interest rate parity exists and covered interest arbitrage by U.S. investors results in the
b. discount; decrease same yield as investing domestically.

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b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a ANS: D PTS: 1
yield above what is possible domestically.
c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield 36. Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume the
above what is possible domestically. bid rate of an Australian dollar is $.62 while the ask rate is $.625 at Bank V. Given this information,
d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much
yield below what is possible domestically. will you end up with over and above the $1,000,000 you started with?
a. $10,003.
ANS: B b. $12,063.
SOLUTION: $1,000,000/$.60 = SF1,666,667 ô (1.1) = SF1,833,333 ô $.62 = $1,136,667 c. $14,441.
Yield = ($1,136,667 2 $1,000,000)/$1,000,000 = 13.7% d. $16,393.
This yield exceeds what is possible domestically. e. $18,219.
PTS: 1 ANS: D
SOLUTION: $1,000,000/$.61 = A$1,639,344 ô $.62 = $1,016,393. Thus, the profit is
34. Assume the following information: $16,393.
Current spot rate of Australian dollar = $.64 PTS: 1

Forecasted spot rate of Australian dollar 1 year from now = $.59
1-year forward rate of Australian dollar = $.62 37. Assume the following information for a bank quoting on spot exchange rates:
Annual interest rate for Australian dollar deposit = 9%
Annual interest rate in the U.S. = 6% Exchange rate of Singapore dollar in U.S. $ = $.60
Exchange rate of pound in U.S. $ = $1.50
Given the information in this question, the return from covered interest arbitrage by U.S. investors Exchange rate of pound in Singapore dollars = S$2.6
with $500,000 to invest is ____%.
a. about 6.00 Based on the information given, as you and others perform triangular arbitrage, what should logically
b. about 9.00 happen to the spot exchange rates?
c. about 7.33 a. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S.
d. about 8.14 dollars should appreciate, and the pound value in Singapore dollars should depreciate.
e. about 5.59 b. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S.
dollars should appreciate, and the pound value in Singapore dollars should depreciate.
ANS: E c. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S.
SOLUTION: $500,000/$.64 = A$781,250 ô (1.09) dollars should appreciate, and the pound value in Singapore dollars should appreciate.
= A$851,563 ô $.62 = $527,969 d. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S.
Yield = ($527,969 2 $500,000)/$500,000 = 5.59% dollars should depreciate, and the pound value in Singapore dollars should appreciate.
PTS: 1 ANS: B PTS: 1
35. Assume the following bid and ask rates of the pound for two banks as shown below: 38. Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian ringgit (MYR). Bank B
quotes a bid rate of $.306 and an ask rate of $.310 for the ringgit. What will be the profit for an
Bid Ask investor who has $500,000 available to conduct locational arbitrage?
Bank C $1.61 $1.63 a. $2,041,667.
Bank D $1.58 $1.60 b. $9,804.
c. $500.
As locational arbitrage occurs: d. $1,639.
a. the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will ANS: D
increase. SOLUTION: $500,000/$.305 = MYR1,639,344 ô $.306 = $501,639. Thus, the profit is
b. the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will $1,639.
decrease.
c. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will
PTS: 1
decrease.
d. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will
39. Which of the following is an example of triangular arbitrage initiation?
increase. a. buying a currency at one bank's ask and selling at another bank's bid, which is higher than

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the former bank's ask. 180-day interest rate in Australia = 3.0%

b. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African
rand (SAR)/Singapore dollar (S$) exchange rate at SAR2.50 when the spot rate for the If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180
rand is $.20. days?
c. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African a. $56,903.
rand/Singapore dollar exchange rate at SAR3.00 when the spot rate for the rand is $.20. b. $61,548.
d. converting funds to a foreign currency and investing the funds overseas. c. $27,000.
d. $31,500.
ANS: C PTS: 1
ANS: A
40. You just received a gift from a friend consisting of 1,000 Thai baht, which you would like to exchange SOLUTION: $900,000/$.62 = A$1,451,612 ô (1.03) = A$1,495,161 ô $.64 = $956,903.
for Australian dollars (A$). You observe that exchange rate quotes for the baht are currently $.023, Thus, the profit is $56,903.
while quotes for the Australian dollar are $.576. How many Australian dollars should you expect to
receive for your baht? PTS: 1
a. A$39.93.
b. A$25,043.48. 43. Assume the following information:
c. A$553.00.
d. none of the above You have $400,000 to invest:
Current spot rate of Sudanese dinar (SDD) = $.00570
ANS: A
90-day forward rate of the dinar = $.00569
SOLUTION: $.023/$.576 ô THB1,000 = A$39.93.
90-day interest rate in the U.S. = 4.0%
90-day interest rate in Sudan = 4.2%
PTS: 1
If you conduct covered interest arbitrage, what amount will you have after 90 days?
41. National Bank quotes the following for the British pound and the New Zealand dollar: a. $416,000.00.
b. $416,800.00.
Quoted Bid Price Quoted Ask Price c. $424,242.86.
Value of a British pound (£) in $ $1.61 $1.62 d. $416,068.77.
Value of a New Zealand dollar (NZ$) in $ $.55 $.56 e. none of the above
Value of a British pound in
New Zealand dollars NZ$2.95 NZ$2.96 ANS: D
SOLUTION: $400,000/$.0057 = SDD70,175,438.60 ô (1.042)
Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this = SDD73,122,807.02 ô $.00569
strategy? = $416,068.77
a. $77.64.
b. $197.53. PTS: 1
c. $15.43.
d. $111.80. Exhibit 7-1
ANS: C Assume the following information:
SOLUTION: $10,000/$1.62 = £6,172.84 ô 2.95
You have $300,000 to invest:
= NZ$18,209.88 ô $.55
The spot bid rate for the euro (¬) is $1.08
= $10,015.43.
The spot ask quote for the euro is $1.10
Thus, the profit is $15.43.
The 180-day forward rate (bid) of the euro is $1.08
The 180-day forward rate (ask) of the euro is $1.10
PTS: 1 The 180-day interest rate in the U.S. is 6%
The 180-day interest rate in Europe is 8%
44. Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what amount will you have after 180
You have $900,000 to invest: days?
Current spot rate of Australian dollar (A$) = $.62 a. $318,109.10.
180-day forward rate of the Australian dollar = $.64 b. $330,000.00.
180-day interest rate in the U.S. = 3.5% c. $312,218.20.

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d. $323,888.90. 49. For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate
e. none of the above for a currency.
a. True
ANS: A b. False
SOLUTION: $300,000/$1.10 = ¬277,777.80 ô (1.08)
= ¬294,444.40 ô $1.08 ANS: F PTS: 1
= $318,109.10
50. Assume locational arbitrage is possible and involves two different banks. The realignment that would
PTS: 1 occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid
rate.
45. Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what is your percentage return after 180 a. True
days? Is covered interest arbitrage feasible in this situation? b. False
a. 7.96%; feasible
b. 6.04%; feasible ANS: T PTS: 1
c. 6.04%; not feasible
d. 4.07%; not feasible 51. Triangular arbitrage tends to force a relationship between the interest rates of two countries and their
e. 10.00%; feasible forward exchange rate premium or discount.
a. True
ANS: B
b. False
SOLUTION: $318,109.10/$300,000 2 1 = 6.04%. Since this rate is slightly higher than the
U.S. interest rate of 6%, covered interest arbitrage is feasible. ANS: F PTS: 1
PTS: 1 52. The interest rate on euros is 8%. The interest rate in the U.S. is 5%. The euro's forward rate should
exhibit a premium of about 3%.
46. According to interest rate parity (IRP): a. True
a. the forward rate differs from the spot rate by a sufficient amount to offset the inflation b. False
differential between two currencies.
b. the future spot rate differs from the current spot rate by a sufficient amount to offset the ANS: F PTS: 1
interest rate differential between two currencies.
c. the future spot rate differs from the current spot rate by a sufficient amount to offset the 53. Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred
inflation differential between two currencies. to as interest rate parity.
d. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate a. True
differential between two currencies. b. False
ANS: D PTS: 1
ANS: F PTS: 1
47. Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is
8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso's 54. Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically,
forward ____ will ____. market forces will increase the ask rate of the bank from which the currency was bought to conduct
a. premium; increase locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to
b. discount; decrease conduct locational arbitrage.
c. discount; increase a. True
d. premium; decrease b. False
ANS: C PTS: 1 ANS: T PTS: 1
48. If the cross exchange rate of two nondollar currencies implied by their individual spot rates with 55. Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by
respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is engaging in forward contracts.
possible. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: F PTS: 1

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56. To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would above what is possible domestically.
convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a
foreign currency forward. yield below what is possible domestically.
a. True
b. False ANS: A
SOLUTION: $1,000,000/$1.30 = 793,651 pounds ô (1.135) = 900,794 ô $1.26 =
ANS: T PTS: 1 $1,100,076.
Yield: ($1,100,076 2 $1,000,000)/($1,000,000) = 10%.
57. If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage
should be equal to the rate available in the foreign country. PTS: 1
a. True
b. False 63. If quoted exchange rates are the same across different locations, then ____ is not feasible.
a. triangular arbitrage
ANS: F PTS: 1 b. covered interest arbitrage
c. locational arbitrage
58. If interest rate parity (IRP) exists, then triangular arbitrage will not be possible. d. A and C
a. True
ANS: D PTS: 1
b. False
64. Points above the IRP line represent situations where:
ANS: F PTS: 1
a. covered interest arbitrage is feasible from the perspective of domestic investors and results
in the same yield as investing domestically.
59. Forward rates are driven by the government rather than market forces.
b. covered interest arbitrage is feasible from the perspective of domestic investors and results
a. True
in a yield above what is possible domestically.
b. False
c. covered interest arbitrage is feasible from the perspective of foreign investors and results
in a yield above what is possible in their local markets.
ANS: F PTS: 1
d. covered interest arbitrage is not feasible for neither domestic nor foreign investors.
60. The foreign exchange market is an over-the-counter market. ANS: C PTS: 1
a. True
b. False 65. Points below the IRP line represent situations where:
a. covered interest arbitrage is feasible from the perspective of domestic investors and results
ANS: F PTS: 1 in the same yield as investing domestically.
b. covered interest arbitrage is feasible from the perspective of domestic investors and results
61. The yield curve of every country has its own unique shape. in a yield above what is possible domestically.
a. True c. covered interest arbitrage is feasible from the perspective of foreign investors and results
b. False in a yield above what is possible in their local markets.
d. covered interest arbitrage is not feasible for neither domestic nor foreign investors.
ANS: T PTS: 1
ANS: B PTS: 1
66. Which of the following might discourage covered interest arbitrage even if interest rate parity does not
U.S. investors have $1,000,000 to invest: exist?
1-year deposit rate offered by U.S. banks = 10% a. transaction costs.
1-year deposit rate offered on British pounds = 13.5% b. political risk.
1-year forward rate of Swiss francs = $1.26 c. differential tax laws.
Spot rate of Swiss franc = $1.30 d. all of the above.
ANS: D PTS: 1
Given this information:
a. interest rate parity exists and covered interest arbitrage by U.S. investors results in the 67. Assume that interest rate parity holds. U.S. interest rate is 13% and British interest rate is 10%. The
same yield as investing domestically. forward rate on British pounds exhibits a ____ of ____ percent.
b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a a. discount; 2.73
yield above what is possible domestically. b. premium; 2.73
c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield

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c. discount; 3.65 71. The interest rate on pounds in the U.K. is 8%. The interest rate in the U.S. is 5%. Interest rate parity
d. premium; 3.65 exists. U.S. investors will earn a lower return domestically than British investors earn domestically.
a. True
ANS: B PTS: 1 b. False
68. Assume the following information: ANS: T PTS: 1
Exchange rate of Japanese yen in U.S. $ = $.011 72. Assume that the real interest rate in the U.S. and in the U.K. is 3%. The expected annual inflation in
Exchange rate of euro in U.S. $ = $1.40 the U.S. is 3%, while in the U.K. it is 4%. The forward rate on the pound should exhibit a premium of
Exchange rate of euro in Japanese yen = 140 yen about 1%.
a. True
What will be the yield for an investor who has $1,000,000 available to conduct triangular arbitrage? b. False
a. $100,000
b. 2$90,909 ANS: F PTS: 1
c. 10%
d. 29.09% 73. If the cross exchange rate of two nondollar currencies implied by their individual spot rates with
ANS: C respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is
SOLUTION: Exchange dollars for pounds = $1,000,000/$1.4 = 714.286; exchange pounds possible.
a. True
for yen = 714,286 ô 140 = 100,000,000 yen. Exchange yen for dollars =
b. False
100,000,000 yen ô $.011 = $1,100,000. Yield = ($1,100,000 2
$1,000,000)/$1,000,000 = 10%
ANS: F PTS: 1
PTS: 1 74. For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate
for a currency.
69. Assume the following information: a. True
b. False
Quoted Bid Price Quoted Ask Price
Value of an Australian dollar (A$) in $ $0.67 $0.69 ANS: F PTS: 1
Value of Mexican peso in $ $.074 $.077
Value of an Australian dollar in 75. Technology enables more consistent prices among banks and reduces the likelihood of significant
Mexican pesos 8.2 8.5 discrepancies in foreign exchange quotations among locations.
a. True
Assume you have $100,000 to conduct triangular arbitrage. What will be your profit from b. False
implementing this strategy?
a. $6,133 ANS: T PTS: 1
b. $2,368
c. $6,518 76. Assume locational arbitrage is possible and involves two different banks. The realignment that would
d. $13,711 occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid
ANS: B rate.
SOLUTION: $100,000/$.077 = 1,298,701 pesos/8.5 = A$152,788 ô $0.67 = $102,368 a. True
Profit = $102,368 2 $100,000 b. False
ANS: T PTS: 1
PTS: 1
77. Locational arbitrage explains why prices among banks at different locations will not normally differ by
70. The interest rate on yen is 7%. The interest rate in the U.S. is 9%. The yen's forward rate should
a significant amount.
exhibit a premium of about 2%.
a. True
a. True
b. False
b. False
ANS: T PTS: 1
ANS: T PTS: 1

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78. Cross exchange rates are used to determine the relationship between the dollar and two nondollar
currencies. ANS: T PTS: 1
a. True
b. False 86. If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.
a. True
ANS: F PTS: 1 b. False
79. Triangular arbitrage tends to force a relationship between the interest rates of two countries and their ANS: F PTS: 1
forward exchange rate premium or discount.
a. True 87. If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is
b. False not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax
laws.
b. False
80. The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate
parity (IRP). ANS: T PTS: 1
a. True
b. False 88. Which of the following is not mentioned in the text as a form of international arbitrage?
a. Locational arbitrage
ANS: T PTS: 1 b. Triangular arbitrage
c. Transactional arbitrage
81. If interest rate parity exists, then the rate of return achieved from covered interest arbitrage should be d. Covered interest arbitrage
equal to the interest rate available in the foreign country. e. All of the above are mentioned in the text as forms of international arbitrage.
a. True
b. False ANS: C PTS: 1
ANS: F PTS: 1 89. Bank A quotes a bid rate of $0.300 and an ask rate of $0.305 for the Malaysian ringgit (MYR). Bank B
quotes a bid rate of $0.306 and an ask rate of $0.310 for the ringgit. What will be the profit for an
82. Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly investor that has $500,000 available to conduct locational arbitrage?
equal to the interest rate differential between the U.S. and the foreign country. a. $2,041,667
a. True b. $9,804
b. False c. $500
d. $1,639
ANS: T PTS: 1 ANS: D PTS: 1
83. The interest rate in South Africa is 8%. The interest rate in the U.S. is 5%. The South African forward 90. American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR);
rate should exhibit a premium of about 3%. National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would
a. True involve:
b. False a. buying rupees from American Bank at the bid rate and selling them to National Bank at
the ask rate.
ANS: F PTS: 1 b. buying rupees from National Bank at the ask rate and selling them to American Bank at
the bid rate.
84. The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will c. buying rupees from American Bank at the ask rate and selling to National Bank at the bid
be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula. rate.
a. True d. buying rupees from National Bank at the bid rate and selling them to American Bank at
b. False the ask rate.
e. Locational arbitrage is not possible in this case.
ANS: T PTS: 1
ANS: B PTS: 1
85. For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not
possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective. 91. Assume you discovered an opportunity for locational arbitrage involving two banks and have taken
a. True advantage of it. Because of your and other arbitrageurs' actions, the following adjustments must take
b. False place.

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a. One bank's ask price will rise and the other bank's bid price will fall. than the interest rate in the home country.
b. One bank's ask price will fall and the other bank's bid price will rise. d. If covered interest arbitrage is possible, you can guarantee a return on your funds that
c. One bank's bid/ask spread will widen and the other bank's bid/ask spread will fall. exceeds the returns you could achieve domestically.
d. A and C e. All of the above are true regarding covered interest arbitrage.
92. Which of the following is an example of triangular arbitrage initiation? 96. Which of the following is not true regarding covered interest arbitrage?
a. Buying a currency at one bank's ask and selling at another bank's bid, which is higher than a. Covered interest arbitrage is a reason for observing interest rate parity (IRP).
the former bank's ask. b. If the forward rate is equal to the spot rate, conducting covered interest arbitrage will yield
b. Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African a return that is exactly equal to the interest rate in the foreign country.
rand (ZAR)/Singapore dollar (S$) exchange rate at ZAR2.50 when the spot rate for the c. When interest rate parity holds, covered interest arbitrage is not possible.
South African rand is $0.20. d. When interest rate disparity exists, covered interest arbitrage may not be profitable.
c. Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African e. All of the above are true.
rand/Singapore dollar exchange rate at ZAR3.00 when the spot rate for the South African
rand is $0.20. ANS: E PTS: 1
d. Converting funds to a foreign currency and investing the funds overseas.
97. Which of the following is not true regarding interest rate parity (IRP)?
ANS: C PTS: 1 a. When interest rate parity holds, covered interest arbitrage is not possible.
b. When the interest rate in the foreign country is higher than that in the home country, the
93. Hewitt Bank quotes a value for the Japanese yen (´) of $0.007, and a value for the Canadian Dollar forward rate of that country's currency should exhibit a discount.
(C$) of $0.821. The cross exchange rate quoted by the bank for the Canadian dollar is ´118.00. You c. When the interest rate in the foreign country is lower than that in the home country, the
have $5,000 to conduct triangular arbitrage. How much will you end up with if you conduct triangular forward rate of that country's currency should exhibit a premium.
arbitrage? d. When covered interest arbitrage is not feasible, interest rate parity must hold.
a. $6,053.27 e. All of the above are true.
b. $5,030.45
c. $6,090.13 ANS: D PTS: 1
d. Triangular arbitrage is not possible in this case.
ANS: B PTS: 1
94. National Bank quotes the following for the British pound and the New Zealand dollar:
Quoted Bid Price Quoted Ask Price

Value of a British pound (£) in $ $1.61 $1.62
Value of a New Zealand dollar (NZ$) in $ $0.55 $0.56
Value of a British pound in
New Zealand dollars NZ$2.95 NZ$2.96
Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this
strategy?
a. $77.64
b. $197.53
c. $15.43
d. $111.80
ANS: C PTS: 1
95. Which of the following is not true regarding covered interest arbitrage?
a. Covered interest arbitrage tends to force a relationship between the interest rates of two
countries and their forward exchange rate premium or discount.
b. Covered interest arbitrage involves investing in a foreign country and covering against
exchange rate risk.
c. Covered interest arbitrage opportunities only exist when the foreign interest rate is higher

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Chapter 84Relationships among Ination, Interest Rates, and exceeds the current foreign in$ation
Exchange Rates rate.
d. a home currency will depreciate if
1. Assume a two-country world: Country A and Country B. Which of the following is the current home in$ation rate
correct about purchasing power parity (PPP) as related to these two countries? exceeds the current foreign in$ation
a. If Country A's in$ation rate exceeds rate.
Country B's in$ation rate, Country
ANS: A PTS: 1
A's currency will weaken.
b. If Country A's interest rate exceeds 4. Because there are a variety of factors in addition to in$ation that a1ect exchange
Country B's in$ation rate, Country rates, this will:
a. reduce the probability that PPP shall
c. If Country A's interest rate exceeds hold.
Country B's in$ation rate, Country
b. increase the probability that PPP
A's currency will strengthen.
shall hold.
d. If Country B's in$ation rate exceeds
c. increase the probability the IFE will
Country A's in$ation rate, Country
hold.
d. B and C
ANS: A PTS: 1
ANS: A PTS: 1
2. Given a home country and a foreign country, purchasing power parity (PPP)
5. Because there are sometimes no substitutes for traded goods, this will:
suggests that:
a. reduce the probability that PPP shall
a. a home currency will depreciate if
hold.
the current home in$ation rate
exceeds the current foreign interest b. increase the probability that PPP
rate. shall hold.
b. a home currency will appreciate if c. increase the probability the IFE will
the current home interest rate hold.
exceeds the current foreign interest d. B and C
rate. ANS: A PTS: 1
c. a home currency will appreciate if
the current home in$ation rate 6. According to the IFE, if British interest rates exceed U.S. interest rates:
exceeds the current foreign in$ation a. the British pound's value will remain
rate. constant.
d. a home currency will depreciate if b. the British pound will depreciate
the current home in$ation rate against the dollar.
exceeds the current foreign in$ation
c. the British in$ation rate will
rate.
decrease.
ANS: D PTS: 1 d. the forward rate of the British pound
will contain a premium.
3. The international Fisher e1ect (IFE) suggests that: e. today's forward rate of the British
a. a home currency will depreciate if pound will equal today's spot rate.
the current home interest rate
ANS: B PTS: 1
exceeds the current foreign interest
rate.
7. Given a home country and a foreign country, the international Fisher e1ect (IFE)
b. a home currency will appreciate if
suggests that:
the current home interest rate
a. the nominal interest rates of both
exceeds the current foreign interest
countries are the same.
rate.
b. the in$ation rates of both countries
c. a home currency will appreciate if
are the same.
the current home in$ation rate
c. the exchange rates of both

