Fundamentals of Multinational Finance, 3e (Moffett) Chapter 3 The International Monetary System 3.1 Multiple Choice and True/False Questions 1) The price of one country’s currency in units of another currency or commodity is the A) foreign interest rate B) foreign currency exchange rate © par value D) international rate Answer: B “Topic: Currency Terminology Shll: Recognition 2) A country that regulates the rate at which its currency is exchanged for all other currencies is considered to have a exchange rate system. A) fixed or managed B) floating or flexible ©) forward D) spot Answer: A pic: Currency Terminology Skil: Recognition 3) You check the Yahoo.com currency web page and find that the Japanese yen is trading at a rate of 1113 yen per dollar. This rate of exchange is typically referred to as the A) forward rate B) par rate €) spot rate D) 113 rate Answer: C Topic: Currency Terminology Skill: Conceptual 4) The drop in value of a currency pegged to gold or another currency is known as, A) revaluation B) depreciation ©) deterioration D) devaluation Answer: D Topic: Currency Terminology Skill: Conceptual5)A currency is expected to devalue or depreciate relative to major currencies. A) soft or weak B) hard or strong ©) deteriorated D) devalued Answer: A Topic: Currency Terminology Skil: Conceptual 6) The increase in value of a currency pegged to gold or another currency is known as A) appreciation B) revaluation ©) strengthened D) hardened Answer: B “opie: Currency Terminology Skil: Conceptual 7) A currency that has increased in foreign exchange value relative to a floating rate currency, has : A) revalued B) violated international trade agreements C) appreciated D) deteriorated Answer: C Topic: Currency Terminology Skill: Conceptual 8) A currency that has decreased in foreign exchange value relative to a floating rate currency has A) revalued B) appreciated ©) devalued D) depreciated Answer: D Topic: Currency Terminology Skil: Conceptual 9) The as of December 2007, is the common currency for 13 of the countries that are ‘members of the European Union. A) SDR (Special Drawing Rights) B) ECU (European Currency Unit) ©) Euro D) Yugo Answer: C ‘pic: Currency Terminology Skil: Recognition10) A United States firm had chosen to deposit money in a British bank and have it denominated in US. dollars. This is an example of a (an) deposit. A) imPounded B) Euroyen ©) Europound D) Eurodollar Answer: D Topic: Currency Terminology Sl: Recognition 11) Under the gold standard of currency exchange that existed from 1879 to 1914, an ounce of gold cost $20.67 in U.S. dollars and £4.2474 in British pounds. Therefore, the exchange rate of pounds per dollar under this fixed exchange regime was A) £4,8665)8. B) £0.2055)8. C) always changing because the price of gold was always changing, D) unknown because there is not enough information to answer this question. Answer: B Topic: Gold Standart Skil: Analytical 12) World War I caused the suspension of the gold standard for fixed international exchange rates because the war ‘A) cost too much money. B) interrupted the free movement of gold ©) lasted too long. D) used gold as the main ingredient in armament plating Answer: B Topic: Gold Standart Skill: Conceptual 13) A speculative technique whereby the speculator sells an asset that he/she doesn't own, such asa currency, to another party for delivery at a future date is called. A) selling ahead B) selling behind C) selling short D) selling long Answer: C Topic: Curreney Speculation Skil: Conceptual 14) Which of the following investment strategies will allow me to make a profit if anticipate that the value of the Euro, a currency that I do not own, is going to fall over the next 90 days and Iam correct in my prediction? A) Sell Euros short, B) Buy Euros short. C) Sell dollars short D) Buy Euros long, Answer: A Topic: Currency Speculation Shi: Conceptual15) The post WWII international monetary agreement that was developed in 1944 is known as the A) United Nations B) League of Nations ) Yalta Agreement D) Bretton Woods Agreement Answer: D Topic: Bretton Woods Agreement Skil: Recognition 16) Another name for the International Bank for Reconstruction and Development is A) the Recon Bank. B) the European Monetary System, ©) the Marshall Plan, D) the World Bank. Answer: D Topic: Bretton Woods Agreement Skill: Recognition 17) The International Monetary Fund (IMF) ‘A) in recent years has provided large loans to