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countries will move in a similar investments.

direction against other currencies.
d. none of the above ANS: C PTS: 1
ANS: D PTS: 1 11. Under purchasing power parity, the future spot exchange rate is a function of the
initial spot rate in equilibrium and:
8. Given a home country and a foreign country, purchasing power parity suggests a. the income di1erential.
that: b. the forward discount or premium.
a. the in$ation rates of both countries c. the in$ation di1erential.
will be the same. d. none of the above
b. the nominal interest rates of both
countries will be the same. ANS: C PTS: 1
c. A and B
d. none of the above 12. According to the international Fisher e1ect, if U.S. investors expect a 5% rate of
domestic in$ation over one year, and a 2% rate of in$ation in European countries
ANS: D PTS: 1 that use the euro, and require a 3% real return on investments over one year, the
nominal interest rate on one-year U.S. Treasury securities would be:
9. If interest rates on the euro are consistently below U.S. interest rates, then for the a. 2%.
international Fisher e1ect (IFE) to hold: b. 3%.
a. the value of the euro would often c. −2%.
appreciate against the dollar. d. 5%.
b. the value of the euro would often e. 8%.
depreciate against the dollar.
c. the value of the euro would remain ANS: E
constant most of the time. SOLUTION: 5% + 3% = 8%
d. the value of the euro would
appreciate in some periods and PTS: 1
depreciate in other periods, but on
average have a zero rate of 13. According to the international Fisher e1ect, if investors in all countries require the
appreciation. same real rate of return, the di1erential in nominal interest rates between any
two countries:
ANS: A PTS: 1
a. follows their exchange rate
movement.
10. If the international Fisher e1ect (IFE) did not hold based on historical data, then
b. is due to their in$ation di1erentials.
this suggests that:
c. is zero.
a. some corporations with excess cash
can lock in a guaranteed higher d. is constant over time.
return on future foreign short-term e. C and D
investments. ANS: B PTS: 1
b. some corporations with excess cash
could have generated pro=ts on 14. Assume that U.S. and British investors require a real return of 2%. If the nominal
average from covered interest U.S. interest rate is 15%, and the nominal British rate is 13%, then according to
arbitrage. the IFE, the British in$ation rate is expected to be about ____ the U.S. in$ation
c. some corporations with excess cash rate, and the British pound is expected to ____.
could have generated higher pro=ts a. 2 percentage points above;
on average from foreign short-term depreciate by about 2%
investments than from domestic b. 3 percentage points above;
short-term investments. depreciate by about 3%
d. most corporations that consistently c. 3 percentage points below;
invest in foreign short-term appreciate by about 3%
investments would have generated
d. 3 percentage points below;
the same pro=ts (on average) as
depreciate by about 3%
from domestic short-term

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e. 2 percentage points below; d. real forward rate.

appreciate by about 2%
ANS: B PTS: 1
ANS: E PTS: 1
20. Latin American countries have historically experienced relatively high in$ation,
15. Assume U.S. and Swiss investors require a real rate of return of 3%. Assume the and their currencies have weakened. This information is somewhat consistent
nominal U.S. interest rate is 6% and the nominal Swiss rate is 4%. According to with the concept of:
the international Fisher e1ect, the franc will ____ by about ____. a. interest rate parity.
a. appreciate; 3% b. locational arbitrage.
b. appreciate; 1% c. purchasing power parity.
c. depreciate; 3% d. the exchange rate mechanism.
d. depreciate; 2%
e. appreciate; 2% ANS: C PTS: 1
ANS: E PTS: 1 21. Assume that the in$ation rate in Singapore is 3%, while the in$ation rate in the
U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%.
16. Assume that the U.S. and Chile nominal interest rates are equal. Then, the U.S. a. appreciate; 4.85
nominal interest rate decreases while the Chilean nominal interest rate remains b. depreciate; 3,11
stable. According to the international Fisher e1ect, this implies expectations of c. appreciate; 3.11
____ than before, and that the Chilean peso should ____ against the dollar. d. depreciate; 4.85
a. lower U.S. in$ation; depreciate
b. lower U.S. in$ation; appreciate ANS: A
c. higher U.S. in$ation; depreciate SOLUTION: (1.08/1.03) − 1 = 4.85%.
d. higher U.S. in$ation; appreciate
PTS: 1
ANS: A PTS: 1
22. The in$ation rate in the U.S. is 3%, while the in$ation rate in Japan is 10%. The
17. According to the international Fisher e1ect, if Venezuela has a much higher current exchange rate for the Japanese yen (¥) is $0.0075. After supply and
nominal rate than other countries, its in$ation rate will likely be ____ than other demand for the Japanese yen has adjusted in the manner suggested by
countries, and its currency will ____. purchasing power parity, the new exchange rate for the yen will be:
a. lower; strengthen a. $0.0076.
b. lower; weaken b. $0.0073.
c. higher; weaken c. $0.0070.
d. higher; strengthen d. $0.0066.
ANS: C PTS: 1 ANS: C
SOLUTION: (1.03/1.10) ×$.0075 = $.0070
18. If interest rate parity holds, then the one-year forward rate of a currency will be
____ the predicted spot rate of the currency in one year according to the
international Fisher e1ect. PTS: 1
a. greater than
23. Assume that the U.S. in$ation rate rate is higher than the New Zealand in$ation
b. less than
rate. This will cause U.S. consumers to ____ their imports from New Zealand and
c. equal to
New Zealand consumers to ____ their imports from the U.S. According to
d. answer is dependent on whether the purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand
forward rate has a discount or dollar (NZ$).
premium
a. reduce; increase; appreciation
ANS: C PTS: 1 b. increase; reduce; appreciation
c. reduce; increase; depreciation
19. The Fisher e1ect is used to determine the: d. reduce; increase; appreciation
a. real in$ation rate.
ANS: B PTS: 1
b. real interest rate.
c. real spot rate.

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24. The following regression analysis was conducted for the in$ation rate information b. appreciate; 2.9
and exchange rate of the British pound: c. depreciate; 1.0
d. appreciate; 1.0
Regression results indicate that a0 = 0 and a1 = 2. Therefore: ANS: B
a. purchasing power parity holds. SOLUTION: (1.06/1.03) − 1 = 2.9%.
b. purchasing power parity
overestimated the exchange rate PTS: 1
change during the period under
examination. 28. There is much evidence to suggest that Japanese investors invest in U.S. Treasury
c. purchasing power parity securities when U.S. interest rates are higher than Japanese interest rates. These
underestimated the exchange rate investors most likely believe in the international Fisher e1ect.
change during the period under a. True
examination. b. False
d. purchasing power parity will
overestimate the exchange rate ANS: F PTS: 1
change of the British pound in the
future. 29. Which of the following is not true regarding IRP, PPP, and the IFE?
a. IRP suggests that a currency's spot
ANS: C PTS: 1
rate will change according to
interest rate di1erentials.
25. Which of the following is indicated by research regarding purchasing power parity
b. PPP suggests that a currency's spot
(PPP)?
rate will change according to
a. PPP clearly holds in the short run.
in$ation di1erentials.
b. Deviations from PPP are reduced in
c. The IFE suggests that a currency's
the long run.
spot rate will change according to
c. PPP clearly holds in the long run. interest rate di1erentials.
d. There is no relationship between d. All of the above are true.
in$ation di1erentials and exchange
rate movements in the short run or ANS: A PTS: 1
long run.
30. The relative form of purchasing power parity (PPP) accounts for the possibility of
ANS: B PTS: 1 market imperfections such as transportation costs, tari1s, and quotas in
establishing a relationship between in$ation rates and exchange rate changes.
26. The interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The a. True
spot rate for the British pound is $1.50. According to the international Fisher b. False
e1ect (IFE), the British pound should adjust to a new level of:
a. $1.47. ANS: T PTS: 1
b. $1.53.
c. $1.43. 31. According to the international Fisher e1ect (IFE), the exchange rate percentage
d. $1.57. change should be approximately equal to the di1erential in income levels
between two countries.
ANS: A a. True
SOLUTION: (1.05/1.07) ×(1.50) = $1.47. b. False
PTS: 1 ANS: F PTS: 1
27. If nominal British interest rates are 3% and nominal U.S. interest rates are 6%, 32. Research indicates that deviations from purchasing power parity (PPP) are
then the British pound (£) is expected to ____ by about ____%, according to the reduced over the long run.
international Fisher e1ect (IFE). a. True
a. depreciate; 2.9 b. False

lOMoARcPSD|11124595
d. interest rate parity (IRP).

ANS: T PTS: 1
ANS: D PTS: 1
33. The IFE theory suggests that foreign currencies with relatively high interest rates
will appreciate because the high nominal interest rates re$ect expected in$ation. 40. Which of the following theories can be assessed using data that exists at one
a. True speci=c point in time?
b. False a. purchasing power parity (PPP)
b. international Fisher e1ect (IFE).
ANS: F PTS: 1 c. A and B
34. If the IFE theory holds, that means that covered interest arbitrage is not feasible.
a. True ANS: D PTS: 1
b. False
41. Which of the following theories suggests the percentage change in spot exchange
ANS: F PTS: 1 rate of a currency should be equal to the interest rate di1erential between two
countries?
35. If interest rate parity holds, and the international Fisher e1ect (IFE) holds, foreign a. absolute form of PPP.
currencies with relatively high interest rates should have forward discounts and b. relative form of PPP.
those currencies would be expected to depreciate. c. international Fisher e1ect (IFE).
a. True d. interest rate parity (IRP).
b. False
ANS: C PTS: 1
ANS: T PTS: 1
42. The following regression analysis was conducted for the in$ation rate information
36. Interest rate parity can only hold if purchasing power parity holds. and exchange rate of the British pound:
a. True
b. False
ANS: F PTS: 1 Regression results indicate that a0 = 0 and a1 = 1. Therefore:

a. purchasing power parity holds.
37. If interest rate parity holds, then the international Fisher e1ect must hold. b. purchasing power parity
a. True overestimated the exchange rate
b. False change during the period under
examination.
ANS: F PTS: 1 c. purchasing power parity
underestimated the exchange rate
38. Which of the following theories suggests that the percentage change in spot change during the period under
exchange rate of a currency should be equal to the in$ation di1erential between examination.
two countries? d. purchasing power parity will
a. purchasing power parity (PPP). overestimate the exchange rate
b. triangular arbitrage. change of the British pound in the
c. international Fisher e1ect (IFE). future.
ANS: A PTS: 1
ANS: A PTS: 1
43. The following regression analysis was conducted for the in$ation rate information
39. Which of the following theories suggests that the percentage di1erence between and exchange rate of the British pound:
the forward rate and the spot rate depends on the interest rate di1erential
between two countries?
a. purchasing power parity (PPP).
b. triangular arbitrage. Regression results indicate that a0 = 0 and a1 = 0.4. Therefore:
c. international Fisher e1ect (IFE). a. purchasing power parity holds.

lOMoARcPSD|11124595
overestimated the exchange rate a. 8%

change during the period under b. 5%
examination. c. 3%
c. purchasing power parity d. 2.78%
underestimated the exchange rate
change during the period under ANS: B PTS: 1
examination.
d. purchasing power parity will 47. Assume that the U.S. one-year interest rate is 3% and the one-year interest rate
overestimate the exchange rate on Australian dollars is 6%. The U.S. expected annual in$ation is 5%, while the
change of the British pound in the Australian in$ation is expected to be 7%. You have $100,000 to invest for one
future. year and you believe that PPP holds. The spot exchange rate of an Australian
dollar is $0.689. What will be the yield on your investment if you invest in the
ANS: B PTS: 1 Australian market?
a. 6%
44. Assume that the one-year interest rate in the U.S. is 7% and in the U.K. is 5%. b. 3%
According to the international Fisher e1ect, British pound's spot exchange rate c. 4%
should ____ by about ____ over the year. d. 2%
a. depreciate; 1.9%
b. appreciate; 1.9% ANS: C
c. depreciate; 3.94% SOLUTION: (1 + .05)/(1 + .07) ×$0.689 =
d. appreciate; 3.94% $0.676. ($100,000/A$0.689) ×(1 + .
06) = A$153,846 ×$0.676 =
ANS: B
$104,000. ($104,000 − $100,000)/
SOLUTION: (1 + .07)/(1 + .05) − 1 = 1.9%
$100,000 = 4%
PTS: 1
PTS: 1
45. According to the international Fisher e1ect (IFE):
48. Assume that the international Fisher e1ect (IFE) holds between the U.S. and the
a. the nominal rate of return on a U.K. The U.S. in$ation is expected to be 5%, while British in$ation is expected to
foreign investment should be equal be 3%. The interest rates o1ered on pounds are 7% and U.S. interest rates are
to the nominal rate of return on the 7%. What does this say about real interest rates expected by British investors?
domestic investment.
a. real interest rates expected by
b. the exchange rate adjusted rate of British investors are equal to the
return on a foreign investment interest rates expected by U.S.
should be equal to the interest rate investors.
on a local money market
b. real interest rates expected by
investment.
British investors are 2 percentage
c. the percentage change in the points lower than the real interest
foreign spot exchange rate will be rates expected by U.S. investors.
positive if the foreign interest rate is
c. real interest rates expected by
higher than the local interest rate.
British investors are 2 percentage
d. the percentage change in the points above the real interest rates
foreign spot exchange rate will be expected by U.S. investors.
negative if foreign interest rate is
d. IFE doesn't hold in this case because
lower than the local interest rate.
the U.S. in$ation is higher than the
ANS: B PTS: 1 British in$ation, but the interest
rates o1ered in both countries are
46. Assume that the U.S. one-year interest rate is 5% and the one-year interest rate equal.
on euros is 8%. You have $100,000 to invest and you believe that the
ANS: C PTS: 1
international Fisher e1ect (IFE) holds. The euro's spot exchange rate is $1.40.
What will be the yield on your investment if you invest in euros?
49. The international Fisher e1ect (IFE) suggests that the currencies with relatively

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high interest rates will appreciate because those high rates will attract a. True
investment and increase the demand for that currency. b. False
a. True
ANS: F PTS: 1 55. According to the international =sher e1ect (IFE), the exchange rate percentage
change should be approximately equal to the di1erential in income levels
50. If purchasing power parity holds, then the Fisher e1ect must also hold. between two countries.
a. True a. True
b. False b. False
ANS: F PTS: 1 ANS: F PTS: 1
51. If the international Fisher e1ect (IFE) holds, the local investors are expected to 56. According to purchasing power parity (PPP), if a foreign country's in$ation rate is
earn the same return from investing internationally as they would from investing below the in$ation rate at home, home country consumers will increase their
in their local markets. imports from the foreign country and foreign consumers will lower their demand
a. True for home country products. These market forces cause the foreign currency to
b. False appreciate.
a. True
52. Assume that in$ation in the U.S. is expected to be 9%, while in$ation in Australia ANS: T PTS: 1
is expected to be 5% over the next year. Today you receive an o1er to purchase a
one-year put option for $.03 per unit on Australian dollars at a strike price of 57. According to the IFE, when the nominal interest rate at home exceeds the
$0.72. Today the Australian dollar is quoted at $0.70. You believe that purchasing nominal interest rate in the foreign country, the home currency should
power parity holds. You should accept the o1er. depreciate.
a. True a. True
b. False b. False
ANS: F ANS: T PTS: 1

SOLUTION: Spot rate in a year = (1.09/1.05) ×
$0.70 = $0.73 58. The in$ation rate in the U.S. is 4%, while the in$ation rate in Japan is 1.5%. The
current exchange rate for the Japanese yen (¥) is $0.0080. After supply and
PTS: 1 demand for the Japanese yen has adjusted according to purchasing power parity,
the new exchange rate for the yen will be
53. Assume that the interest rate o1ered on pounds is 5% and the pound is expected a. $0.0078.
to depreciate by 1.5%. For the international Fisher e1ect (IFE) to hold between b. $0.0082.
the U.K. and the U.S., the U.S. interest rate should be ____. c. $0.0111.
a. 3.43% d. $0.00492.
b. 5.68% e. None of the above
c. 6.5%
ANS: B PTS: 1
d. 7.3%
ANS: A 59. Assume that the New Zealand in$ation rate is higher than the U.S. in$ation rate.
SOLUTION: This will cause U.S. consumers to ____ their imports from New Zealand and New
(1 + .05) ×(1 + .015) − 1 = 3.43%
Zealand consumers to ____ their imports from the U.S. According to purchasing
OR 1.05 x (-.015 + 1) = 1.03426 =
power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$).
3.43%
a. reduce; increase; appreciation
b. increase; reduce; depreciation
PTS: 1
c. reduce; increase; depreciation
54. Purchasing power parity (PPP) focuses on the relationship between nominal d. reduce; increase; appreciation
interest rates and exchange rates between two countries. ANS: C PTS: 1

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Chapter 94Forecasting Exchange Rates

60. The following regression was conducted for the exchange rate of the Cyprus
pound (CYP):
1. Which of the following forecasting techniques would best represent the use of today's forward
exchange rate to forecast the future exchange rate?
a. fundamental forecasting.
Regression results indicate that a0 = 0 and a1 = 2. Therefore, b. market-based forecasting.
c. technical forecasting.
a. purchasing power parity holds.
d. mixed forecasting.
overestimated the exchange rate ANS: B PTS: 1
change during the period under
examination.
c. purchasing power parity 2. Which of the following forecasting techniques would best represent sole use of today's spot exchange
underestimated the exchange rate rate of the euro to forecast the euro's future exchange rate?
change during the period under a. fundamental forecasting.
examination. b. market-based forecasting.
d. purchasing power parity will c. technical forecasting.
overestimate the exchange rate d. mixed forecasting.
change of the Cyprus pound in the
ANS: B PTS: 1
future.
ANS: C PTS: 1 3. Which of the following forecasting techniques would best represent the use of relationships between
economic factors and exchange rate movements to forecast the future exchange rate?
61. Among the reasons that purchasing power parity (PPP) does not consistently a. fundamental forecasting.
occur are: b. market-based forecasting.
a. exchange rates are a1ected by c. technical forecasting.
interest rate di1erentials. d. mixed forecasting.
b. exchange rates are a1ected by ANS: A PTS: 1
national income di1erentials and
government controls. 4. Which of the following forecasting techniques would best represent the sole use of the pattern of
c. supply and demand may not adjust historical currency values of the euro to predict the euro's future currency value?
if no substitutable goods are a. fundamental forecasting.
available. b. market-based forecasting.
d. all of the above are reasons that PPP c. technical forecasting.
does not consistently occur. d. mixed forecasting.
62. Which of the following is not true regarding IRP, PPP, and the IFE? 5. If a particular currency is consistently declining substantially over time, then a market-based forecast
a. IRP suggests that a currency's spot will usually have:
rate will change according to a. underestimated the future exchange rates over time.
interest rate di1erentials. b. overestimated the future exchange rates over time.
b. PPP suggests that a currency's spot c. forecasted future exchange rates accurately.
rate will change according to d. forecasted future exchange rates inaccurately but without any bias toward consistent
underestimating or overestimating.
in$ation di1erentials.
c. The IFE suggests that a currency's ANS: B PTS: 1
spot rate will change according to
interest rate di1erentials. 6. According to the text, the analysis of currencies forecasted with use of the forward rate suggests that:
d. All of the above are true. a. currencies exhibited about the same mean forecast errors as a percent of the realized value.
b. the Canadian dollar can be forecasted by U.S. firms with greater accuracy than other
ANS: A PTS: 1 currencies.
c. the Swiss franc can be forecasted by U.S. firms with greater accuracy than other
currencies.

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d. none of the above a. sensitivity analysis.

b. discriminant analysis.
ANS: B PTS: 1 c. technical analysis.
d. factor analysis.
ANS: A PTS: 1
Predicted Value of Realized Value of
Period New Zealand Dollar New Zealand Dollar 12. When the value from the prior period of an influential factor affects the forecast in the future period,
1 $.52 $.50 this is an example of a(n):
2 .54 .60 a. lagged input.
3 .44 .40 b. instantaneous input.
4 .51 .50 c. simultaneous input.
d. B and C
Given this information, the mean absolute forecast error as a percentage of the realized value is about:
a. 1.5%. ANS: A PTS: 1
b. 26%.
c. 6%. 13. Assume a forecasting model uses inflation differentials and interest rate differentials to forecast the
d. 6.5%. exchange rate. Assume the regression coefficient of the interest rate differential variable is −.5, and the
e. none of the above coefficient of the inflation differential variable is .4. Which of the following is true?
a. The interest rate variable is inversely related to the exchange rate, and the inflation variable
ANS: D is directly (positively) related to the interest rate variable.
SOLUTION: [|$.52 − $.50|/$.50 + |$.54 − $.60|/$.60 + |$.44 − $.40|/$.40 + |$.51 − $.50|/ b. The interest rate variable is inversely related to the exchange rate, and the inflation variable
$.50)]/4 is directly related to the exchange rate.
= [.04 + .10 + .10 + .02]/4 c. The interest rate variable is directly related to the exchange rate, and the inflation variable
= .065 = 6.50% is directly related to the exchange rate.
d. The interest rate variable is directly related to the exchange rate, and the inflation variable
PTS: 1 is directly related to the interest rate variable.
ANS: B PTS: 1
8. If it was determined that the movement of exchange rates was not related to previous exchange rate
values, this implies that a ____ is not valuable for speculating on expected exchange rate movements.
14. Which of the following is not a limitation of fundamental forecasting?
a. technical forecast technique
a. uncertain timing of impact.
b. fundamental forecast technique
b. forecasts are needed for factors that have a lagged impact.
c. all of the above
c. omission of other relevant factors from the model.
d. possible change in sensitivity of the forecasted variable to each factor over time.
ANS: A PTS: 1 e. none of the above
ANS: B PTS: 1
a. Forecast errors cannot be negative.
15. Assume that interest rate parity holds. The U.S. five-year interest rate is 5% annualized, and the
b. Forecast errors are negative when the forecasted rate exceeds the realized rate.
Mexican five-year interest rate is 8% annualized. Today's spot rate of the Mexican peso is $.20. What
c. Absolute forecast errors are negative when the forecasted rate exceeds the realized rate.
is the approximate five-year forecast of the peso's spot rate if the five-year forward rate is used as a
d. None of the above.
forecast?
ANS: D PTS: 1 a. $.131.
b. $.226.
10. Which of the following is true according to the text? c. $.262.
a. Forecasts in recent years have been very accurate. d. $.140.
b. Use of the absolute forecast error as a percent of the realized value is a good measure to e. $.174.
use in detecting a forecast bias.
ANS: E
c. Forecasting errors are smaller when focused on longer term periods.
d. None of the above.
SOLUTION: (1.05)5/(1.08)5 − 1 = −13%; $.20[1 + (−13%)] = $.174
ANS: D PTS: 1 PTS: 1
11. A fundamental forecast that uses multiple values of the influential factors is an example of:

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16. Assume that the forward rate is used to forecast the spot rate. The forward rate of the Canadian dollar c. fundamental forecasting.
contains a 6% discount. Today's spot rate of the Canadian dollar is $.80. The spot rate forecasted for d. market-based forecasting.
one year ahead is:
a. $.860. ANS: A PTS: 1
b. $.848.
c. $.740. 22. The following regression model was estimated to forecast the value of the Malaysian ringgit (MYR):
d. $.752.
e. none of the above MYRt = a0 + a1INCt − 1 + a2INFt − 1 + µt,
ANS: D where MYR is the quarterly change in the ringgit, INF is the previous quarterly percentage change in
SOLUTION: $.80 × [1 + (−6%)] = $.752 the inflation differential, and INC is the previous quarterly percentage change in the income growth
differential. Regression results indicate coefficients of a0 = .005; a1 = .4; and a2 = .7. The most recent
PTS: 1 quarterly percentage change in the inflation differential is −5%, while the most recent quarterly
percentage change in the income differential is 3%. Using this information, the forecast for the
17. If today's exchange rate reflects all relevant public information about the euro's exchange rate, but not percentage change in the ringgit is:
all relevant private information, then ____ would be refuted. a. 4.60%.
a. weak-form efficiency b. −1.80%.
b. semistrong-form efficiency c. 5.2%.
c. strong-form efficiency d. −4.60%.
d. A and B e. none of the above
e. B and C
ANS: B
ANS: D PTS: 1 SOLUTION: MYRt = .005 + (.4)(.03) + (.7)(−.05) = −1.80%
18. According to the text, research generally supports ____ in foreign exchange markets.
PTS: 1
a. weak-form efficiency
b. semistrong-form efficiency
23. The following regression model was estimated to forecast the value of the Indian rupee (INR):
c. strong-form efficiency
d. A and B
e. B and C INRt = a0 + a1INTt + a2INFt − 1 + µt,
ANS: D PTS: 1 where INR is the quarterly change in the rupee, INT is the real interest rate differential in period t
between the U.S. and India, and INF is the inflation rate differential between the U.S. and India in the
19. Assume that the U.S. interest rate is 11 percent, while Australia's one-year interest rate is 12 percent. previous period. Regression results indicate coefficients of a0 = .003; a1 = −.5; and a2 = .8. Assume that
Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to INFt − 1 = 2%. However, the interest rate differential is not known at the beginning of period t and must
forecast the future spot rate, the forecast would reflect an expectation of: be estimated. You have developed the following probability distribution:
a. depreciation in the Australian dollar's value over the next year.
b. appreciation in the Australian dollar's value over the next year. Probability Possible Outcome
c. no change in the Australian dollar's value over the next year. 30% −2%
d. information on future interest rates is needed to answer this question. 40% −3%
ANS: A PTS: 1 30% −4%
20. If the forward rate was expected to be an unbiased estimate of the future spot rate, and interest rate The expected change in the Indian rupee in period t is:
parity holds, then: a. 3.40%.
a. covered interest arbitrage is feasible. b. 0.40%.
b. the international Fisher effect (IFE) is supported. c. 3.10%.
c. the international Fisher effect (IFE) is refuted. d. 1.70%.
d. the average absolute error from forecasting would equal zero. e. none of the above
ANS: B PTS: 1 ANS: A
SOLUTION: E[INTt] = (−.02)(.3) + (−.03)(.4) + (−.04)(.3) = −3.00%
21. Which of the following is not a forecasting technique mentioned in your text? INRt = .003 + (−.5)(−.03) + (.8)(.02) = 3.40%
a. accounting-based forecasting.
b. technical forecasting. PTS: 1

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a. weaken; delay
24. Huge Corporation has just initiated a market-based forecast system using the forward rate as an b. weaken; expedite
estimate of the future spot rate of the Japanese yen (¥) and the Australian dollar (A$). Listed below are c. appreciate; expedite
the forecasted and realized values for the last period: d. none of the above
Currency Forecasted Value Realized Value ANS: B PTS: 1

Australian dollar $.60 $.55
Japanese yen $.0067 $.0069 28. If an MNC invests excess cash in a foreign county, it would like the foreign currency to ____; if an
MNC issues bonds denominated in a foreign currency, it would like the foreign currency to ____.
According to this information and using the absolute forecast error as a percentage of the realized a. appreciate; depreciate
value, the forecast of the yen by Huge Corp. is ____ the forecast of the Australian dollar. b. appreciate; appreciate
a. more accurate than c. depreciate; depreciate
b. less accurate than d. depreciate; appreciate
c. more biased than ANS: A PTS: 1
d. the same as
ANS: A 29. Severus Co. has to pay 5 million Canadian dollars for supplies it recently received from Canada.
SOLUTION: Absolute forecast error for the Australian dollar = (|.60 − .55|)/.55 = 9.09% Today, the Canadian dollar has appreciated by 2 percent against the U.S. dollar. Severus has
determined that whenever the Canadian dollar appreciates against the U.S. dollar by more than 1
percent, it experiences a reversal of 40 percent on the following day. Based on this information, the
Absolute forecast error for the Japanese yen = (|.0067 − .0069|)/.0069 = 2.90%
Canadian dollar is expected to ____ tomorrow, and Severus would prefer to make payment ____.
a. depreciate by .8%; today
Therefore, Huge Corp. has estimated the Japanese yen more accurately by b. depreciate by .8%; tomorrow
approximately 6.19%. c. appreciate by .8%; today
d. appreciate by .8%; tomorrow
PTS: 1
ANS: B
25. Gamma Corporation has incurred large losses over the last ten years due to exchange rate fluctuations SOLUTION: et + 1 = (2%) × (−40%) = −0.8%
of the Egyptian pound (EGP), even though the company has used a market-based forecast based on the
forward rate. Consequently, management believes its forecasts to be biased. The following regression PTS: 1
model was estimated to determine if the forecasts over the last ten years were biased:
30. Corporations tend to make only limited use of technical forecasting because it typically focuses on the
St = a0 + a1Ft − 1 + µt, near future, which is not very helpful for developing corporate policies.
a. True
where St is the spot rate of the pound in year t and Ft − 1 is the forward rate of the pound in year t − 1. b. False
Regression results reveal coefficients of a0 = 0 and a1 = 1.3. Thus, Gamma has reason to believe that
its past forecasts have ____ the realized spot rate. ANS: T PTS: 1
a. overestimated
b. underestimated 31. Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following
c. correctly estimated equation for the euro:
eurot = b0 + b1INFt − 1 + b2INCt − 1
ANS: B PTS: 1
= .005 + .9INFt − 1 + 1.1INCt − 1
26. Which of the following is not a method of forecasting exchange rate volatility?
The most recent quarterly percentage change in the inflation differential between the U.S. and Europe
a. using the absolute forecast error as a percentage of the realized value.
was 2 percent, while the most recent quarterly percentage change in the income growth differential
b. using the volatility of historical exchange rate movements as a forecast for the future.
c. using a time series of volatility patterns in previous periods. between the U.S. and Europe was −1 percent. Based on this information, the forecast for the euro is
d. deriving the exchange rate's implied standard deviation from the currency option pricing a(n) ____ of ____%.
model. a. appreciation; 3.4
b. depreciation; 3.4
ANS: A PTS: 1 c. appreciation; 0.7
d. appreciation; 1.2
27. If a foreign currency is expected to ____ substantially against the parent's currency, the parent may
prefer to ____ the remittance of subsidiary earnings. ANS: D

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SOLUTION: eurot = .005 + .9(.02) + 1.1(−.01) = 1.2% d. none of the above

ANS: B PTS: 1
PTS: 1
37. Silicon Co. has forecasted the Canadian dollar for the most recent period to be $0.73. The realized
32. The U.S. inflation rate is expected to be 4 percent over the next year, while the European inflation rate value of the Canadian dollar in the most recent period was $0.80. Thus, the absolute forecast error as a
is expected to be 3 percent. The current spot rate of the euro is $1.03. Using purchasing power parity, percentage of the realized value was ____%.
the expected spot rate at the end of one year is $____. a. 9.6
a. 1.02 b. −9.6
b. 1.03
c. 8.8
c. 1.04
d. −8.8
ANS: C ANS: C
SOLUTION: SOLUTION:
E(St + 1) = $1.03(1.0097) = $1.04

PTS: 1
PTS: 1
38. The absolute forecast error of a currency is ____, on average, in periods when the currency is more
33. If the one-year forward rate for the euro is $1.07, while the current spot rate is $1.05, the expected ____.
percentage change in the euro is ____%. a. lower; volatile
a. 1.90 b. higher; stable
b. 2.00 c. lower; stable
c. −1.87 d. none of the above
d. none of the above ANS: C PTS: 1
ANS: A
SOLUTION: E(e) = 1.07/1.05 − 1 = 1.90% 39. If the foreign exchange market is ____ efficient, then historical and current exchange rate information
is not useful for forecasting exchange rate movements.
a. weak-form
PTS: 1
b. semistrong-form
c. strong form
34. If both interest rate parity and the international Fisher effect hold, then between the forward rate and
d. all of the above
the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation
countries. ANS: D PTS: 1
a. spot; high
b. spot; low 40. Foreign exchange markets are generally found to be at least ____ efficient.
c. forward; high a. weak-form
d. forward; low b. semistrong-form
c. strong form
ANS: C PTS: 1
35. If a foreign country's interest rate is similar to the U.S. rate, the forward rate premium or discount will ANS: B PTS: 1
be ____, meaning that the forward rate and spot rate will provide ____ forecasts.
a. substantial; similar 41. MNCs can forecast exchange rate volatility to determine the potential range surrounding their
b. substantial; very different exchange rate forecast.
c. close to zero; similar a. True
d. close to zero; very different b. False
ANS: C PTS: 1
ANS: T PTS: 1
36. Factors such as economic growth, inflation, and interest rates are an integral part of ____ forecasting.
42. If the pattern of currency values over time appears random, then technical forecasting is appropriate.
a. technical
a. True
b. fundamental
b. False
c. market-based

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ANS: F PTS: 1
ANS: F PTS: 1
43. Inflation and interest rate differentials between the U.S. and foreign countries are examples of
variables that could be used in fundamental forecasting. 51. A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast.
a. True a. True
b. False b. False
ANS: T PTS: 1 ANS: T PTS: 1
44. A regression analysis of the Australian dollar value on the inflation differential between the U.S. and 52. Two methods to assess exchange rate volatility are the volatility of historical exchange rate movements
Australia produced a coefficient of .8. Thus, for every 1% increase in the inflation differential, the and the exchange rate's implied standard deviation from the currency option pricing model.
Australian dollar is expected to depreciate by .8%. a. True
a. True b. False
b. False
ANS: T PTS: 1
ANS: F PTS: 1
53. Market-based forecasting involves the use of historical exchange rate data to predict future values.
45. The most sophisticated forecasting techniques provide consistently accurate forecasts. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: F PTS: 1
54. Fundamental models examine moving averages over time and thus allow the development of a
46. If the forward rate is used as an indicator of the future spot rate, the spot rate is expected to appreciate forecasting rule.
or depreciate by the same amount as the forward premium or discount, respectively. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: T PTS: 1
55. A forecasting technique based on fundamental relationships between economic variables and exchange
47. Research indicates that currency forecasting services almost always outperform forecasts based on the rates, such as inflation, is referred to as technical forecasting.
forward rate. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: F PTS: 1
56. Usually, fundamental forecasting is used for short-term forecasts, while technical forecasting is used
48. When measuring forecast performance of different currencies, it is often useful to adjust for their for longer-term forecasts.
relative sizes. Thus, percentages, rather than nominal amounts, are often used to compute forecast a. True
errors. b. False
a. True
ANS: T PTS: 1 57. If points are scattered evenly on both sides of the perfect forecast line, then the forecast appears to be
very accurate.
49. The closer graphical points are to the perfect forecast line, the better is the forecast. a. True
a. True b. False
b. False
ANS: F PTS: 1
ANS: T PTS: 1
58. If foreign exchange markets are strong-form efficient, then all relevant public and private information
50. Foreign exchange markets appear to be strong-form efficient. is already reflected in today's exchange rates.
a. True a. True
b. False b. False

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ANS: T PTS: 1 66. The following regression model was estimated to forecast the percentage change in the Australian
Dollar (AUD):
59. Exchange rates one year in advance are typically forecasted with almost perfect accuracy for the major
currencies, but not for currencies of smaller countries. AUDt = a0 + a1INTt + a2INFt − 1 + µt,
a. True
b. False where AUD is the quarterly change in the Australian Dollar, INT is the real interest rate differential in
period t between the U.S. and Australia, and INF is the inflation rate differential between the U.S. and
ANS: F PTS: 1 Australia in the previous period. Regression results indicate coefficients of a0 = .001; a1 = −.8; and
a2 = .5. Assume that INFt − 1 = 4%. However, the interest rate differential is not known at the beginning
60. The potential forecast error is larger for currencies that are more volatile. of period t and must be estimated. You have developed the following probability distribution:
a. True
b. False Probability Possible Outcome
20% −3%
ANS: T PTS: 1
80% −4%
61. A forecast of a currency one year in advance is typically more accurate than a forecast one week in
advance since the currency reverts to equilibrium over a longer term period. There is a 20% probability that the Australian dollar will change by ____, and an 80% probability it
a. True will change by ____.
b. False a. 4.5%; 6.1%;
b. 6.1%; 4.5%
ANS: F PTS: 1 c. 4.5%; 5.3%
d. None of the above
62. In general, any key managerial decision that is based on forecasted exchange rates should rely ANS: C
completely on one forecast rather than alternative exchange rate scenarios. SOLUTION: Probability 20% = .001 + (−.8)(−.03) + (.5)(.04) = 4.5%
a. True
Probability 80% = .001 + (−.8)(−.04) + (.5)(.04) = 5.3%
b. False
ANS: F PTS: 1 PTS: 1
63. Monson Co., based in the U.S., exports products to Japan denominated in yen. If the forecasted value 67. Purchasing power parity is used in:
of the yen is substantially ____ than the forward rate, Monson Co. will likely decide ____ the a. technical forecasting.
payments. b. fundamental forecasting.
a. higher; to hedge c. market-based accounting.
b. lower; not to hedge d. all of the above.
c. higher; not to hedge ANS: B PTS: 1
ANS: C PTS: 1 68. If speculators expect the spot rate of the yen in 60 days to be ____ than the 60-day forward rate on the
yen, they will ____ the yen forward and put ____ pressure on the yen's forward rate.
64. When a U.S.-based MNC wants to determine whether to establish a subsidiary in a foreign country, it a. higher; buy; upward
will always accept that project if the foreign currency is expected to appreciate. b. higher; sell; downward
a. True c. higher; sell; upward
b. False d. lower; buy; upward
ANS: A PTS: 1
ANS: F PTS: 1
69. If speculators expect the spot rate of the Canadian dollar in 30 days to be ____ than the 30-day forward
65. The following is not a limitation of technical forecasting: rate on Canadian dollars, they will ____ Canadian dollars forward and put ____ pressure on the
a. It's not suitable for long-term forecasts of exchange rates. Canadian dollar forward rate.
b. It doesn't provide point estimates or a range of possible future values. a. lower; sell; upward
c. It cannot be applied to currencies that exhibit random movements. b. lower; sell; downward
d. It cannot be applied to currencies that exhibit a continuous trend for short-term forecast. c. higher; sell; upward
ANS: D PTS: 1 d. higher; sell; downward

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ANS: B PTS: 1 75. Assume that U.S. interest rate for the next three years is 5%, 6%, and 7% respectively. Also assume
that Canadian interest rates for the next three years are 3%, 6%, 9%. The current Canadian spot rate is
70. Assume that U.S. annual inflation equals 8%, while Japanese annual inflation equals 5%. If purchasing $.840. What is the approximate three-year forecast of Canadian dollar spot rate if the three-year
power parity is used to forecast the future spot rate, the forecast would reflect an expectation of: forward rate is used as a forecast?
a. appreciation of yen's value over the next year. a. $.840
b. depreciation of yen's value over the next year. b. $.890
c. no change in yen's value over the next year. c. $.856
d. information about interest rates is needed to answer this question. d. $.854
ANS: A PTS: 1 ANS: C
SOLUTION: {[(1.05)(1.06)(1.07)]/[(1.03)(1.05)(1.08)]} × $.84 = $.856
71. Assume that U.S. interest rates are 6%, while British interest rates are 7%. If the international Fisher
effect holds and is used to determine the future spot rate, the forecast would reflect an expectation of: PTS: 1
a. appreciation of pound's value over the next year.
b. depreciation of pound's value over the next year. 76. Which of the following is not one of the major reasons for MNCs to forecast exchange rates?
c. no change in pound's value over the next year. a. to decide in which foreign market to invest the excess cash.
d. not enough information to answer this question. b. to decide where to borrow at the lowest cost.
ANS: B PTS: 1 c. to determine whether to require the subsidiary to remit the funds or invest them locally.
d. to speculate on the exchange rate movements.
72. If the foreign exchange market is ____ efficient, then technical analysis is not useful in forecasting ANS: D PTS: 1
exchange rate movements.
a. weak-form 77. Sensitivity analysis allows for all of the following except:
b. semistrong-form a. accountability for uncertainty.
c. strong form b. focus on a single point estimate of future exchange rates.
d. all of the above c. development of a range of possible future values.
ANS: D PTS: 1 d. consideration of alternative scenarios.
ANS: B PTS: 1
73. If today's exchange rate reflects any historical trends in Canadian dollar exchange rate movements, but
not all relevant public information, then the Canadian dollar market is: 78. If graphical points lie above the perfect forecast line, than the forecast overestimated the future value.
a. weak-form efficient. a. True
b. semistrong-form efficient. b. False
c. strong-form efficient.
d. all of the above. ANS: F PTS: 1
ANS: A PTS: 1
79. A regression model was applied to explain movements in the Canadian dollar's value over time. The
74. Leila Corporation used the following regression model to determine if the forecasts over the last ten coefficient for the inflation differential between the U.S. and Canada was −0.2. The coefficient of the
years were biased: interest rate differential between the U.S. and Canada produced a coefficient of 0.8. Thus, the
Canadian dollar depreciates when the inflation differential ____ and the interest rate differential ____.
St = a0 + a1Ft − 1 + µt, a. increases; increases
b. decreases; increases
c. increases; decreases
where St is the spot rate of the yen in year t and Ft − 1 is the forward rate of the yen in year t − 1.
d. increases; decreases
Regression results reveal coefficients of a0 = 0 and a1 = .30. Thus, Leila Corporation has reason to
believe that its past forecasts have ____ the realized spot rate. ANS: C PTS: 1
a. overestimated
b. underestimated 80. If the pattern of currency values over time appears random, then technical forecasting is appropriate.
c. correctly estimated a. True
d. none of the above b. False
ANS: A PTS: 1
ANS: F PTS: 1
81. Market-based forecasting is based on fundamental relationships between economic variables and
exchange rates.