Russia, South Korea, and Brazil, B) was created as a result of the Bretton Woods Agreement C) aids countries with balance of payment and exchange rate problems, D) isall of the above, Answer: D Topic: Bretton Woods Agreement Skill: Recognition 18) Under the terms of Bretton Woods countries tried to maintain the value of their currencies to within 1% of a hybrid security made up of the U.S. dollar, British pound, and Japanese yen. Answer: FALSE Topic: Bretton Woods Agreement Skill Recognition 19) Members of the International Monetary Fund may settle transactions among themselves by transferring Special Drawing Rights (SDRs). Answer: TRUE Topic: Bretton Woods Agreement Skil: Recognition 20) Today, the United States has been ejected from the International Monetary Fund for refusal to pay annual dues. Answer: FALSE ‘Topic: Bretton Woods Agreement Skill: Analytical21) Which of the following led to the eventual demise of the fixed currency exchange rate regime worked out at Bretton Woods? A) widely divergent national monetary and fiscal poticies among member nations B) differential rates of inflation across member nations. ) several unexpected economic shocks to member nations D) all of the above Answer: D “Topic: Exchange Rate Regimes Skil: Conceptual 22) The IMF exchange rate regime classification identifies _ as the most rigidly fixed, and as the least fixed. ‘A) exchange arrangements with no separate legal tender; independent floating, B) crawling pegs; managed float ©) currency board arrangements; independent floating D) pegged exchange rates within horizontal bands; exchange rates within crawling pegs Answer: A Topic: Exchange Rate Regimes Sk: Recognition 23) Which of the following correctly identifies exchange rate regimes from less fixed to more fixed? ‘A) independent floating, currency board arrangement, crawling pegs B) independent floating, currency board arrangement, managed float ©) independent floating, crawling pegs, exchange arrangements with no separate legal tender D) exchange arrangements with no separate legal tender, currency board arrangement, crawling pegs Answer: C Topic: Exchange Rate Regimes Skill: Conceptual 24) As of January 2002, the Independent Floating regime of exchange rate classifications was used by over 75% of the 186 countries identified by the IMF. Answer: FALSE “Topic: Exchange Rate Regimes Skil: Recognition 25) A small economy country whose GDP is heavily dependent on trade with the United States could use a(an) exchange rate regime to minimize the risk to their economy that could arise due to unfavorable changes in the exchange rate. A) pegged exchange rate with the United States B) pegged exchange rate with the Euro ©) independent floating 1D) managed float Answer: A “Topic: Exchange Rate Regimes Skil: Conceptual26) The United States currently uses a A) crawling peg B) pegged ©) floating D) fixed Answer: C Topic: Exchange Rate Regimes Sl: Recngition exchange rate regime. 27) Based on the premise that, other things equal, countries would prefer a fixed exchange rate: Variable rates provide stability in international prices for the conduct of trade. Answer: FALSE ‘Topi: Exchange Rate Regimes Skil: Conceptual 28) Based on the premise that, other things equal, countries would prefer a fixed exchange rate, which of the following statements is NOT true? A) Fixed rates provide stability in international prices for the conduct of trade. B) Fixed exchange rate regimes necessitate that central banks maintain large quantities of international reserves for use in the occasional defense of the fixed rate. ) Fixed rates are inherently inflationary in that they require the country to follow loose monetary and fiscal policies, D) Stable prices aid in the growth of international trade and lessen exchange rate risks for businesses. Answer: C Topic: Exchange Rate Regimes Skil: Recognition 29) Which of the following is not an attribute of the “ideal” currency? A) monetary independence B) full financial integration ©) exchange rate stability D) Alll are attributes of an ideal currency. Answer: D “pic: Exchange Rate Regimes Skil: Conceptual 30) If exchange rates were fixed, investors and traders would be relatively certain about the current and near future exchange value of each currency. Answer: TRUE Topic: Exchange Rate Regimes Skill: Conceptual31) The authors discuss the concept of the “Impossible Trinity” or the inability to achieve simultaneously the goals of