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a. True 89. A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast.
b. False a. True
b. False
ANS: F PTS: 1
ANS: T PTS: 1
82. In market-based forecasting, a forward rate quoted for a specific date in the future can be used as the
forecasted spot rate on that future date. 90. Two methods to assess exchange rate volatility are the volatility of historical exchange rate movements
a. True and the exchange rate's implied standard deviation from the currency option pricing model.
b. False a. True
b. False
ANS: T PTS: 1
ANS: T PTS: 1
83. Since the forward rate does not capture the nominal interest rate between two countries, it should
provide a less accurate forecast for currencies in high-inflation countries than the spot rate. 91. Which of the following is not a forecasting technique mentioned in your text?
a. True a. Accounting-based forecasting
b. False b. Technical forecasting
c. Fundamental forecasting
ANS: F PTS: 1 d. Market-based forecasting
e. Mixed forecasting
84. Inflation and interest rate differentials between the U.S. and foreign countries are examples of
variables that could be used in fundamental forecasting. ANS: A PTS: 1
a. True
b. False 92. The following regression model was estimated to forecast the value of the Malaysian ringgit (MYR):
ANS: T PTS: 1 MYRt = a0 + a1INCt − 1 + a2INFt − 1 + µt,
85. If a foreign country's interest rate is similar to the U.S. rate, the forward rate premium or discount will where MYR is the quarterly change in the ringgit, INF is the previous quarterly percentage change in
be close to zero, meaning that the forward rate and spot rate will provide similar forecasts. the inflation differential, and INC is the previous quarterly percentage change in the income growth
a. True differential. Regression results indicate coefficients of a0 = 0.005; a1 = 0.4; and a2 = 0.7. The most
b. False recent quarterly percentage change in the inflation differential is −5%, while the most recent quarterly
percentage change in the income differential is 3%. Using this information, the forecast for the
ANS: T PTS: 1 percentage change in the ringgit is
a. 4.60%.
86. Using the inflation differential between two countries to forecast their exchange rates is not always b. −1.80%.
accurate because of such factors as the uncertain timing of the impact of inflation and barriers to trade. c. 5.2%.
a. True d. −4.60%.
b. False e. None of the above
ANS: T PTS: 1 ANS: B PTS: 1
87. When measuring forecast performance of different currencies, it is often useful to adjust for their 93. Pro Corp, a U.S.-based MNC, uses purchasing power parity to forecast the value of the Thai baht
relative sizes. Thus, percentages rather than nominal amounts are often used to compute forecast (THB), which has a current exchange rate of $0.022. Inflation in the U.S. is expected to be 3% during
errors. the next year, while inflation in Thailand is expected to be 10%. Under this scenario, Pro Corp would
a. True forecast the value of the baht at the end of the year to be:
b. False a. $0.023.
b. $0.021.
ANS: T PTS: 1 c. $0.020.
d. None of the above
88. Forecast errors tend to be large for short forecast horizons.
ANS: B PTS: 1
a. True
b. False
ANS: F PTS: 1

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94. Small Corporation would like to forecast the value of the Cyprus pound (CYP) five years from now Chapter 104Measuring Exposure to Exchange Rate Fluctuations
using forward rates. Unfortunately, Small is unable to obtain quotes for five-year forward contracts.
However, Small observes that the five-year interest rate in the U.S. is 11%, while the Cyprus five-year
interest rate is 15%. Based on this information, the Cyprus pound should ____ by ____% over the next 1. Translation exposure reflects:
five years. a. the exposure of a firm's international contractual transactions to exchange rate fluctuations.
a. appreciate; 16.22 b. the exposure of a firm's local currency value to transactions between foreign exchange
b. depreciate; 16.22 traders.
c. appreciate; 6.66 c. the exposure of a firm's financial statements to exchange rate fluctuations.
d. depreciate; 6.66 d. the exposure of a firm's cash flows to exchange rate fluctuations.
e. none of the above ANS: C PTS: 1
ANS: B PTS: 1
2. Transaction exposure reflects:
95. The one-year forward rate of the British pound is $1.55, while the current spot rate is $1.60. Based on a. the exposure of a firm's international contractual transactions to exchange rate fluctuations.
the forward rate, what is the expected percentage change in the British pound over the next year? b. the exposure of a firm's local currency value to transactions between foreign exchange
a. +5.0% traders.
b. −3.1% c. the exposure of a firm's financial statements to exchange rate fluctuations.
d. the exposure of a firm's cash flows to exchange rate fluctuations.
c. +3.1%
d. +3.2% ANS: A PTS: 1
e. None of the above
3. Economic exposure refers to:
ANS: B PTS: 1
a. the exposure of a firm's international contractual transactions to exchange rate fluctuations.
b. the exposure of a firm's local currency value to transactions between foreign exchange
96. Which of the following is not a method of forecasting exchange rate volatility?
traders.
a. Using the absolute forecast error as a percentage of the realized value to improve your
c. the exposure of a firm's financial statements to exchange rate fluctuations.
forecast.
d. the exposure of a firm's cash flows to exchange rate fluctuations.
b. Using the volatility of historical exchange rate movements as a forecast for the future.
e. the exposure of a country's economy (specifically GNP) to exchange rate fluctuations.
c. Using a time series of volatility patterns in previous periods.
d. Deriving the exchange rate's implied standard deviation from the currency option pricing ANS: D PTS: 1
model.
4. Diz Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Swiss francs.
ANS: A PTS: 1
These two currencies are highly correlated in their movements against the dollar. Yanta Co. is a U.S.-
based MNC that has the same level of net cash flows in these currencies as Diz Co. except that its
euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk?
a. Diz Co.
b. Yanta Co.
c. the firms have about the same level of exposure.
d. neither firm has any exposure.
ANS: A PTS: 1
5. Jacko Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Sunland francs.
These two currencies are highly negatively correlated in their movements against the dollar. Kriner Co.
is a U.S.-based MNC that has the same exposure as Jacko Co. in these currencies, except that its
Sunland francs represent cash outflows. Which firm has a high exposure to exchange rate risk?
a. Jacko Co.
b. Kriner Co.
c. the firms have about the same level of exposure.
d. neither firm has any exposure.
ANS: B PTS: 1
6. According to the text, currency variability levels ____ perfectly stable over time, and currency
correlations ____ perfectly stable over time.
a. are; are not

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b. are; are d. none of the above

c. are not; are not
d. are not; are ANS: A PTS: 1
ANS: C PTS: 1 13. Magent Co. is a U.S. company that has exposure to the Swiss francs (SF) and Danish kroner (DK). It
has net inflows of SF200 million and net outflows of DK500 million. The present exchange rate of the
7. Which of the following operations benefits from appreciation of the firm's local currency? SF is about $.40 while the present exchange rate of the DK is $.10. Magent Co. has not hedged these
a. borrowing in a foreign currency and converting the funds to the local currency prior to the positions. The SF and DK are highly correlated in their movements against the dollar. If the dollar
appreciation. weakens, then Magent Co. will:
b. receiving earnings dividends from foreign subsidiaries. a. benefit, because the dollar value of its SF position exceeds the dollar value of its DK
c. purchasing supplies locally rather than overseas. position.
d. exporting to foreign countries. b. benefit, because the dollar value of its DK position exceeds the dollar value of its SF
position.
ANS: A PTS: 1 c. be adversely affected, because the dollar value of its SF position exceeds the dollar value
of its DK position.
8. Which of the following operations benefit(s) from depreciation of the firm's local currency? d. be adversely affected, because the dollar value of its DK position exceeds the dollar value
a. borrowing in a foreign country and converting the funds to the local currency prior to the of its SF position.
depreciation.
b. purchasing foreign supplies. ANS: A PTS: 1
c. investing in foreign bank accounts denominated in foreign currencies prior to depreciation
of the local currency. 14. Generally, MNCs with less foreign costs than foreign revenues will be ____ affected by a ____ foreign
d. A and B currency.
a. favorably; stronger
ANS: C PTS: 1 b. not; stronger
c. favorably; weaker
9. Economic exposure can affect: d. not; weaker
a. MNCs only. e. B and D
b. purely domestic firms only.
c. A and B ANS: A PTS: 1
15. When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are ____ affected
ANS: C PTS: 1 by translation exposure. When the dollar weakens, the reported consolidated earnings are ____
affected.
10. Under FASB 52: a. favorably; favorably affected but by a smaller degree
a. translation gains and losses are included in the reported net income. b. favorably; favorably affected by a higher degree
b. translation gains and losses are included in stockholder's equity. c. unfavorably; favorably affected
c. A and B d. favorably; unfavorably affected
ANS: C PTS: 1
ANS: B PTS: 1
16. A firm produces goods for which substitute goods are produced in all countries. Appreciation of the
11. Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the firm's local currency should:
equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in a. increase local sales as it reduces foreign competition in local markets.
pounds. During a ____ cycle, the firm is ____ affected by its exposure. b. increase the firm's exports denominated in the local currency.
a. strong dollar; favorably c. increase the returns earned on the firm's foreign bank deposits.
b. weak dollar; not d. increase the firm's cash outflow required to pay for imported supplies denominated in a
c. strong dollar; not foreign currency.
d. weak dollar; favorably e. none of the above
ANS: A PTS: 1 ANS: E PTS: 1
12. A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively 17. A firm produces goods for which substitute goods are produced in all countries. Depreciation of the
correlated currencies. During ____ dollar cycles, cash outflows are ____. firm's local currency should:
a. weak; somewhat stable a. decrease local sales as foreign competition in local markets is reduced.
b. weak; favorably affected b. decrease the firm's exports denominated in the local currency.
c. weak; adversely affected

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c. decrease the returns earned on the firm's foreign bank deposits. PTS: 1
d. decrease the firm's cash outflow required to pay for imported supplies denominated in a
foreign currency. 23. Dubas Co. is a U.S.-based MNC that has a subsidiary in Germany and another subsidiary in Greece.
e. none of the above Both subsidiaries frequently remit their earnings back to the parent company. The German subsidiary
generated a net outflow of ¬2,000,000 this year, while the Greek subsidiary generated a net inflow of
ANS: E PTS: 1 ¬1,500,000. What is the net inflow or outflow as measured in U.S. dollars this year? The exchange rate
for the euro is $1.05.
18. If a U.S. firm's cost of goods sold exposure is much greater than its sales exposure in Switzerland, a. $3,675,000 outflow
there is a ____ overall impact of the Swiss franc's depreciation against the dollar on ____. b. $525,000 outflow
a. positive; interest expenses c. $525,000 inflow
b. positive; gross profit d. $210,000 outflow
c. negative; gross profit
d. negative; interest expenses ANS: B
SOLUTION: −¬2,000,000 + ¬1,500,000 = −¬500,000 × $1.05 = −$525,000
ANS: B PTS: 1
19. Assume that your firm is an importer of Mexican chairs denominated in pesos. Your competition is PTS: 1
mainly U.S. producers of chairs. You wish to assess the relationship between the percentage change in
its stock price (SPt) and the percentage change in the peso's value relative to the dollar (PESO t). SPt is 24. One argument for exchange rate irrelevance is that:
the dependent variable. You apply the regression model to an earlier subperiod and a more recent a. MNCs can hedge exchange rate exposure much more effectively than individual investors.
subperiod. In the recent subperiod, you increased your importing volume. You should expect that the b. investors can invest in a diversified stock portfolio of MNCs that have different exposures
regression coefficient in the PESOt variable would be ____ in the first subperiod and ____ in the to exchange rates.
second subperiod. c. purchasing power parity does not hold very well.
a. negative; positive d. MNCs are typically not diversified across numerous countries.
b. positive; positive ANS: B PTS: 1
c. positive; negative
d. negative; negative 25. ____ exposure is the degree to which the value of contractual transactions can be affected by exchange
ANS: D PTS: 1 rate fluctuations.
a. Transaction
20. A set of currency cash inflows is more volatile if the correlations are low. b. Economic
a. True c. Translation
b. False d. None of the above
ANS: A PTS: 1
ANS: F PTS: 1
26. If an MNC expects cash inflows of equal amounts in two currencies, and the two currencies are ____
21. Which of the following is not a form of exposure to exchange rate fluctuations? correlated, the MNC's transaction exposure is relatively ____.
a. transaction exposure. a. negatively; high
b. credit exposure. b. negatively; low
c. economic exposure. c. positively; low
d. translation exposure. d. none of the above
ANS: B PTS: 1 ANS: B PTS: 1
22. Subsidiary A of Mega Corporation has net inflows in Australian dollars of A$1,000,000, while 27. If an MNC has a net inflow in one currency and a net outflow of about the same amount in another
Subsidiary B has net outflows in Australian dollars of A$1,500,000. The expected exchange rate of the currency, then the MNCs' transaction exposure is ____ if the two currencies are ____ correlated.
Australian dollar is $.55. What is the net inflow or outflow as measured in U.S. dollars? a. high; positively
a. $500,000 outflow. b. low; negatively
b. $500,000 inflow. c. high; negatively
c. $275,000 inflow. d. none of the above
d. $275,000 outflow.
ANS: C PTS: 1
ANS: D
SOLUTION: A$1,000,000 − A$1,500,000 = −A$500,000 × $.55 = −$275,000 Exhibit 10-1

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Cerra Co. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands.
ANS: B
Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the
SOLUTION:
last 100 days. Assume that these percentage changes are normally distributed. Use the value-at-risk
(VAR) method based on a 95% confidence level for the following question(s).
28. Refer to Exhibit 10-1. What is the maximum one-day loss if the expected percentage change of the
euro tomorrow is 0.5%? PTS: 1
a. −0.5%
b. −2.2% 32. Refer to Exhibit 10-2. Assuming an expected percentage change of 0 percent for each currency during
c. −1.5% the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent
d. −1.2% confidence level and assume the monthly percentage changes for each currency are normally
distributed.
ANS: D a. −9.00%.
SOLUTION: 0.5% − (1.65 × 1%) = −1.2% b. −30.00%.
c. −5.00%.
PTS: 1 d. none of the above
29. Refer to Exhibit 10-1. What is the maximum one-day loss in dollars if the expected percentage change ANS: A
of the euro tomorrow is 0.5%? The current spot rate of the euro (before considering the maximum one- SOLUTION:
day loss) is $1.01.
a. −$75,750.
b. −$60,600. 0% − (1.65 × 5.44%) = −9.00%
c. −$111,100.
d. −$25,250. PTS: 1
ANS: B 33. Appreciation in a firm's local currency causes a(n) ____ in cash inflows and a(n) ____ in cash
SOLUTION: 0.5% − (1.65 × 1%) = −1.2% outflows.
$1.01 × (−.012) × 5,000,000 = −$60,600 a. reduction; reduction
b. increase; increase
PTS: 1 c. increase; reduction
d. reduction; increase
30. The maximum one-day loss computed for the value-at-risk (VAR) method does not depend on:
ANS: A PTS: 1
a. the expected percentage change in the currency for the next day.
b. the standard deviation of the daily percentage changes in the currency over a previous
34. In general, a firm that concentrates on local sales, has very little foreign competition, and obtains
period.
foreign supplies (denominated in foreign currencies) will likely ____ a(n) ____ local currency.
c. the current level of interest rates.
a. be hurt by; appreciated
d. the confidence level used.
b. benefit from; depreciated
ANS: C PTS: 1 c. be hurt by; depreciated
Exhibit 10-2
ANS: C PTS: 1
Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both
euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to
35. The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the
be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on
percentage of a given financial statement item that is susceptible to translation exposure.
data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes
a. greater; smaller
to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between
b. smaller; greater
the euro and the Canadian dollar is 0.30.
c. greater; greater
31. Refer to Exhibit 10-2. What is the portfolio standard deviation?
a. 3.00%. ANS: C PTS: 1
b. 5.44%.
c. 17.98%. 36. Under FASB 52, consolidated earnings are sensitive to the functional currency's weighted average
d. none of the above exchange rate.

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a. True Based on these results, which of the following statements is probably not true?
b. False a. The MNC was more sensitive to movements in the Australian dollar than in the dinar in the
earlier subperiod.
ANS: T PTS: 1 b. The MNC was more sensitive to movements in the dinar than in the Australian dollar in the
more recent subperiod.
37. If the U.S. dollar appreciates, an MNC's: c. The MNC probably had more outflows than inflows in Australian dollars in the earlier
a. U.S. sales will probably decrease. subperiod.
b. exports denominated in U.S. dollars will probably increase. d. The MNC probably had more inflows than outflows denominated in dinar in the more
c. interest owed on foreign funds borrowed will probably increase. recent subperiod.
d. exports denominated in foreign currencies will probably increase. e. All of the above are true.
e. all of the above
ANS: C PTS: 1
ANS: A PTS: 1
41. Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP). 25% of
38. Assume that Mill Corporation, a U.S.-based MNC, has applied the following regression model to the MNC's funds are Taiwan dollars and 75% are pounds. The standard deviation of exchange
estimate the sensitivity of its cash flows to exchange rate movements: movements is 7% for Taiwan dollars and 5% for pounds. The correlation coefficient between
movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the
PCFt = a0 + a1et + µt standard deviation of this two-currency portfolio is approximately:
a. 5.13%.
where the term on the left-hand side is the percentage change in inflation-adjusted cash flows b. 2.63%.
measured in the firm's home currency over period t, and et is the percentage change in the exchange c. 4.33%.
rate of the currency over period t. The regression model estimates a coefficient of a1 of 2. This d. 5.55%.
indicates that:
ANS: A
a. if the foreign currency appreciates by 1%, Mill's cash flows will decline by 2%.
SOLUTION:
b. if the foreign currency appreciates by 1%, Mill's cash flows will decline by .2%.
c. if the foreign currency depreciates by 1%, Mill's cash flows will increase by 2%.
d. if the foreign currency depreciates by 1%, Mill's cash flows will decline by 2%.
PTS: 1
ANS: B PTS: 1
42. Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL). 30% of
39. ____ is (are) not a determinant of translation exposure. the MNC's funds are lev and 70% are leu. The standard deviation of exchange movements is 10% for
a. The MNC's degree of foreign involvement lev and 15% for leu. The correlation coefficient between movements in the value of the lev and the leu
b. The locations of foreign subsidiaries is .85. Based on this information, the standard deviation of this two-currency portfolio is
c. The local (domestic) earnings of the MNC approximately:
d. The accounting methods used a. 17.28%.
ANS: C PTS: 1 b. 13.15%.
c. 14.50%.
40. The following regression model was run by a U.S.-based MNC to determine its degree of economic d. 12.04%.
exposure as it relates to the Australian dollar and Sudanese dinar (SDD): ANS: B
SOLUTION:
PCFt = a0 + a1et + µt
where the term on the left-hand side is the percentage change in inflation-adjusted cash flows
measured in the firm's home currency over period t, and et is the percentage change in the exchange
rate of the currency over period t. The regression was run over two subperiods for each of the two PTS: 1
currencies, with the following results:
43. One argument why exchange rate risk is irrelevant to corporations is that shareholders can deal with
Regression Coefficient (a1) Regression Coefficient (a1) this risk individually.
Currency Earlier Subperiod Recent Subperiod a. True
Australian dollar (A$) −.80 .10 b. False
Sudanese dinar (SDD) .20 .25
ANS: T PTS: 1

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44. Because creditors may prefer that firms maintain low exposure to exchange rate risk, exchange rate ANS: F PTS: 1
movements may cause earnings to be more volatile, and because investors may prefer corporations to
perform hedging for them, exchange rate risk is probably relevant. 52. Assume a regression model in which the dependent variable is the firm's stock price percentage
a. True change, and the independent variable is percentage change in the foreign currency. The coefficient is
b. False negative. This implies that the company's stock price increases if the foreign currency appreciates.
a. True
45. A firm's transaction exposure in any foreign currency is based solely on the size of its open position in ANS: F PTS: 1
that currency.
a. True 53. A company may become more exposed or sensitive to an individual currency's movements over time
b. False for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or
an increased use of the foreign currency.
b. False
46. Two highly negatively correlated currencies move in tandem almost as if they are the same currency.
b. False
54. Regression analysis cannot be used to assess the sensitivity of a company's performance to economic
ANS: F PTS: 1 conditions because economic conditions are unpredictable.
a. True
47. The transaction exposure of two inflow currencies is offset when the correlation between the b. False
currencies is high.
b. False
55. A high correlation between two currencies would be desirable for achieving low exchange rate risk if
ANS: F PTS: 1 one is an inflow currency and the other is an outflow currency.
a. True
48. The Canadian dollar consistently appears to move almost independently of other currencies. That is it b. False
exhibits low correlations with the other currencies.
b. False
56. Firms with more in foreign costs than in foreign revenues will be favorably affected by a stronger
ANS: T PTS: 1 foreign currency.
a. True
49. U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing b. False
to reduce their profit margin.
b. False
57. The exposure of an MNC's consolidated financial statements to exchange rate fluctuations is known as
ANS: T PTS: 1 transaction exposure.
a. True
50. If the functional currencies for reporting purposes are highly correlated, translation exposure is b. False
magnified.
b. False
58. In general, translation exposure is larger with MNCs that have a larger proportion of earnings
ANS: T PTS: 1 generated by foreign subsidiaries.
a. True
51. An MNC can avoid translation exposure if its earnings are not remitted by the foreign subsidiary to the b. False
parent.
b. False
59. A reduction in hedging will probably reduce transaction exposure.

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a. True
ANS: D PTS: 1
b. False
67. Yomance Co. is a U.S. company that has exposure to Japanese yen and British pounds. It has net
ANS: F PTS: 1
inflows of 5,000,000 yen and net outflows of 60,000 pounds. The present exchange rate of the
Japanese yen is $.012 while the present exchange rate of the British pound is $1.50. Yomance Co. has
60. The VAR method presumes that the distribution of exchange rate movements is normal.
not hedged its positions. The yen and pound movements against the dollar are highly and positively
a. True
correlated. If the dollar strengthens, then Yomance Co. will:
b. False
a. benefit, because the dollar value of its pound position exceeds the dollar value of its yen
position.
ANS: T PTS: 1
b. benefit, because the dollar value of its yen position exceeds the dollar value of its pound
position.
61. The VAR method assumes that the volatility (standard deviation) of exchange rate movements changes
c. be adversely affected, because the dollar value of its pound position exceeds the dollar
over time.
value of its yen position.
a. True
d. be adversely affected, because the dollar value of its yen position exceeds the dollar value
b. False
of its pound position.
ANS: F PTS: 1 ANS: A PTS: 1
62. If exchange rate movements are less volatile in the past than in the future, the estimated maximum 68. Generally, MNCs with less foreign revenues than foreign costs will be ____ affected by a ____ foreign
expected loss derived from the VAR method will be underestimated. currency.
a. True a. favorably; stronger
b. False b. favorably; weaker
c. not; stronger
ANS: T PTS: 1 d. not; weaker
63. Some MNCs are subject to economic exposure without being subject to transaction exposure. ANS: B PTS: 1
a. True
b. False 69. If a U.S. firm's cost of goods sold in Switzerland is much greater than its sales in Switzerland, the
appreciation of the Swiss franc has a ____ impact on the firm's ____.
ANS: T PTS: 1 a. positive; interest expenses
b. positive; gross profit
64. If positions in a specific currency among an MNC's subsidiaries offset each other, the decision by one c. negative; gross profit
subsidiary to hedge its position in that currency would increase the MNC's overall exposure. d. negative; interest expenses
a. True
ANS: C PTS: 1
b. False
70. If a U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, the
ANS: T PTS: 1
appreciation of the Australian dollar has a ____ impact on the firm's ____.
a. positive; interest expenses
65. Vada, Inc. exports computers to Australia invoiced in U.S. dollars. Its main competitor is located in
b. positive; gross profit
Japan. Vada is subject to:
c. negative; interest expenses
a. economic exposure.
d. negative; gross profit
b. transaction exposure.
c. translation exposure. ANS: B PTS: 1
d. economic and transaction exposure.
71. U.S. based Majestic Co. sells products to U.S. consumers and purchases all of materials from U.S.
ANS: A PTS: 1
suppliers. Its main competitor is located in Belgium. Majestic Co. is subject to:
a. economic exposure.
66. Jenco Co. imports raw materials from Japan, invoiced in U.S. dollars. The price it pays is not expected
b. translation exposure.
to change for the next several years. If the Japanese yen appreciates, its imports from Japan will
c. transaction exposure.
probably ____ and if the Japanese yen depreciates, its imports from Japan will probably ____.
d. no exposure to exchange rate fluctuations.
a. increase; decrease
b. decrease; increase ANS: A PTS: 1
c. increase; stay the same
d. stay the same; stay the same

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72. Vermont Co. has one foreign subsidiary. Its translation exposure is directly affected by each of the c. translation exposure.
following, except: d. all of the above.
a. the interest rate in the country of the subsidiary.
b. proportion of business conducted by the subsidiary. ANS: D PTS: 1
c. its accounting method.
d. the exchange rate movements of the subsidiary's currency. 76. Lampon Co. is a U.S. firm that has a subsidiary in Hong Kong that produces light fixtures and sells
them to Japan, denominated in Japanese yen. Its subsidiary pays all of its expenses, including the cost
ANS: A PTS: 1 of goods sold, in U.S. dollars. The Hong Kong dollar is pegged to the U.S. dollar. If the Japanese yen
appreciates against the U.S. dollar, the Hong Kong subsidiary's revenue will ____, and its expenses
73. Treck Co. expects to pay ¬200,000 in one month for its imports from Greece. It also expects to receive will ____.
¬250,000 for its exports to Italy in one month. Treck Co. estimates the standard deviation of monthly a. increase; decrease
percentage changes of the euro to be 3 percent over the last 40 months. Assume that these percentage b. decrease; remain unchanged
changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence c. decrease; increase
level, what is the maximum one-month loss in dollars if the expected percentage change of the euro d. increase; remain unchanged
during next month is −2%? Assume that the current spot rate of the euro (before considering the
ANS: D PTS: 1
maximum one-month loss) is $1.23.
a. −$38,468
77. Assume that the Japanese yen is expected to depreciate substantially over the next year. The U.S.-
b. −$21,371 based MNC has a subsidiary in Japan, where its costs exceed revenues. The overall value of MNC will
c. −$17,097 ____ because of the yen's depreciation.
d. −$4,274 a. decrease
b. increase
ANS: D c. remain unchanged
SOLUTION: Net exposure = ¬250,000 − ¬200,000 = ¬50,000 d. A and C are possible
Maximum one-month loss: −2% − (1.65 × 3%) = −6.95%
$1.23 × (−.0695%) × ¬50,000 = −$4,274 ANS: B PTS: 1
78. If the net inflow of one currency is about the same amount as a net outflow in another currency, the
PTS: 1
firm will benefit if these two currencies are negatively correlated because the transaction exposure is
offset.
74. Jensen Co. expects to pay ¬50,000 in one month for its imports from France. It also expects to receive
a. True
¬200,000 for its exports to Belgium in one month. Jensen estimates the standard deviation of monthly
b. False
percentage changes of the euro to be 2.5 percent over the last 50 months. Assume that these percentage
changes are normally distributed. Using the value-at-risk (VAR) method based on a 97.5% confidence
ANS: F PTS: 1
level, what is the maximum one month loss in dollars if the expected percentage change of the euro
during next month is 2%? Assume that current spot rate of the euro (before considering the maximum
79. A purely domestic firm is never exposed to exchange rate fluctuations.
one-month loss) is $1.35.
a. True
a. −$4,303
b. False
b. −$7,830
c. −$5,873 ANS: F PTS: 1
d. −$1,958
80. The transaction exposure of two inflow currencies is offset when the correlation between the
ANS: C currencies is high.
SOLUTION: Net exposure = ¬200,000 − ¬50,000 = ¬150,000 a. True
Maximum one-month loss: 2% − (1.96 × 2.5%) = −2.9% b. False
¬150,000 × $1.35 × (−0.029) = −$5,873
ANS: F PTS: 1
PTS: 1
81. Currency correlations are generally negative.
75. Lazer Co. is a U.S. firm that exports computers to Belgium invoiced in euros and to Italy invoiced in a. True
dollars. Additionally, Lazer Co. has a subsidiary in Korea that produces computers in South Korea and b. False
sells them there. Lazer also has competitors in different countries. Lazer Co. is subject to:
a. transaction exposure. ANS: F PTS: 1
b. economic exposure.

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82. Dollar cash flows associated with two foreign inflow currencies will normally be less volatile if the 90. A company may become more exposed or sensitive to an individual currency's movements over time
standard deviations of the individual currencies are lower. for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or
a. True an increased use of the foreign currency.
b. False a. True
b. False
ANS: T PTS: 1
ANS: T PTS: 1
83. The maximum one-day loss estimated using the value-at-risk (VAR) method is independent of the
confidence level used. 91. Which of the following is not a form of exposure to exchange rate fluctuations?
a. True a. Transaction exposure
b. False b. Credit exposure
c. Economic exposure
ANS: F PTS: 1 d. Translation exposure
84. The degree to which a firm's present value of future cash flows can be influenced by exchange rate ANS: B PTS: 1
fluctuations is referred to as transaction exposure.
a. True 92. Which of the following is not true regarding currency correlations?
b. False a. Two highly positively correlated currencies act almost as if they are the same currency.
b. If two inflow currencies are highly positively correlated transaction exposure is somewhat
ANS: F PTS: 1 offset.
c. If two inflow currencies are negatively correlated transaction exposure is somewhat offset.
85. Purely domestic firms are never affected by economic exposure. d. If two currencies, one an inflow currency and the other an outflow currency, are highly
a. True positively correlated, transaction exposure is somewhat offset.
b. False ANS: B PTS: 1
ANS: F PTS: 1 93. If the U.S. dollar appreciates,
a. an MNC's U.S. sales will probably decrease.
86. U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing b. an MNC's exports denominated in U.S. dollars will probably increase.
to reduce their profit margin. c. an MNC's interest owed on foreign funds borrowed will probably increase.
a. True d. an MNC's exports denominated in foreign currencies will probably increase.
b. False e. all of the above
ANS: T PTS: 1 ANS: A PTS: 1
87. Firms with more foreign costs than foreign revenues will generally be favorably affected by a stronger 94. Which of the following is not true regarding economic exposure?
foreign currency. a. Even purely domestic firms can be affected by economic exposure.
a. True b. In general, depreciation of the firm's local currency causes a decrease in both cash inflows
b. False and outflows.
c. The degree of economic exposure will likely be much greater for a firm involved in
ANS: F PTS: 1 international business than for a purely domestic firm.
d. The impact of a change in the local currency on inflow and outflow variables can
88. Translation exposure affects an MNC's cash flows. sometimes be indirect and therefore different from what is expected.
a. True e. All of the above are true.
b. False
ANS: B PTS: 1
ANS: F PTS: 1
89. Since earnings can affect stock prices, many MNCs are concerned about translation exposure.
a. True
b. False
ANS: T PTS: 1

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Chapter 11: Managing Transaction Exposure 515

Chapter 10
U.S. deposit rate for 1 year = 11%
U.S. borrowing rate for 1 year = 12%
New Zealand deposit rate for 1 year = 8%
Managing Transaction Exposure New Zealand borrowing rate for 1 year = 10%
New Zealand dollar forward rate for 1 year = $.40
New Zealand dollar spot rate = $.39
1. Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the
spot rate 90 days from now, then the real cost of hedging payables will be: Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and expects to
A) positive. receive NZ$600,000 in 1 year. You are a consultant for this firm.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a Using the information above, what will be the approximate value of these exports in 1 year in U.S.
discount. dollars given that the firm executes a money market hedge?
D) zero. A) $238,584.
B) $240,000.
ANSWER: D C) $234,000.
D) $236,127.
2. Assume zero transaction costs. If the 180-day forward rate is an accurate estimate of the spot rate
180 days from now, then the real cost of hedging receivables will be: ANSWER: D
A) positive.
B) negative. SOLUTION:
C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a 1. Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.
discount.
D) zero. 2. Convert NZ$545,455 to $212,727 (at $.39 per NZ$).
ANSWER: D 3. Invest $212,727 to accumulate $236,127 ($212,727 × 1.11) = $236,127.
3. Assume the following information: 5. An example of cross-hedging is:
A) find two currencies that are highly positively correlated; match the payables of the one
U.S. deposit rate for 1 year = 11% currency to the receivables of the other currency.
U.S. borrowing rate for 1 year = 12% B) use the forward market to sell forward whatever currencies you will receive.
Swiss deposit rate for 1 year = 8% C) use the forward market to buy forward whatever currencies you will receive.
Swiss borrowing rate for 1 year = 10% D) use the forward market to sell forward or buy forward whatever currencies you will receive.
Swiss forward rate for 1 year = $.40
Swiss franc spot rate = $.39 ANSWER: A
Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and expects to 6. Which of the following reflects a hedge of net receivables in British pounds by a U.S. firm?
receive SF600,000 in 1 year. A) purchase a currency put option in British pounds.
B) sell pounds forward.
Using the information above, what will be the approximate value of these exports in 1 year in U.S. C) borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
dollars given that the firm executes a forward hedge? D) purchase a current put option in British pounds OR sell pounds forward
A) $234,000.
B) $238,584. ANSWER: D
C) $240,000.
D) $236,127.
ANSWER: C
SOLUTION: SF600,000 × $.40 = $240,000
514

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516 International Financial Management Chapter 11: Managing Transaction Exposure 517
7. Which of the following reflects a hedge of net payables on British pounds by a U.S. firm? 12. Use the following information to calculate the dollar cost of using a money market hedge to hedge
A) purchase a currency put option in British pounds. 200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the
B) sell pounds forward. spot rate of the pound is $2.02 and the 180-day forward rate is $2.00. The British interest rate is
C) sell a currency call option in British pounds. 5%, and the U.S. interest rate is 4% over the 180-day period.
D) borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit. A) $391,210.
E) purchase a currency put option in British pounds OR sell pounds forward B) $396,190.
C) $388,210.
ANSWER: D D) $384,761.
E) none of these.
8. If Lazer Co. desired to lock in the maximum it would have to pay for its net payables in euros but
wanted to be able to capitalize if the euro depreciates substantially against the dollar by the time ANSWER: E
payment is to be made, the most appropriate hedge would be:
A) a money market hedge. SOLUTION:
B) purchasing euro put options. 1. Need to invest £190,476 (£200,000/1.05) = £190,476.
C) a forward purchase of euros.
D) purchasing euro call options. 2. Need to exchange $384,762 to obtain the £190,476 (£190,476 × $2.02) = $384,762.
E) selling euro call options.
3. At the end of 180 days, need $400,152 to repay loan ($384,762 × 1.04) = $400,152.
ANSWER: D
13. Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding
9. If a Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in between a forward hedge and a money market hedge, it _______ determine which hedge is
Japanese yen but wanted to be able to capitalize if the yen appreciates substantially against the preferable before implementing the hedge. It _______ determine whether either hedge will
dollar by the time payment arrives, the most appropriate hedge would be: outperform an unhedged strategy before implementing the hedge.
A) a money market hedge. A) can; can
B) a forward sale of yen. B) can; cannot
C) purchasing yen call options. C) cannot; can
D) purchasing yen put options. D) cannot; cannot
E) selling yen put options.
ANSWER: B
ANSWER: D
14. Foghat Co. has 1,000,000 euros as receivables due in 30 days, and is certain that the euro will
10. The real cost of hedging payables with a forward contract equals: depreciate substantially over time. Assuming that the firm is correct, the ideal strategy is to:
A) the nominal cost of hedging minus the nominal cost of not hedging. A) sell euros forward.
B) the nominal cost of not hedging minus the nominal cost of hedging. B) purchase euro currency put options.
C) the nominal cost of hedging divided by the nominal cost of not hedging. C) purchase euro currency call options.
D) the nominal cost of not hedging divided by the nominal cost of hedging. D) purchase euros forward.
E) remain unhedged.
ANSWER: A
ANSWER: A
11. From the perspective that Detroit Co. has payables in Mexican pesos and receivables in Canadian
dollars, hedging the payables would be most desirable if the expected real cost of hedging
payables is _______, and hedging the receivables would be most desirable if the expected real cost
of hedging receivables is _______.
A) negative; positive
B) zero; positive
C) zero; zero
D) positive; negative
E) negative; negative
ANSWER: E

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15. Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the 18. Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest
total dollar amount received (after accounting for the option premium) if the firm purchases and rates:
exercises a put option:
U.S. Switzerland
Exercise price = $.61 360-day borrowing rate 7% 5%
Premium = $.02 360-day deposit rate 6% 4%
Spot rate = $.60
Expected spot rate in 30 days = $.56 Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If
30-day forward rate = $.62 Parker Company uses a money market hedge, it will receive _______ in 360 days.
A) $101,904
A) $630,000. B) $101,923
B) $610,000. C) $98,769
C) $600,000. D) $96,914
D) $590,000. E) $92,307
E) $580,000.
ANSWER: D
ANSWER: D
SOLUTION:
SOLUTION: ($.61 3 $.02) × SF1,000,000 = $590,000 1. Borrow SF190,476 (SF200,000/1.05) = SF190,476.
16. A _______ involves an exchange of currencies between two parties, with a promise to 2. Convert SF190,476 to $91,428 (SF190,476 × $.48) = $91,428.
re-exchange currencies at a specified exchange rate and future date.
A) long-term forward contract 3. Invest $91,428 at 6% to accumulate $96,914 ($91,428 × 1.06) = $96,914.
B) currency option contract
C) parallel loan 19. The forward rate of the Swiss franc is $.50. The spot rate of the Swiss franc is $.48. The following
D) money market hedge interest rates exist:
ANSWER: C U.S. Switzerland

360-day borrowing rate 7% 5%
17. If interest rate parity exists and transactions costs are zero, the hedging of payables in euros with a 360-day deposit rate 6% 4%
forward hedge will:
A) have the same result as a call option hedge on payables. You need to purchase SF200,000 in 360 days. If you use a money market hedge, the amount of
B) have the same result as a put option hedge on payables. dollars you need in 360 days is:
C) have the same result as a money market hedge on payables. A) $101,904.
D) require more dollars than a money market hedge. B) $101,923.
E) have the same result as a call option hedge on payables AND require more dollars than a C) $98,770.
money market hedge. D) $96,914.
E) $92,307.
ANSWER: C
ANSWER: C
SOLUTION:
1. Need to invest SF192,308 (SF200,000/1.04) = SF192,308.
2. Need to borrow $92,308 to exchange for SF192,308 (SF192,308 × $.48) = $92,308.
3. At the end of 360 days, need $98,769 to repay the loan ($92,308 × 1.07) = $98,770.

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20. Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar 23. Assume that Kramer Co. will receive SF800,000 in 90 days. Today9s spot rate of the Swiss franc
is $.80. If you use a forward hedge, you will: is $.62, and the 90-day forward rate is $.635. Kramer has developed the following probability
A) receive $750,000 today. distribution for the spot rate in 90 days:
B) receive $750,000 in 90 days.
C) pay $750,000 in 90 days. Possible Spot Rate
D) receive $480,000 today. in 90 Days Probability
E) receive $480,000 in 90 days. $.61 10%
$.63 20%
ANSWER: E $.64 40%
$.65 30%
SOLUTION: C$600,000 × $0.80 = $480,000
The probability that the forward hedge will result in more dollars received than not hedging is:
21. A call option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, A) 10%.
and a premium of $.03 per unit. A put option exists on British pounds with an exercise price of B) 20%.
$1.60, a 90-day expiration date, and a premium of $.02 per unit. You plan to purchase options to C) 30%.
cover your future receivables of 700,000 pounds in 90 days. You will exercise the option in 90 D) 50%.
days (if at all). You expect the spot rate of the pound to be $1.57 in 90 days. Determine the E) 70%.
amount of dollars to be received, after deducting payment for the option premium.
A) $1,169,000. ANSWER: C
B) $1,099,000.
C) $1,106,000. SOLUTION: The forward hedge will result in more dollars if the spot rate is less than the forward
D) $1,143,100. rate, which is true in the first two cases.
E) $1,134,000.
24. Assume that Jones Co. will need to purchase 100,000 Singapore dollars (S$) in 180 days. Today9s
ANSWER: C spot rate of the S$ is $.50, and the 180-day forward rate is $.53. A call option on S$ exists, with an
exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on S$
SOLUTION: ($1.60 3 $.02) × £700,000 = $1,106,000 exists, with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Jones has
developed the following probability distribution for the spot rate in 180 days:
22. Assume that Smith Corporation will need to purchase 200,000 British pounds in 90 days. A call
option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a Possible Spot Rate
premium of $.04. A put option exists on British pounds, with an exercise price of $1.69, a 90-day in 90 Days Probability
expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its $.48 10%
future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the $.53 60%
pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, $.55 30%
including the amount paid for the option premium.
A) $360,000. The probability that the forward hedge will result in a higher payment than the options hedge is
B) $338,000. _______ (include the amount paid for the premium when estimating the U.S. dollars required for
C) $332,000. the options hedge).
D) $336,000. A) 0%
E) $344,000. B) 10%
C) 30%
ANSWER: E D) 40%
E) 70%
SOLUTION: ($1.68 + $.04) × £200,000 = $344,000
ANSWER: B
SOLUTION: There is a 10% probability that the call option will not be exercised. In that case,
Jones will pay $.48 × S$100,000 = $48,000, which is less than the amount paid with the forward
hedge ($.53 × S$100,000 = $53,000).

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25. Assume that Patton Co. will receive 100,000 New Zealand dollars (NZ$) in 180 days. Today9s 27. Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables.
spot rate of the NZ$ is $.50, and the 180-day forward rate is $.51. A call option on NZ$ exists, For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000.
with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on The 30-day forward rate is $.23. Furthermore, Money9s financial center has indicated that the
NZ$ exists with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with
Patton Co. has developed the following probability distribution for the spot rate in 180 days: probabilities of .30 and .70, respectively. Based on this information, what is the expected real cost
of hedging receivables?
Possible Spot Rate A) $0.
in 90 Days Probability B) 3$7,500.
$.48 10% C) $7,500.
$.49 60% D) none of these.
$.55 30% ANSWER: C
The probability that the forward hedge will result in more U.S. dollars received than the options SOLUTION:
hedge is _______ (deduct the amount paid for the premium when estimating the U.S. dollars RCH (1) = ( MYR1,500,000 ô $0.20) 2 ( MYR1,500,000 ô $0.23) = 2$45,000
received on the options hedge).
RCH (2) = ( MYR1,500,000 ô $0.25) 2 ( MYR1,500,000 ô $0.23) = $30,000
A) 10%
B) 30% E[ RCH ] = (.30)( 245,000) + (.7)(30,000) = 7,500
C) 40%
D) 70% 28. Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the
E) none of these next quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day
forward rate is $1.50. Furthermore, Hanson9s financial center has indicated that the possible values
ANSWER: D of the British pound at the end of next quarter are $1.57 and $1.59, with probabilities of .50 and
.50, respectively. Based on this information, what is the expected real cost of hedging payables?
SOLUTION: The put option will be exercised in the first two cases, resulting in an amount A) $80,000.
received per unit of $.51 3 $.02 = $.49. Thus, the forward hedge will result in more U.S. dollars B) 3$80,000.
received ($.51 per unit). C) $1,570,000.
D) $1,580,000.
26. The _______ hedge is not a technique to eliminate transaction exposure discussed in the text.
A) index ANSWER: B
B) futures
C) forward SOLUTION:
D) money market RCH (1) = (£1,000,000 ô $1.50) 2 (£1,000,000 ô $1.57) = 2$70,000
E) currency option
RCH (2) = (£1,000,000 ô $1.50) 2 (£1,000,000 ô $1.59) = 2$90,000
ANSWER: A E[ RCH ] = (.50)(270,000) + (.50)(290,000) = 280,000

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The following information refers to questions 29 and 30. 31. Lorre Company needs 200,000 Canadian dollars (C$) in 90 days and is trying to determine
whether or not to hedge this position. Lorre has developed the following probability distribution
U.S. Jordan for the Canadian dollar:
360-day borrowing rate 6% 5%
360-day deposit rate 5% 4% Possible Value of Canadian Dollar in 90 Days Probability
$0.54 15%
29. Perkins Corp. will receive 250,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the 0.57 25%
dinar is $1.48, while the 360-day forward rate is $1.50. How much will Perkins receive in 360 0.58 35%
days from implementing a money market hedge (assume any receipts before the date of the 0.59 25%
receivable are invested)?
A) $377,115. The 90-day forward rate of the Canadian dollar is $.575, and the expected spot rate of the
B) $373,558. Canadian dollar in 90 days is $.55. If Lorre implements a forward hedge, what is the probability
C) $363,019. that hedging will be more costly to the firm than not hedging?
D) $370,000. A) 40%.
B) 60%.
ANSWER: D C) 15%.
D) 85%.
SOLUTION:
1. Borrow JOD238,095.24 (JOD250,000/1.05) = JOD238,095.24. ANSWER: A
2. Convert JOD238,095.24 to $352,380.95 (JOD238,095.24 × $1.48) = $352,380.95. SOLUTION: Since Lorre locks into the $.575 with a forward contract, the first two cases would
have been cheaper had Lorre not hedged (15% + 25% = 40%).
3. Invest $352,380.95 at 5% to accumulate $370,000 ($352,280.95 × 1.05) = $370,000.
32. Quasik Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-
30. Pablo Corp. will need 150,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day
dinar is $1.48, while the 360-day forward rate is $1.46. What is Pablo9s cost from implementing a put option with an exercise price of $.73 and a premium of $.01 is available. Quasik plans to
money market hedge (assume Pablo does not have any excess cash)? purchase options to hedge its receivable position. Assuming that the spot rate in 90 days is $.71,
A) $224,135. what is the net amount received from the currency option hedge?
B) $226,269. A) $219,000.
C) $224,114. B) $222,000.
D) $223,212. C) $216,000.
D) $213,000.
ANSWER: B
ANSWER: C
SOLUTION:
1. Need to invest JOD144,230.76 (JOD150,000/1.04) = JOD144,230.76. SOLUTION: ($.73 3 $.01) × 300,000 = $216,000.
2. Need to convert $213,461.52 to obtain the JOD144,230.76 dinar (JOD144,230.76 × $1.48) =

$213,461.52.
3. At the end of 360 days, need $226,269.22 ($213,461.52 × 1.06) = $226,269.21.

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33. FAB Corporation will need 200,000 Canadian dollars (C$) in 90 days to cover a payable position. 36. Which of the following is the least effective way of hedging transaction exposure in the long run?
Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. A) long-term forward contract.
Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB B) currency swap.
plans to purchase options to hedge its payable position. Assuming that the spot rate in 90 days is C) parallel loan.
$.71, what is the net amount paid, assuming FAB wishes to minimize its cost? D) money market hedge.
A) $140,000.
B) $148,000. ANSWER: D
C) $152,000.
D) $150,000. 37. When a perfect hedge is not available to eliminate transaction exposure, the firm may consider
methods to at least reduce exposure, such as:
ANSWER: A A) leading.
B) lagging.
SOLUTION: ($.71 3 $.01) × 200,000 = $140,000. Note: the call option is not exercised since the C) cross-hedging.
spot rate is less than the exercise price. D) currency diversification.
E) all of these.
34. You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future
receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a ANSWER: E
premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot
rate of the Australian dollar in 180 days is: 38. To hedge a _______ in a foreign currency, a firm may _______ a currency futures contract for that
currency.
Future Spot Rate Probability A) receivable; purchase
$.46 20% B) payable; sell
$.48 30% C) payable; purchase
$.52 50% D) none of these
The 90-day forward rate of the Australian dollar is $.50. ANSWER: C
What is the probability that the put option will be exercised (assuming Arizona purchased it)? 39. A forward contract hedge is very similar to a futures contract hedge, except that _______ contracts
A) 0%. are commonly used for _______ transactions.
B) 80%. A) forward; small
C) 50%. B) futures; large
D) none of these. C) forward; large
D) none of these
ANSWER: C
ANSWER: C
SOLUTION: Arizona will exercise when the exercise price is greater than the future spot (20% +
30% = 50%). 40. Celine Co. will need ¬500,000 in 90 days to pay for German imports. Today9s 90-day forward rate
of the euro is $1.07. There is a 40 percent chance that the spot rate of the euro in 90 days will be
35. If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield $1.02, and a 60 percent chance that the spot rate of the euro in 90 days will be $1.09. Based on this
the same result as the _______ hedge. information, the expected value of the real cost of hedging payables is $_______.
A) put option A) 335,000
B) forward B) 25,000
C) call option C) 31,000
D) none of these D) 1,000
ANSWER: B ANSWER: D
SOLUTION: E[ RCH p ] = 2$35,000 ô 0.40 + $25,000 ô 0.60 = $1,000

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41. In a forward hedge, if the forward rate is an accurate predictor of the future spot rate, the real cost 44. If interest rate parity exists, and transaction costs do not exist, the _______ hedge will yield the
of hedging payables will be: same result as the _______ hedge.
A) highly positive. A) money market; futures
B) highly negative. B) money market; options
C) zero. C) money market; forward
D) none of these. D) forward; options
ANSWER: C ANSWER: C
42. Samson Inc. needs ¬1,000,000 in 30 days. Samsong can earn 5 percent annualized on a German 45. To hedge a contingent exposure, in which an MNC9s exposure is contingent on a specific event
security. The current spot rate for the euro is $1.00. Samson can borrow funds in the U.S. at an occurring, the appropriate hedge would be a(n) _______ hedge.
annualized interest rate of 6 percent. If Samson uses a money market hedge, how much should it A) money market
borrow in the U.S.? B) futures
A) $952,381. C) forward
B) $995,851. D) options
C) $943,396.
D) $995,025. ANSWER: D
ANSWER: B 46. A _______ is not a technique for hedging long-term transaction exposure.
A) long-term forward contact
SOLUTION: 1,000,000 /[1 + (5% ô 30 / 360)] = $995,851 B) long-term futures contract
C) currency swap
43. Blake Inc. needs ¬1,000,000 in 30 days. It can earn 5 percent annualized on a German security. D) parallel loan
The current spot rate for the euro is $1.00. Blake can borrow funds in the U.S. at an annualized
interest rate of 6 percent. If Blake uses a money market hedge to hedge the payable, what is the ANSWER: B
cost of implementing the hedge?
A) $1,000,000. 47. The _______ does not represent an obligation.
B) $1,055,602. A) long-term forward contract
C) $1,000,830. B) currency swap
D) $1,045,644. C) parallel loan
D) currency option
ANSWER: C
ANSWER: D
SOLUTION:
1. Borrow $995,851 from a U.S. bank (¬1,000,000 × $1.00 × [1 + (.05 × 30/360)] 48. Sometimes the overall performance of an MNC may already be insulated by offsetting effects
between subsidiaries and it may not be necessary to hedge the position of each individual
2. Convert $995,851 to ¬995,851, given the exchange rate of $1.00 per euro. subsidiary.
A) true.
3. Use the euros to purchase a German security that offers 0.42% interest over 30 days. B) false.
4. Repay the U.S. loan in 30 days, plus interest; the amount owed is $1,000,830 (computed as ANSWER: A
$995,851 × [1 + (.06 × 30/360)].
49. If an MNC is hedging various currencies, it should measure the real cost of hedging in each
currency as a dollar amount for comparison purposes.
A) true.
B) false.
ANSWER: B

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50. Since the results of both a money market hedge and a forward hedge are known beforehand, an 57. To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an
MNC can implement the one that is more feasible. MNC would buy futures.
A) true. A) true.
B) false. B) false.
ANSWER: A ANSWER: B
51. Hedging the position of individual subsidiaries is generally necessary, even if the overall 58. When the real cost of hedging is positive, this implies that hedging was more favorable than not
performance of the MNC is already insulated by the offsetting positions between subsidiaries. hedging.
A) true. A) true.
B) false. B) false.
ANSWER: B ANSWER: B
52. If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis 59. A futures hedge involves taking a money market position to cover a future payables or receivables
indicates that remaining unhedged will probably be less costly than hedging. position.
A) true. A) true.
B) false. B) false.
ANSWER: A ANSWER: B
53. A money market hedge involves taking a money market position to cover a future payables or 60. If interest rate parity (IRP) exists, then the money market hedge will yield the same result as the
receivables position. options hedge.
A) true. A) true.
B) false. B) false.
ANSWER: A ANSWER: B
54. To hedge a payable position with a currency option hedge, an MNC would write a call option. 61. The price at which a currency put option allows the holder to sell a currency is called the
A) true. settlement price.
B) false. A) true.
B) false.
ANSWER: B
ANSWER: B
55. MNCs generally do not need to hedge because shareholders can hedge their own risk.
A) true. 62. A put option essentially represents two swaps of currencies, one swap at the inception of the loan
B) false. contract and another swap at a specified date in the future.
A) true.
ANSWER: B B) false.
56. Currency futures are very similar to forward contracts, except that they are standardized and are ANSWER: B
more appropriate for firms that prefer to hedge in smaller amounts.
A) true. 63. The hedging of a foreign currency for which no forward contract is available with a highly
B) false. correlated currency for which a forward contract is available is referred to as cross-hedging.
A) true.
ANSWER: A B) false.
ANSWER: A

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532 International Financial Management

9
64. The exact cost of hedging with call options (as measured in the text) is not known with certainty at Student: ___________________________________________________________________________
the time that the options are purchased.
A) true. 1. Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange
B) false. rate
A. can have significant economic consequences for U.S. firms.
ANSWER: A B. can have significant economic consequences for Japanese firms.
C. can have significant economic consequences for both U.S. and Japanese firms.
65. The tradeoff when considering alternative call options to hedge a currency position is that an D. none of the above
MNC can obtain a call option with a higher exercise price, but would have to pay a higher
premium. 2. Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange
A) true. rate
B) false. A. will tend to weaken the competitive position of import-competing U.S. car makers.
B. will tend to strengthen the competitive position of import-competing U.S. car makers.
ANSWER: B C. will tend to strengthen the competitive position of Japanese car makers at the expense of U.S. makers.
D. none of the above
66. When comparing the forward hedge to the options hedge, the MNC can easily determine which
hedge is more desirable, because the cost of each hedge can be determined with certainty. 3. The link between a firm's future operating cash flows and exchange rate fluctuations is
A) true. A. asset exposure.
B) false. B. operating exposure.
C. both a and b
ANSWER: B D. none of the above
67. When comparing the forward hedge to the money market hedge, the MNC can easily determine 4. When the Mexican peso collapsed in 1994, declining by 37 percent,
which hedge is more desirable, because the cost of each hedge can be determined with certainty. A. U.S. firms that exported to Mexico and priced in peso were adversely affected.
A) true. B. U.S. firms that exported to Mexico and priced in dollars were adversely affected.
B) false. C. U.S. firms were unaffected by the peso collapse, since Mexico is such a small market.
D. both a and b
ANSWER: A
5. When exchange rates change,
A. U.S. firms that produce domestically and sell only to domestic customers will be unaffected.
B. U.S. firms that produce domestically and sell only to domestic customers can be affected if they
compete against imports.
C U.S. firms that produce domestically and sell only to domestic customers will be affected, but only if
. they borrow in foreign currency to finance their domestic operations.
D. both a and b
6. When exchange rates change,
A. this can alter the operating cash flow of a domestic firm.
B. this can alter the competitive position of a domestic firm.
C. this can alter the home currency values of a multinational firm's assets and liabilities.
D. all of the above
7. Two studies found a link between exchange rates and the stock prices of U.S. firms,
A.this suggests that exchange rate changes can systematically affect the value of the firm by influencing
its operating cash flows.
B this suggests that exchange rate changes can systematically affect the value of the firm by influencing
. the domestic currency values of its assets and liabilities.
C. both a and b

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8. It is conventional to classify foreign currency exposures into the following types: 15.
A. economic exposure, transaction exposure, and translation exposure.
B. economic exposure, noneconomic exposure, and political exposure. The exposure coefficient in the regression is:
C. national exposure, international exposure, and trade exposure. A. A measure of how a change in the exchange rate affects the dollar value of a firm's assets.
D. conversion exposure, and exchange exposure. B. Has a value of zero if the value of the firm's assets is perfectly correlated with changes in the exchange
rate.
9. Exposure to currency risk can be measured by the sensitivities of C. both a and b
A. the future home currency values of the firm's assets and liabilities. D. none of the above
B. the firm's operating cash flows to random changes in exchange rates.
C. both a and b 16.
D. none of the above The exposure coefficient in the regression informs
A. how much of a foreign currency to sell forward.
10. Operating exposure measures B. the part of the variability of the dollar value of the asset that is related to random changes in the
A. the extent to which the foreign currency value of the firm's assets is affected by unanticipated changes exchange rate.
in exchange rates. C. captures the residual part of the dollar value variability that is independent of exchange rate
B. the extent to which the firm's operating cash flows will be affected by unexpected changes in exchange movements.
rates. D. how many call options to write.
C. the affect of changes in exchange rates will have on the consolidated financial reports of a MNC.
D the affect of unanticipated changes in exchange rates on the dollar value of contractual obligations 17. Before you can use the hedging strategies such as a forward market hedge, options market hedge, and so
. denominated in a foreign currency.
on, you should consider running a regression of the form . When reviewing the output,
11. Economic exposure refers to you should initially focus on
A the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in A. the intercept a.
. foreign currencies to unexpected exchange rate changes. B. the slope coefficient b.
B. the extent to which the value of the firm would be affected by unanticipated changes in exchange rate. C. mean square error, MSE.
C. the potential that the firm's consolidated financial statement can be affected by changes in exchange D. R2.
rates.
18. The link between the home currency value of a firm's assets and liabilities and exchange rate fluctuations
D. ex post and ex ante currency exposures.
is
12. Currency risk A. asset exposure.
A. is the same as currency exposure. B. operating exposure.
B. represents random changes in exchange rates. C. both a and b
C. measure "what the firm has at risk." D. none of the above
D. both a and b
19. A purely domestic firm that sources and sells only domestically,
13. Suppose a U.S.-based MNC maintains a vacation home for employees in the British countryside and A. faces exchange rate risk to the extent that it has international competitors in the domestic market.
the local price of this property is always moving together with the pound price of the U.S. dollar. As a B. faces no exchange rate risk.
result, C. should never hedge since this could actually increase its currency exposure.
A. whenever the pound depreciates against the dollar, the local currency price of this property goes up by D. both b and c
the same proportion.
20. In recent years, the U.S. dollar has depreciated substantially against most major currencies of the world,
B. the firm is not exposed to currency risk even if the pound-dollar exchange rate fluctuates randomly.
especially against the euro.
C. both a and b
A The stronger euro has made many European products more expensive in dollar terms, hurting sales of
. these products in the United States.
14. The exposure coefficient in the regression B. The stronger euro has made many American products less expensive in euro terms, boosting sales of
is given by: U.S. products in Europe.
A. C. Both a and b
D. None of the above
B.
C. 21. In recent years,
A. the U.S. dollar has appreciated substantially against most major currencies of the world, especially
against the euro.
B. the U.S. dollar has depreciated substantially against most major currencies of the world, especially
against the euro.
C. the U.S. dollar has maintained its value against most major currencies of the world, especially against
the euro.

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22. From the perspective of the U.S. firm that owns an asset in Britain, the exposure that can be measured by 29. The extent to which the firm's operating cash flows would be affected by random changes in exchange
the coefficient b in regressing the dollar value P of the British asset on the dollar/pound exchange rate S rates is called
using the regression equation is A. asset exposure.
A. asset exposure. B. operating exposure.
B. operating exposure. C. both a and b
C. accounting exposure. D. none of the above
D. none of the above 30. The variability of the dollar value of an asset (invested overseas) depends on
23. On the basis of regression Equation A. the variability of the dollar value of the asset that is related to random changes in the exchange rate.
we can decompose the variability of the dollar B. the dollar value variability that is independent of exchange rate movements.
value of the asset, Var(P), into two separate components. C. both a and b
2
A. Cov(P,S) = b × Var(P) + Var(S) D. none of the above
B. Var(P) = b2 × Var(S) + Var(e)
C. Cov(P,S) = b2 × Cov(S,P) + Cov(S,e) 31. Consider a U.S. MNC who owns a foreign asset. If the foreign currency value of the asset is inversely
D. Var(P) = b2 × Var(S) related to changes in the dollar-foreign currency exchange rate,
E. None of the above A. the company has a built-in hedge.
B. the dollar value variability that is independent of exchange rate movements.
24. On the basis of regression Equation we can decompose the variability of the dollar C. both a and b
value of the asset, Var(P), into two separate components Var(P) = b2 × Var(S) + Var(e). D. none of the above
2
The first term in the right-hand side of the equation, b × Var(S) represents.
A. the part of the variability of the dollar value of the asset that is related to random changes in the 32. With regard to operational hedging versus financial hedging,
exchange rate. A. operational hedging provides a more stable long-term approach than does financial hedging.
B. captures the residual part of the dollar value variability that is independent of exchange rate B. financial hedging, when instituted on a rollover basis, is a superior long-term approach to operational
movements. hedging.
C. none of the above C. since they both have the same goal, stabilizing the firm's cash flows in domestic currency, they are
fungible in use.
25. On the basis of regression Equation we can decompose the variability of the dollar D. none of the above
value of the asset, Var(P), into two separate components Var(P) = b2 × Var(S) + Var(e).
33. Which of the following are identified by your text as a strategy for managing operating exposure:
The second term in the right-hand side of the equation, Var(e) represents.
A. the part of the variability of the dollar value of the asset that is related to random changes in the 1) Selecting low-cost production sites
exchange rate. 2) Flexible sourcing policy
B. captures the residual part of the dollar value variability that is independent of exchange rate 3) Diversification of the market
movements. 4) Product differentiation and R&D efforts
C. none of the above 5) Financial Hedging
A. 1), 3), and 5) only
26. What does it mean to have redenominated an asset in terms of the dollar? B. 2) and 4) only
A. You have undertaken a hedging strategy that gives the asset a constant dollar value. C. 1), 4), and 5) only
B. Multiply the foreign currency value of the asset by the spot exchange rate. D. 1), 2), 3), 4), and 5)
C. Undertaken accounting changes to eliminate translation exposure.
D. None of the above A U.S. firm holds an asset in Great Britain and faces the following scenario:
27. A firm with a highly elastic demand for its products
A will be unable to pass increased costs following unfavorable changes in the exchange rate without
. significantly lowering the quantity sold.
B. will be able to raise prices following unfavorable changes in the exchange rate without significantly
lowering the quantity sold.
C. can easily pass increased costs on to consumers. where,
D. will sell about the same amount of product regardless of price.
P* = Pound sterling price of the asset held by the U.S. firm
28. Operating exposure can be defined as P = Dollar price of the same asset
A. the link between the future home currency values of the firm's assets and liabilities and exchange rate
fluctuations. 34. The expected value of the investment in U.S. dollars is
B. the extent to which the firm's operating cash flows would be affected by random changes in exchange A. $4,950.
rates. B. $3,700.
C the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in C. $2,112.50.
. foreign currencies to unexpected exchange rate changes. D. none of the above
D. the potential that the firm's consolidated financial statement can be affected by changes in exchange
rates.

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35. The variance of the exchange rate is: 41. The "exposure" (i.e. the regression coefficient beta) is:
A. 0.0200
B. 0.10
C. 0.002
D. none of the above A. 7,500
36. The "exposure" (i.e. the regression coefficient beta) is: B. 2,5000
C. -2,500
42. Which of the following conclusions are correct?
A. -25,000 AMost of the volatility of the dollar value of the British asset can be removed by hedging exchange risk
B. 2,5000 . because b2[Var(S)] and Var(e) are 1,125,000 ($)2 and 2,500 ($)2 respectively.
C. -2,500 BMost of the volatility of the dollar value of the British asset cannot be removed by hedging exchange
D. none of the above . risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively.
CMost of the volatility of the dollar value of the British asset cannot be removed by hedging exchange
37. Which of the following conclusions are correct? . risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively.
AMost of the volatility of the dollar value of the British asset can be removed by hedging exchange risk DMost of the volatility of the dollar value of the British asset can be removed by hedging exchange risk
. because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. . because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively.
BMost of the volatility of the dollar value of the British asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. 43. Which of the following would be an effective hedge?
CMost of the volatility of the dollar value of the British asset cannot be removed by hedging exchange A. Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
. risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. B. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
DMost of the volatility of the dollar value of the British asset can be removed by hedging exchange risk C. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
. because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. D. None of the above
38. Which of the following would be an effective hedge? A U.S. firm holds an asset in Great Britain and faces the following scenario:
A. Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
B. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
C. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
A U.S. firm holds an asset in Great Britain and faces the following scenario:
where,
P = Dollar price of the same asset
44. The expected value of the investment in U.S. dollars is:
A. $5,050
where, B. $4,500
C. $2,112.50
P* = Pound sterling price of the asset held by the U.S. firm D. none of the above
45. The variance of the exchange rate is:
39. The expected value of the investment in U.S. dollars is: A. 0.0200
A. $5,050 B. 0.101875
B. $3,700 C. 0.002
C. $2,112.50 D. none of the above
46. The "exposure" (i.e. the regression coefficient beta) is:
A. 0.0200
B. 0.10
C. 0.002 A. 7,500
D. none of the above B. 2,5000
C. -2,500

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47. Which of the following conclusions are correct? 53. Which of the following would be an effective hedge?
A Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk A. Sell 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.
. because b2[Var(S)] and Var(e) are 0 ($)2 and 0 ($)2 respectively. B. Buy 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.
B None of the volatility of the dollar value of the British asset can be removed by hedging exchange risk C. Sell 12,898 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.
. because b2[Var(S)] and Var(e) are 0 ($)2 and 0 ($)2 respectively. D. None of the above
CMost of the volatility of the dollar value of the British asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. 54. Find an effective hedge financial hedge if a U.S. firm holds an asset in Great Britain and faces the
DMost of the volatility of the dollar value of the British asset can be removed by hedging exchange risk following scenario:
. because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively.
48. Which of the following would be an effective hedge?
A. Sell £2,278.13 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
C. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero. P* = Pound sterling price of the asset held by the U.S. firm
D. None of the above P = Dollar price of the same asset
A U.S. firm holds an asset in Israel and faces the following scenario: The CFO runs a regression of the form
The regression coefficient beta is calculated as

Where
where,
P* = Israeli shekel (IS) price of the asset held by the U.S. firm
A. $2,083.33
B. $762.50
C. $6,250.00 The variance of the exchange rate is calculated as:
D. $6,562.50 E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00
50. The variance of the exchange rate is: VAR(S) = 0.25($2.20 - $2.00)2 + 0.50($2.00 - $2.00)2 + 0.25($1.80 - $2.00)2 = 0.01 + 0 + 0.01
A. 0.001968 = 0.02
B. 0.002969 The expected value of the investment in U.S. dollars is:
C. 0.003968 E[P] = 0.25 × $6,600 + 0.50 × $5,000 + 0.25 × $3,600 = $5,050
D. 0.004968 Which of the following is the most effective hedge financial hedge?
51. The "exposure" (i.e. the regression coefficient beta) is: A. Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
C. Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
D. 0.25 × £3,000 + 0.50 × £2,500 + 0.25 × £2,000 = £2,500
A. -52.6316 55. Suppose that you implement your hedge from the last question at F1($/£) = $2/£. Your cash flows in state
B. 1,289.80 1, 2, and 3 respectively will be
C. 12,898.00 A. $5,100, $5,000, $5,100.
D. none of the above B. $5,100, $5,100, $5,100.
C. $5,000, $5,000, $5,000.
52. Which of the following conclusions are correct? D. none of the above
AMost of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk
. because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively.
BMost of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively.
CMost of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 8.22 ($)2 and 59,211 ($)2, respectively.
DMost of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk
. because b2[Var(S)] and Var(e) are 8.22 ($)2 and 59,211 ($)2 respectively.

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56. A U.S. firm holds an asset in Great Britain and faces the following scenario: 59. Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose
there are only three states of the world and each state is equally likely to occur. The future local currency
price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on
the realized state of the world.
Where
The CFO decides to hedge his exposure by selling forward the expected value of the pound denominated
cash flow at F1($/£) = $2/£. As a result
A. The firm's exposure to the exchange rate is made worse. Which of the following statements is most correct?
B. He has a nearly perfect hedge. A.The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate
C. He has a perfect hedge. are negatively correlated.
D. None of the above B The firm faces substantial exchange rate risk since the local currency price of the asset and the
. exchange rate are positively correlated.
57. A U.S. firm holds an asset in Italy and faces the following scenario:
C. The firm's exchange rate exposure can be completely hedged with derivatives written on the British
pound.
D. Since randomness is involved, no hedging is possible.
60. Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose
Where there are only three states of the world and each state is equally likely to occur. The future local currency
price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on
P* = Euro price of the asset held by the U.S. firm the realized state of the world.
The CFO decides to hedge his exposure by selling forward the expected value of the euro denominated
cash flow at F1($/£) = $1.50/¬. As a result
A. the firm's exposure to the exchange rate is made worse.
B. he has a nearly perfect hedge.
C. he has a perfect hedge.
Which of the following statements is most correct?
58. Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose A.The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate
there are only three states of the world and each state is equally likely to occur. The future local currency are negatively correlated.
price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on B The firm faces substantial exchange rate risk since the local currency price of the asset and the
the realized state of the world. . exchange rate are positively correlated.
pound.
61. Suppose a U.S. firm has an asset in Italy whose local currency price is random. For simplicity, suppose
there are only three states of the world and each state is equally likely to occur. The future local currency
Which of the following statements is most correct? price of this asset (P*) as well as the future exchange rate (S) will be determined, depending on the
A.The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate realized state of the world.
are negatively correlated.
B The firm faces substantial exchange rate risk since the local currency price of the asset and the
. exchange rate are positively correlated.
pound.
Assume that you choose to "hedge" this asset by selling forward the expected value of the euro
denominated cash flow at F1($/£) = $1.50/¬. Calculate your cash flows in each of the possible states.
A. $1,400, $1,400, $1,400
B. $1,496.6, $1,400, $1,306.40
C. $1,404, $1,404. $1,404

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62. Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the 68. Which of the following is true?
dollar against the euro, which of the following conclusions are correct? AThe competitive effect is that a currency depreciation may affect operating cash flow in the foreign
A. The cash flow in euro could be altered due an alteration in the firm's competitive position in the . currency by altering the firm's competitive position in the marketplace.
marketplace. B The conversion effect is defined as a given accounting cash value in a foreign currency will be
B. A given operating cash flow in euro will be converted to a higher U.S. dollar cash flow. . converted into a lower dollar amount after currency depreciation.
C. Both a and b C The competitive effect is defined as a given operating cash flow in a foreign currency will be converted
D. None of the above . into a lower dollar amount after a currency depreciation.
63. Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the
dollar against the euro, which of the following describes the competitive effect of the depreciation? 69. Consider a U.S.-based MNC with a wholly-owned European subsidiary selling a product sourced in euro
A. The cash flow in euro could be altered due an alteration in the firm's competitive position in the and priced in euro with inelastic demand. Following a depreciation of the dollar against the euro, which
marketplace. of the following is the most true?
B. A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow. A. Since they have inelastic demand, the U.S. firm can just pass through the impact of the exchange rate
C. Both a and b change.
D. None of the above B. Since they have elastic demand, the U.S. firm cannot just pass through the impact of the exchange rate
change.
64. Consider a U.S. MNC with operations in Great Britain. Which of the following are potential risks C. Since the exchange rate movement was favorable to the U.S. firm, there is no impact on the firm's
following a strengthening of the dollar? position.
A A pound sterling depreciation may affect operating cash flow in pounds by altering the firm's D. None of the above.
. competitive position in the marketplace.
B. A given operating cash flow in pounds will be converted into a lower dollar amount after the pound 70. A firm's operating exposure is
depreciation. A. defined as the extent to which the firm's operating cash flows would be affected by the random changes
C. Both a and b in exchange rates.
D. None of the above B.determined by the structure of the markets in which the firm sources its inputs, such as labor and
materials, and sells its products.
65. Which of the following is false? C.determined by the firm's ability to mitigate the effect of exchange rate changes by adjusting its markets,
A The competitive effect is that a depreciation may affect operating cash flow in the foreign currency by product mix, and sourcing.
. altering the firm's competitive position in the marketplace. D. all of the above
B The conversion effect is defined as a given operating cash flow in a foreign currency will be converted
. into a lower dollar amount after a currency depreciation. 71. Generally speaking, a firm is subject to high degrees of operating exposure
C The competitive effect is defined as a given operating cash flow in a foreign currency will be converted A. when its costs are sensitive to exchange rate changes.
. into a lower dollar amount after a currency depreciation. B. when its prices are sensitive to exchange rate changes.
D. None of the above C. when either its cost or its price is sensitive to exchange rate changes.
66. Consider a U.S.-based MNC with a wholly-owned German subsidiary. Following a depreciation of the
dollar against the euro, which of the following describes the conversion effect of the depreciation? 72. Generally speaking, when both a firm's costs and its price is sensitive to exchange rate changes
A. The cash flow in euro could be altered due a change in the firm's competitive position in the A. the firm is not subject to high degrees of operating exposure.
marketplace. B. the firm is subject to high degrees of operating exposure.
B. A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow. C. the firm should hedge.
C. Both a and b D. none of the above
73. The firm may not be subject to high degrees of operating exposure
67. Consider a U.S.-based MNC with a wholly-owned French subsidiary. Following a depreciation of A. when changes in real exchange rates are exactly offset by the inflation differential.
the dollar against the euro, which of the following best describes the mechanism of any effect of the B. when changes in nominal exchange rates are exactly matched by the inflation differential.
depreciation? C. when changes in nominal exchange rates are exactly offset by the inflation differential.
AThe change in the cash flow in euro due an alteration in the firm's competitive position in the D. none of the above
. marketplace is in part a function of the elasticity of demand for the firm's product.
B.A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow regardless of 74. The firm may not be able to pass through changes in the exchange rate
the firm's hedging program. A. in markets with low product differentiation.
C. Both a and b B. in markets with high price elasticities.
D. None of the above C. both a and b
75. The firm may not be able to pass through changes in the exchange rate
A. in markets with mainly domestics (foreign to the firm) competitors.
B. in markets with low price elasticities.
C. both a and b

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76. Generally speaking, a firm is subject to high degrees of operating exposure when 85. Developing multiple production sites in a variety of countries,
A. either its cost or its price is sensitive to exchange rate changes. A. can create an excess capacity problem.
B. both the cost and the price are sensitive to exchange rate changes. B. can lead to underutilization of domestic plants.
C. both the cost and the price are insensitive to exchange rate changes. C. can lead to domestic job losses.
D. none of the above D. all of the above
77. What is the objective of managing operating exposure? 86. A flexible sourcing policy
A. Stabilize cash flows in the face of fluctuating exchange rates. A. is primarily concerned with low-cost (and often low-quality) vendors.
B. Selecting low cost production sites. B. need not be confined just to materials and parts.
C. Increase the variability of cash flows in the face of fluctuating exchange rates. C. only works for manufacturing firms, not service firms.
D. Both a and c D. puts the focus on the exchange rate at the expense of shipping rates.
78. What is the objective of managing operating exposure? 87. A firm that is committed to keeping manufacturing facilities in only the home country (and not
A. Stabilize accounting results in the face of fluctuating exchange rates. developing multiple production sites in a variety of countries) can
B. Selecting low cost production sites. A. not mitigate the effects of exchange rate changes.
C. Increase the variability of cash flows in the face of fluctuating exchange rates. B. lessen the effect of exchange rate changes by sourcing from where input costs are low.
D. None of the above C. focus on selling commodity products with product differentiation.
D. pursue a strategy of increasing its products price elasticity of demand.
79. Managing operating exposure
A. is a short-term tactical issue. 88. If the domestic currency is strong or expected to become strong,
B. is a long-term issue, like selecting a site for a factory. A a firm can choose to locate production facilities in a foreign country where costs are low due to either
C. is relatively unimportant, since most MNCs have a built-in hedge. . the undervalued currency or underpriced factors of production.
D. none of the above B. a firm should curtail R&D efforts until the exchange rate situation improves.
C. a firm should abandon international sales and focus on domestic market share.
80. Which of the following can a company use to manage operating exposure? D. the firm should focus on profiting in the currency futures market based on its forecasts.
A. Selecting low-cost production sites, diversifying the market.
B. Low cost production sites, but not financial hedging. 89. Which of the following is a true statement?
C. Pursuing a flexible sourcing policy, product differentiation, R&D efforts. A As long as exchange rates do not always move in the same direction, the firm can stabilize its operating
D. Both a and c. . cash flows by diversifying its export market.
B The firm should not get into new lines of business solely to diversify exchange risk because
81. When the domestic currency is strong or expected to become strong, . conglomerate expansion can bring about inefficiency and losses.
A. this could erode the competitive position of the firm's exports. C. All of the above are true
B. this could erode the competitive position of the firm's import competition. D. None of the above is true
C. the firm should consider locating production facilities in a foreign country where costs are low.
D. both a and c 90. A firm that is committed to keeping manufacturing facilities in only the home country (and not
developing multiple production sites in a variety of countries) can
82. A foreign country could provide low cost production sites A.lessen the effect of exchange rate changes by pursuing a strategy of diversifying the markets in which
A. because the factors of production are underpriced. the firm's products are sold.
B. because the currency is undervalued. B. not mitigate the effects of exchange rate changes.
C. because the locals like to give away their land labor and capital to foreigners. C.lessen the effect of exchange rate changes by pursuing a strategy of selling commodity products
D. both a and b without product differentiation.
83. While maintaining multiple production sites does provide a firm valuable options,
A. a firm may miss out on economies of scope. 91. It can be argued that, while financial hedging can be used to stabilize a firm's cash flows,
B. a firm may miss out on economies of scale. A. it is not a substitute for long-term operational hedging.
C. a firm may find that exchange rate changes can fully offset the advantage of multiple manufacturing B. it is therefore a substitute for long-term operational hedging.
sites. C. it is inferior to money market hedging.
D. both a and b D. none of the above.
84. Goldman Sachs estimates that as much as __% of the pretax profits that Porsche reported for a recent 92. Investments in R&D
fiscal year came from skillfully executing currency options. A. are usually a waste of time and money.
A. 5 B. can allow the firm to maintain and strengthen its competitive position.
B. 10 C. can allow the firm to cut costs and enhance productivity.
C. 15 D. both b and c
D. 75

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93. The price elasticity of demand for unique products tends to be 98. Estimate your exposure (b) to the exchange risk.
A. highly elastic.
B. highly inelastic.
C. both a and b
94. The price elasticity of demand for commodity products tends to be
A. highly elastic.
B. highly inelastic.
C. both a and b 99. Compute the variance of the dollar value of your property that is attributable to exchange rate
D. none of the above uncertainty.
95. In the figure at right, label curves A and B respectively,
100.Discuss how you can hedge your exchange risk exposure and also examine the consequences of
hedging.
A. unhedged, hedged.
B. hedged, unhedged.
C. normal, abnormal.
96. Investment in R&D activities can allow the firm to maintain and strengthen its competitive position in the
face of adverse exchange rate movements. The mechanism for this includes
A. successful R&D efforts allow the firm to cut costs and enhance productivity.
BR&D efforts can lead to the introduction of new and unique products for which competitors offer no
. close substitutesÑsince the demand for unique products tends to be highly inelastic the firm would be
less exposed to exchange risk.
Csuccessful R&D efforts can create a perception among consumers that its product is indeed different
. from those offered by competitors. Once the firm's product acquires a unique identity, its demand is less
likely to be price-sensitive.
D. all of the above
97. If the stock market of a foreign country is consistently up when the dollar value of the currency is
down,
A. there may not be a great deal of exchange rate risk for a U.S.-based investor.
B. there will be a great deal of exchange rate risk for a U.S.-based investor.
C. then investors can ignore diversification.
Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a
U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy
booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the
British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound
will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60
percent probability and a slowdown with a 40 percent probability.

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7. Two studies found a link between exchange rates and the stock prices of U.S. firms,
A. this suggests that exchange rate changes can systematically affect the value of the firm by
influencing its operating cash flows.
9 Key B this suggests that exchange rate changes can systematically affect the value of the firm by
1. Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange . influencing the domestic currency values of its assets and liabilities.
rate C. both a and b
A. can have significant economic consequences for U.S. firms. D. none of the above
B. can have significant economic consequences for Japanese firms.
C. can have significant economic consequences for both U.S. and Japanese firms. Eun - Chapter 09 #7
Topic: How to Measure Economic Exposure
D. none of the above 8. It is conventional to classify foreign currency exposures into the following types:
Eun - Chapter 09 #1 A. economic exposure, transaction exposure, and translation exposure.
Topic: How to Measure Economic Exposure B. economic exposure, noneconomic exposure, and political exposure.
2. Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange C. national exposure, international exposure, and trade exposure.
rate D. conversion exposure, and exchange exposure.
A. will tend to weaken the competitive position of import-competing U.S. car makers.
B. will tend to strengthen the competitive position of import-competing U.S. car makers. Eun - Chapter 09 #8
C. will tend to strengthen the competitive position of Japanese car makers at the expense of U.S. 9. Exposure to currency risk can be measured by the sensitivities of
makers. A. the future home currency values of the firm's assets and liabilities.
D. none of the above B. the firm's operating cash flows to random changes in exchange rates.
Eun - Chapter 09 #2 C. both a and b
Topic: How to Measure Economic Exposure D. none of the above
3. The link between a firm's future operating cash flows and exchange rate fluctuations is
A. asset exposure. Eun - Chapter 09 #9
B. operating exposure. 10. Operating exposure measures
C. both a and b A. the extent to which the foreign currency value of the firm's assets is affected by unanticipated
D. none of the above changes in exchange rates.
Eun - Chapter 09 #3 B. the extent to which the firm's operating cash flows will be affected by unexpected changes in
Topic: How to Measure Economic Exposure exchange rates.
4. When the Mexican peso collapsed in 1994, declining by 37 percent, C. the affect of changes in exchange rates will have on the consolidated financial reports of a MNC.
A. U.S. firms that exported to Mexico and priced in peso were adversely affected. D the affect of unanticipated changes in exchange rates on the dollar value of contractual obligations
B. U.S. firms that exported to Mexico and priced in dollars were adversely affected. . denominated in a foreign currency.
C. U.S. firms were unaffected by the peso collapse, since Mexico is such a small market.
D. both a and b Eun - Chapter 09 #10
Eun - Chapter 09 #4 11. Economic exposure refers to
Topic: How to Measure Economic Exposure A the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated
5. When exchange rates change, . in foreign currencies to unexpected exchange rate changes.
A. U.S. firms that produce domestically and sell only to domestic customers will be unaffected. B. the extent to which the value of the firm would be affected by unanticipated changes in exchange
B. U.S. firms that produce domestically and sell only to domestic customers can be affected if they rate.
compete against imports. C. the potential that the firm's consolidated financial statement can be affected by changes in
C U.S. firms that produce domestically and sell only to domestic customers will be affected, but only exchange rates.
. if they borrow in foreign currency to finance their domestic operations. D. ex post and ex ante currency exposures.
D. both a and b
Eun - Chapter 09 #11
Eun - Chapter 09 #5 Topic: How to Measure Economic Exposure
Topic: How to Measure Economic Exposure 12. Currency risk
6. When exchange rates change, A. is the same as currency exposure.
A. this can alter the operating cash flow of a domestic firm. B. represents random changes in exchange rates.
B. this can alter the competitive position of a domestic firm. C. measure "what the firm has at risk."
C. this can alter the home currency values of a multinational firm's assets and liabilities. D. both a and b
D. all of the above
Eun - Chapter 09 #6 Topic: How to Measure Economic Exposure

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13. Suppose a U.S.-based MNC maintains a vacation home for employees in the British countryside and 19. A purely domestic firm that sources and sells only domestically,
the local price of this property is always moving together with the pound price of the U.S. dollar. As a A. faces exchange rate risk to the extent that it has international competitors in the domestic market.
result, B. faces no exchange rate risk.
A. whenever the pound depreciates against the dollar, the local currency price of this property goes up C. should never hedge since this could actually increase its currency exposure.
by the same proportion. D. both b and c
B. the firm is not exposed to currency risk even if the pound-dollar exchange rate fluctuates randomly.
C. both a and b Topic: How to Measure Economic Exposure
D. none of the above 20. In recent years, the U.S. dollar has depreciated substantially against most major currencies of the
world, especially against the euro.
Topic: How to Measure Economic Exposure A The stronger euro has made many European products more expensive in dollar terms, hurting sales
14. The exposure coefficient in the regression is given by: . of these products in the United States.
A. B. The stronger euro has made many American products less expensive in euro terms, boosting sales
of U.S. products in Europe.
C. Both a and b
B. D. None of the above
C.
21. In recent years,
Topic: How to Measure Economic Exposure A. the U.S. dollar has appreciated substantially against most major currencies of the world, especially
15. against the euro.
B. the U.S. dollar has depreciated substantially against most major currencies of the world, especially
The exposure coefficient in the regression is: against the euro.
A. A measure of how a change in the exchange rate affects the dollar value of a firm's assets. C. the U.S. dollar has maintained its value against most major currencies of the world, especially
B. Has a value of zero if the value of the firm's assets is perfectly correlated with changes in the against the euro.
exchange rate.
C. both a and b Eun - Chapter 09 #21
D. none of the above 22. From the perspective of the U.S. firm that owns an asset in Britain, the exposure that can be measured
Eun - Chapter 09 #15 by the coefficient b in regressing the dollar value P of the British asset on the dollar/pound exchange
rate S using the regression equation is
16.
A. asset exposure.
The exposure coefficient in the regression informs B. operating exposure.
A. how much of a foreign currency to sell forward. C. accounting exposure.
B. the part of the variability of the dollar value of the asset that is related to random changes in the D. none of the above
exchange rate.
C. captures the residual part of the dollar value variability that is independent of exchange rate Topic: How to Measure Economic Exposure
movements. 23. On the basis of regression Equation we can decompose the variability of the dollar
D. how many call options to write. value of the asset, Var(P), into two separate components.
2
A. Cov(P,S) = b × Var(P) + Var(S)
Topic: How to Measure Economic Exposure B. Var(P) = b2 × Var(S) + Var(e)
17. Before you can use the hedging strategies such as a forward market hedge, options market hedge, and C. Cov(P,S) = b2 × Cov(S,P) + Cov(S,e)
so on, you should consider running a regression of the form . When reviewing the D. Var(P) = b2 × Var(S)
output, you should initially focus on E. None of the above
A. the intercept a.
B. the slope coefficient b. Topic: How to Measure Economic Exposure
C. mean square error, MSE. 24. On the basis of regression Equation we can decompose the variability of the dollar
D. R2. value of the asset, Var(P), into two separate components Var(P) = b2 × Var(S) + Var(e).
2
The first term in the right-hand side of the equation, b × Var(S) represents.
Topic: How to Measure Economic Exposure A. the part of the variability of the dollar value of the asset that is related to random changes in the
18. The link between the home currency value of a firm's assets and liabilities and exchange rate exchange rate.
fluctuations is B. captures the residual part of the dollar value variability that is independent of exchange rate
A. asset exposure. movements.
B. operating exposure. C. none of the above
C. both a and b
D. none of the above Eun - Chapter 09 #24

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25. On the basis of regression Equation we can decompose the variability of the dollar 31. Consider a U.S. MNC who owns a foreign asset. If the foreign currency value of the asset is inversely
value of the asset, Var(P), into two separate components Var(P) = b2 × Var(S) + Var(e). related to changes in the dollar-foreign currency exchange rate,
The second term in the right-hand side of the equation, Var(e) represents. A. the company has a built-in hedge.
A. the part of the variability of the dollar value of the asset that is related to random changes in the B. the dollar value variability that is independent of exchange rate movements.
exchange rate. C. both a and b
B. captures the residual part of the dollar value variability that is independent of exchange rate D. none of the above
movements. Eun - Chapter 09 #31
C. none of the above Topic: Operating Exposure: Definition
32. With regard to operational hedging versus financial hedging,
Eun - Chapter 09 #25 A. operational hedging provides a more stable long-term approach than does financial hedging.
26. What does it mean to have redenominated an asset in terms of the dollar? B. financial hedging, when instituted on a rollover basis, is a superior long-term approach to
A. You have undertaken a hedging strategy that gives the asset a constant dollar value. operational hedging.
B. Multiply the foreign currency value of the asset by the spot exchange rate. C. since they both have the same goal, stabilizing the firm's cash flows in domestic currency, they are
C. Undertaken accounting changes to eliminate translation exposure. fungible in use.
D. None of the above D. none of the above
Eun - Chapter 09 #26 Eun - Chapter 09 #32

Topic: How to Measure Economic Exposure Topic: Operating Exposure: Definition
27. A firm with a highly elastic demand for its products 33. Which of the following are identified by your text as a strategy for managing operating exposure:
A will be unable to pass increased costs following unfavorable changes in the exchange rate without 1) Selecting low-cost production sites
. significantly lowering the quantity sold. 2) Flexible sourcing policy
B. will be able to raise prices following unfavorable changes in the exchange rate without significantly 3) Diversification of the market
lowering the quantity sold. 4) Product differentiation and R&D efforts
C. can easily pass increased costs on to consumers. 5) Financial Hedging
D. will sell about the same amount of product regardless of price. A. 1), 3), and 5) only
Eun - Chapter 09 #27 B. 2) and 4) only
Topic: How to Measure Economic Exposure C. 1), 4), and 5) only
28. Operating exposure can be defined as D. 1), 2), 3), 4), and 5)
A. the link between the future home currency values of the firm's assets and liabilities and exchange
rate fluctuations. Eun - Chapter 09 #33
Topic: Operating Exposure: Definition
B. the extent to which the firm's operating cash flows would be affected by random changes in A U.S. firm holds an asset in Great Britain and faces the following scenario:
exchange rates.
C the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated
. in foreign currencies to unexpected exchange rate changes.
D. the potential that the firm's consolidated financial statement can be affected by changes in
exchange rates.
Topic: Operating Exposure: Definition where,
29. The extent to which the firm's operating cash flows would be affected by random changes in exchange
rates is called
A. asset exposure.
B. operating exposure. Eun - Chapter 09
C. both a and b 34. The expected value of the investment in U.S. dollars is
D. none of the above A. $4,950.
B. $3,700.
Topic: Operating Exposure: Definition C. $2,112.50.
30. The variability of the dollar value of an asset (invested overseas) depends on D. none of the above
A. the variability of the dollar value of the asset that is related to random changes in the exchange rate. Eun - Chapter 09 #34
B. the dollar value variability that is independent of exchange rate movements. Topic: Operating Exposure: Definition
C. both a and b 35. The variance of the exchange rate is:
D. none of the above A. 0.0200
B. 0.10
Topic: Operating Exposure: Definition C. 0.002

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36. The "exposure" (i.e. the regression coefficient beta) is: 41. The "exposure" (i.e. the regression coefficient beta) is:
A. -25,000 A. 7,500
B. 2,5000 B. 2,5000
C. -2,500 C. -2,500
D. none of the above D. none of the above
Topic: Operating Exposure: Definition Topic: Operating Exposure: Definition
37. Which of the following conclusions are correct? 42. Which of the following conclusions are correct?
AMost of the volatility of the dollar value of the British asset can be removed by hedging exchange AMost of the volatility of the dollar value of the British asset can be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 1,125,000 ($)2 and 2,500 ($)2 respectively.
B Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange B Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively.
C Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange C Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively.
DMost of the volatility of the dollar value of the British asset can be removed by hedging exchange DMost of the volatility of the dollar value of the British asset can be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively.
38. Which of the following would be an effective hedge? 43. Which of the following would be an effective hedge?
A. Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. A. Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
B. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. B. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
C. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero. C. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero.
D. None of the above D. None of the above
A U.S. firm holds an asset in Great Britain and faces the following scenario: A U.S. firm holds an asset in Great Britain and faces the following scenario:
where,
where,
P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset
Eun - Chapter 09
Eun - Chapter 09 44. The expected value of the investment in U.S. dollars is:
39. The expected value of the investment in U.S. dollars is: A. $5,050
A. $5,050 B. $4,500
B. $3,700 C. $2,112.50
C. $2,112.50 D. none of the above
Topic: Operating Exposure: Definition 45. The variance of the exchange rate is:
40. The variance of the exchange rate is: A. 0.0200
A. 0.0200 B. 0.101875
B. 0.10 C. 0.002
C. 0.002 D. none of the above

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46. The "exposure" (i.e. the regression coefficient beta) is: 51. The "exposure" (i.e. the regression coefficient beta) is:
A. 7,500 A. -52.6316
B. 2,5000 B. 1,289.80
C. -2,500 C. 12,898.00
D. none of the above D. none of the above
47. Which of the following conclusions are correct? 52. Which of the following conclusions are correct?
A Most of the volatility of the dollar value of the British asset can be removed by hedging exchange AMost of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 0 ($)2 and 0 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively.
B None of the volatility of the dollar value of the British asset can be removed by hedging exchange B Most of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 0 ($)2 and 0 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively.
C Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange CMost of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 8.22 ($)2 and 59,211 ($)2, respectively.
DMost of the volatility of the dollar value of the British asset can be removed by hedging exchange DMost of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange
. risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and -127,500 ($)2 respectively. . risk because b2[Var(S)] and Var(e) are 8.22 ($)2 and 59,211 ($)2 respectively.
48. Which of the following would be an effective hedge? 53. Which of the following would be an effective hedge?
A. Sell £2,278.13 forward at the 1-year forward rate, F1($/£), that prevails at time zero. A. Sell 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.
B. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. B. Buy 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.
C. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero. C. Sell 12,898 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.
D. None of the above D. None of the above
A U.S. firm holds an asset in Israel and faces the following scenario:
where,
P* = Israeli shekel (IS) price of the asset held by the U.S. firm
Eun - Chapter 09
A. $2,083.33
B. $762.50
C. $6,250.00
D. $6,562.50
A. 0.001968
B. 0.002969
C. 0.003968
D. 0.004968

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54. Find an effective hedge financial hedge if a U.S. firm holds an asset in Great Britain and faces the 56. A U.S. firm holds an asset in Great Britain and faces the following scenario:
following scenario:
Where
P* = Pound sterling price of the asset held by the U.S. firm P* = Pound sterling price of the asset held by the U.S. firm
P = Dollar price of the same asset The CFO decides to hedge his exposure by selling forward the expected value of the pound
denominated cash flow at F1($/£) = $2/£. As a result
The CFO runs a regression of the form A. The firm's exposure to the exchange rate is made worse.
B. He has a nearly perfect hedge.
C. He has a perfect hedge.
The regression coefficient beta is calculated as D. None of the above
Where Eun - Chapter 09 #56
57. A U.S. firm holds an asset in Italy and faces the following scenario:
Where
The variance of the exchange rate is calculated as: P* = Euro price of the asset held by the U.S. firm
E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00 The CFO decides to hedge his exposure by selling forward the expected value of the euro
VAR(S) = 0.25($2.20 - $2.00)2 + 0.50($2.00 - $2.00)2 + 0.25($1.80 - $2.00)2 = 0.01 + 0 + 0.01 denominated cash flow at F1($/£) = $1.50/¬. As a result
= 0.02 A. the firm's exposure to the exchange rate is made worse.
The expected value of the investment in U.S. dollars is: B. he has a nearly perfect hedge.
E[P] = 0.25 × $6,600 + 0.50 × $5,000 + 0.25 × $3,600 = $5,050 C. he has a perfect hedge.
Which of the following is the most effective hedge financial hedge?
A. Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Eun - Chapter 09 #57
B. Buy £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. 58. Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity,
C. Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. suppose there are only three states of the world and each state is equally likely to occur. The
D. 0.25 × £3,000 + 0.50 × £2,500 + 0.25 × £2,000 = £2,500 future local currency price of this British asset (P*) as well as the future exchange rate (S) will be
Eun - Chapter 09 #54 determined, depending on the realized state of the world.
55. Suppose that you implement your hedge from the last question at F1($/£) = $2/£. Your cash flows in
state 1, 2, and 3 respectively will be
A. $5,100, $5,000, $5,100.
B. $5,100, $5,100, $5,100.
C. $5,000, $5,000, $5,000.
Eun - Chapter 09 #55 A. The firm faces no exchange rate risk since the local currency price of the asset and the exchange
rate are negatively correlated.
B. The firm faces substantial exchange rate risk since the local currency price of the asset and the
exchange rate are positively correlated.
pound.

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59. Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, 61. Suppose a U.S. firm has an asset in Italy whose local currency price is random. For simplicity,
suppose there are only three states of the world and each state is equally likely to occur. The suppose there are only three states of the world and each state is equally likely to occur. The future
future local currency price of this British asset (P*) as well as the future exchange rate (S) will be local currency price of this asset (P*) as well as the future exchange rate (S) will be determined,
determined, depending on the realized state of the world. depending on the realized state of the world.
Which of the following statements is most correct? Assume that you choose to "hedge" this asset by selling forward the expected value of the euro
A. The firm faces no exchange rate risk since the local currency price of the asset and the exchange denominated cash flow at F1($/£) = $1.50/¬. Calculate your cash flows in each of the possible
rate are negatively correlated. states.
B. The firm faces substantial exchange rate risk since the local currency price of the asset and the A. $1,400, $1,400, $1,400
exchange rate are positively correlated. B. $1,496.6, $1,400, $1,306.40
C. The firm's exchange rate exposure can be completely hedged with derivatives written on the British C. $1,404, $1,404. $1,404
pound. D. None of the above
Eun - Chapter 09 #59 Topic: Operating Exposure: Definition
Topic: Operating Exposure: Definition 62. Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the
60. Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, dollar against the euro, which of the following conclusions are correct?
suppose there are only three states of the world and each state is equally likely to occur. The A. The cash flow in euro could be altered due an alteration in the firm's competitive position in the
future local currency price of this British asset (P*) as well as the future exchange rate (S) will be marketplace.
determined, depending on the realized state of the world. B. A given operating cash flow in euro will be converted to a higher U.S. dollar cash flow.
C. Both a and b
Topic: Illustration of Operating Exposure
63. Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the
dollar against the euro, which of the following describes the competitive effect of the depreciation?
A. The firm faces no exchange rate risk since the local currency price of the asset and the exchange A. The cash flow in euro could be altered due an alteration in the firm's competitive position in the
rate are negatively correlated. marketplace.
B. The firm faces substantial exchange rate risk since the local currency price of the asset and the B. A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.
exchange rate are positively correlated. C. Both a and b
C. The firm's exchange rate exposure can be completely hedged with derivatives written on the British D. None of the above
pound.
D. Since randomness is involved, no hedging is possible. Topic: Illustration of Operating Exposure

64. Consider a U.S. MNC with operations in Great Britain. Which of the following are potential risks
Topic: Operating Exposure: Definition following a strengthening of the dollar?
A A pound sterling depreciation may affect operating cash flow in pounds by altering the firm's
. competitive position in the marketplace.
B. A given operating cash flow in pounds will be converted into a lower dollar amount after the pound
depreciation.
C. Both a and b

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65. Which of the following is false? 70. A firm's operating exposure is

A The competitive effect is that a depreciation may affect operating cash flow in the foreign currency A. defined as the extent to which the firm's operating cash flows would be affected by the random
. by altering the firm's competitive position in the marketplace. changes in exchange rates.
B The conversion effect is defined as a given operating cash flow in a foreign currency will be B. determined by the structure of the markets in which the firm sources its inputs, such as labor and
. converted into a lower dollar amount after a currency depreciation. materials, and sells its products.
C The competitive effect is defined as a given operating cash flow in a foreign currency will be C. determined by the firm's ability to mitigate the effect of exchange rate changes by adjusting its
. converted into a lower dollar amount after a currency depreciation. markets, product mix, and sourcing.
D. None of the above D. all of the above
Topic: Illustration of Operating Exposure Topic: Determinants of Operating Exposure
66. Consider a U.S.-based MNC with a wholly-owned German subsidiary. Following a depreciation of the 71. Generally speaking, a firm is subject to high degrees of operating exposure
dollar against the euro, which of the following describes the conversion effect of the depreciation? A. when its costs are sensitive to exchange rate changes.
A. The cash flow in euro could be altered due a change in the firm's competitive position in the B. when its prices are sensitive to exchange rate changes.
marketplace. C. when either its cost or its price is sensitive to exchange rate changes.
B. A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow. D. none of the above
C. Both a and b
D. None of the above Topic: Determinants of Operating Exposure
72. Generally speaking, when both a firm's costs and its price is sensitive to exchange rate changes
Topic: Illustration of Operating Exposure A. the firm is not subject to high degrees of operating exposure.
67. Consider a U.S.-based MNC with a wholly-owned French subsidiary. Following a depreciation of B. the firm is subject to high degrees of operating exposure.
the dollar against the euro, which of the following best describes the mechanism of any effect of the C. the firm should hedge.
depreciation? D. none of the above
AThe change in the cash flow in euro due an alteration in the firm's competitive position in the
. marketplace is in part a function of the elasticity of demand for the firm's product. Topic: Determinants of Operating Exposure
B. A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow regardless 73. The firm may not be subject to high degrees of operating exposure
of the firm's hedging program. A. when changes in real exchange rates are exactly offset by the inflation differential.
C. Both a and b B. when changes in nominal exchange rates are exactly matched by the inflation differential.
D. None of the above C. when changes in nominal exchange rates are exactly offset by the inflation differential.
68. Which of the following is true? Topic: Determinants of Operating Exposure
A The competitive effect is that a currency depreciation may affect operating cash flow in the foreign 74. The firm may not be able to pass through changes in the exchange rate
. currency by altering the firm's competitive position in the marketplace. A. in markets with low product differentiation.
B The conversion effect is defined as a given accounting cash value in a foreign currency will be B. in markets with high price elasticities.
. converted into a lower dollar amount after currency depreciation. C. both a and b
C The competitive effect is defined as a given operating cash flow in a foreign currency will be D. none of the above
. converted into a lower dollar amount after a currency depreciation.
D. None of the above Topic: Determinants of Operating Exposure
75. The firm may not be able to pass through changes in the exchange rate
Topic: Illustration of Operating Exposure A. in markets with mainly domestics (foreign to the firm) competitors.
69. Consider a U.S.-based MNC with a wholly-owned European subsidiary selling a product sourced in B. in markets with low price elasticities.
euro and priced in euro with inelastic demand. Following a depreciation of the dollar against the euro, C. both a and b
which of the following is the most true? D. none of the above
A. Since they have inelastic demand, the U.S. firm can just pass through the impact of the exchange
rate change. Topic: Determinants of Operating Exposure
B. Since they have elastic demand, the U.S. firm cannot just pass through the impact of the exchange 76. Generally speaking, a firm is subject to high degrees of operating exposure when
rate change. A. either its cost or its price is sensitive to exchange rate changes.
C. Since the exchange rate movement was favorable to the U.S. firm, there is no impact on the firm's B. both the cost and the price are sensitive to exchange rate changes.
position. C. both the cost and the price are insensitive to exchange rate changes.
D. None of the above. D. none of the above
Topic: Determinants of Operating Exposure Topic: Managing Operating Exposure

lOMoARcPSD|11124595
77. What is the objective of managing operating exposure? 84. Goldman Sachs estimates that as much as __% of the pretax profits that Porsche reported for a recent
A. Stabilize cash flows in the face of fluctuating exchange rates. fiscal year came from skillfully executing currency options.
B. Selecting low cost production sites. A. 5
C. Increase the variability of cash flows in the face of fluctuating exchange rates. B. 10
D. Both a and c C. 15
D. 75
Topic: Managing Operating Exposure
78. What is the objective of managing operating exposure? Topic: Selecting Low-Cost Production Sites
A. Stabilize accounting results in the face of fluctuating exchange rates. 85. Developing multiple production sites in a variety of countries,
B. Selecting low cost production sites. A. can create an excess capacity problem.
C. Increase the variability of cash flows in the face of fluctuating exchange rates. B. can lead to underutilization of domestic plants.
D. None of the above C. can lead to domestic job losses.
D. all of the above
79. Managing operating exposure Topic: Selecting Low-Cost Production Sites
A. is a short-term tactical issue. 86. A flexible sourcing policy
B. is a long-term issue, like selecting a site for a factory. A. is primarily concerned with low-cost (and often low-quality) vendors.
C. is relatively unimportant, since most MNCs have a built-in hedge. B. need not be confined just to materials and parts.
D. none of the above C. only works for manufacturing firms, not service firms.
D. puts the focus on the exchange rate at the expense of shipping rates.
80. Which of the following can a company use to manage operating exposure? Topic: Flexible Sourcing Policy
A. Selecting low-cost production sites, diversifying the market. 87. A firm that is committed to keeping manufacturing facilities in only the home country (and not
B. Low cost production sites, but not financial hedging. developing multiple production sites in a variety of countries) can
C. Pursuing a flexible sourcing policy, product differentiation, R&D efforts. A. not mitigate the effects of exchange rate changes.
D. Both a and c. B. lessen the effect of exchange rate changes by sourcing from where input costs are low.
C. focus on selling commodity products with product differentiation.
Topic: Managing Operating Exposure D. pursue a strategy of increasing its products price elasticity of demand.
81. When the domestic currency is strong or expected to become strong, Eun - Chapter 09 #87
A. this could erode the competitive position of the firm's exports. Topic: Flexible Sourcing Policy
B. this could erode the competitive position of the firm's import competition. 88. If the domestic currency is strong or expected to become strong,
C. the firm should consider locating production facilities in a foreign country where costs are low. A a firm can choose to locate production facilities in a foreign country where costs are low due to
D. both a and c . either the undervalued currency or underpriced factors of production.
B. a firm should curtail R&D efforts until the exchange rate situation improves.
Topic: Selecting Low-Cost Production Sites C. a firm should abandon international sales and focus on domestic market share.
82. A foreign country could provide low cost production sites D. the firm should focus on profiting in the currency futures market based on its forecasts.
A. because the factors of production are underpriced.
B. because the currency is undervalued. Topic: Flexible Sourcing Policy
C. because the locals like to give away their land labor and capital to foreigners. 89. Which of the following is a true statement?
D. both a and b A As long as exchange rates do not always move in the same direction, the firm can stabilize its
. operating cash flows by diversifying its export market.
Topic: Selecting Low-Cost Production Sites B The firm should not get into new lines of business solely to diversify exchange risk because
83. While maintaining multiple production sites does provide a firm valuable options, . conglomerate expansion can bring about inefficiency and losses.
A. a firm may miss out on economies of scope. C. All of the above are true
B. a firm may miss out on economies of scale. D. None of the above is true
C. a firm may find that exchange rate changes can fully offset the advantage of multiple
manufacturing sites. Topic: Diversification of the Market
D. both a and b 90. A firm that is committed to keeping manufacturing facilities in only the home country (and not
developing multiple production sites in a variety of countries) can
Topic: Selecting Low-Cost Production Sites A.lessen the effect of exchange rate changes by pursuing a strategy of diversifying the markets in
which the firm's products are sold.
B. not mitigate the effects of exchange rate changes.
C. lessen the effect of exchange rate changes by pursuing a strategy of selling commodity products
without product differentiation.
Topic: Diversification of the Market

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91. It can be argued that, while financial hedging can be used to stabilize a firm's cash flows, 96. Investment in R&D activities can allow the firm to maintain and strengthen its competitive position in
A. it is not a substitute for long-term operational hedging. the face of adverse exchange rate movements. The mechanism for this includes
B. it is therefore a substitute for long-term operational hedging. A. successful R&D efforts allow the firm to cut costs and enhance productivity.
C. it is inferior to money market hedging. BR&D efforts can lead to the introduction of new and unique products for which competitors offer no
D. none of the above. . close substitutesÑsince the demand for unique products tends to be highly inelastic the firm would
be less exposed to exchange risk.
Topic: Financial Hedging Csuccessful R&D efforts can create a perception among consumers that its product is indeed different
Topic: R&D Efforts and Product Differentiation . from those offered by competitors. Once the firm's product acquires a unique identity, its demand is
92. Investments in R&D less likely to be price-sensitive.
A. are usually a waste of time and money. D. all of the above
B. can allow the firm to maintain and strengthen its competitive position.
C. can allow the firm to cut costs and enhance productivity. Eun - Chapter 09 #96
Topic: Financial Hedging
D. both b and c Topic: R&D Efforts and Product Differentiation
97. If the stock market of a foreign country is consistently up when the dollar value of the currency is
Topic: Financial Hedging down,
Topic: R&D Efforts and Product Differentiation A. there may not be a great deal of exchange rate risk for a U.S.-based investor.
93. The price elasticity of demand for unique products tends to be B. there will be a great deal of exchange rate risk for a U.S.-based investor.
A. highly elastic. C. then investors can ignore diversification.
B. highly inelastic. D. none of the above
C. both a and b
D. none of the above Eun - Chapter 09 #97
Topic: R&D Efforts and Product Differentiation
Topic: Financial Hedging Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a
Topic: R&D Efforts and Product Differentiation U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy
94. The price elasticity of demand for commodity products tends to be booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If
A. highly elastic. the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the
B. highly inelastic. pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a
C. both a and b 60 percent probability and a slowdown with a 40 percent probability.
Eun - Chapter 09
95. In the figure at right, label curves A and B respectively,
A. unhedged, hedged.
B. hedged, unhedged.
C. normal, abnormal.

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Chapter 24International Flow of Funds

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ANS: B PTS: 1 d. none of the above

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33. A balance of trade surplus indicates an excess of imports over exports.

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ANS: F PTS: 1 ANS: T PTS: 1

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ANS: F PTS: 1 ANS: A PTS: 1

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e. None of the above

71. Which of the following statements is not true?

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PTS: 1 ANS: D PTS: 1

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. currency at a reasonable exchange rate.

ANS: A PTS: 1 ANS: B PTS: 1

ANS: B ANS: C PTS: 1

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ANS: A PTS: 1 20. LIBOR is:

ANS: A PTS: 1 21. A syndicated loan:

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. regulations in the U.S.

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ANS: C PTS: 1 ANS: D

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ANS: D PTS: 1 ANS: D PTS: 1

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c The loans are provided by a group of banks to a borrower.

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86. Which of the following is not true regarding ADRs?

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b indirect; direct exposure to British pound payables?

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Chapter 4: Exchange Rate Determination 415

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416 International Financial Management Chapter 4: Exchange Rate Determination 417

1. Borrow $5 million. 1. Borrow ¬20 million.

NZ$10,416,667 × [1 + 6.80% (5/360)] $22,600,000 × [1 + 6.73% (90/360)]

4. Convert the NZ$ back to dollars: 4. Determine euros owed:

NZ$10,426,505 × $.50 = $5,213,252 ¬20,000,000 × [1 + 7.28% (90/360)] = ¬20,364,000.

$5,000,000 × [1 + 7.5% (5/360)] ¬20,364,000 × $1.10 = $22,400,400.

= $5,000,000 × [1.00104] 6. The dollar profit is:

= $5,005,208 $22,980,245 3 $22,400,400 = $579,845.

6. After repaying the loan, the remaining dollar profit is:

$5,213,252 3 $5,005,208 = $208,044

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418 International Financial Management Chapter 4: Exchange Rate Determination 419

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420 International Financial Management Chapter 4: Exchange Rate Determination 421

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422 International Financial Management Chapter 4: Exchange Rate Determination 423

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424 International Financial Management Chapter 54Currency Derivatives