exchange rate stability, full financial integration, and monetary independence. If a country chooses to have a pure float exchange rate regime, which two of the three goals is a country most able to achieve? ‘A) monetary independence and exchange rate stability B) exchange rate stability and full financial integration © full financial integration and monetary independence D) A country cannot attain any of the exchange rate goals with a pure float exchange rate regime. Answer: C Topic: Currency Regimes Skil: Conceptual 32) The attempt by many countries to stimulate their domestic economies and to gain access to global financial markets, is causing more and more countries to choose a or exchange rate regime. ‘A) floating; monetary union B) monetary union; full capital controls ©) full capital controls; floating, D) pegged: fixed Answer: A Topic: Currency Regimes Shll: Recognition 33) Beginning in 1991 Argentina conducted its monetary policy through a currency board. In January 2002, Argentina abandoned the currency board and allowed its currency to float against other currencies. The country took this step because ‘A) the Argentine Peso had grown too strong against major trading powers thus the currency board policies were hurting the domestic economy. B) the United States required the action as a prerequisite to finalizing a free trade zone with all of North, South, and Central America, ) the Argentine government lost the ability to maintain the pegged relationship asin fact investors and traders perceived a lack of equality between the Argentine Peso and the US. dollar, D) all of the above. Answer: C ‘opi: Currency Regimes Skil: Recognition 34) In January 2002, the Argentine Peso was officially valued ata rate of Peso 40/USD. More recently the exchange rate is Peso 3.10/USD, thus, the Argentine Peso against the US. dollar. A) strengthened B) weakened ©) remained neutral D) all of the above Answer: B ‘pi: Currency Regimes Skil: Analytical35) On September 9, 2000 Ecuador officially replaced its national currency, the Ecuadorian sucre, with the US. dollar. This practice is known as. A) bi-currencyism B) sucrerization ©) Yankee bailout D) dollarization Answer: D Topic: Currency Regimes Skil: Conceptual 36) You have been hired as a consultant to the central bank for a country that has for many years suffered from repeated currency crises and depends heavily on the U‘S. financial and, product markets. Which of the following policies would have the greatest effectiveness for reducing currency volatility of the client country with the United States? A) dollarization B) an exchange rate pegged to the U.S. dollar ©) an exchange rate with a fixed price per ounce of gold D) an internationally floating exchange rate Answer: A “pic: Currency Regimes Skil: Conceptual 37) A bank holiday A) occurs every day after 3:00 p.m. B) isa term used when a country's central government freezes (temporarily) all deposits in commercial banks. ©) is observed in Europe every fourth Friday. D) occurs the last three working days ofthe year to prepare financial statements for tax purposes. Answer: B Topic: Bank Hokiday Shill: Recognition 38) Which of the following is NOT an argument against dollarization? A) The dollarized country’s central bank can no longer act as a lender of last resort. B) The dollarized country can no longer profit from seignorage (the ability to profit from the creation of money within its economy) ©) The dollarized country losses sovereignty over its own monetary policy. 1D) All of the above are arguments against dollarization from the viewpoint of the affected country. Answer: D Topic: Currency Regimes Skil: Conceptual 39) The Euro currency is fixed against other currencies on the intemational currency exchange ‘markets, but allows member country currencies to float against each other. Answer: FALSE Topic: The Euro Sill: Recognition40) Even though the Euro currency has been designed and printed, itis still not available for «general use by the public, except for tourists, in the European Union, Answer: FALSE Topic: The Euro Skil: Recognition 41) Which of the following is NOT a required convergence criteria to become a full member of the European Economic and Monetary Union (EMU)? A) National birthrates must be at 2.0 or lower per person. B) The fiscal deficit should be no more than 3% of GDP. C) Nominal inflation should be no more than 1.5% above the average inflation rate for the three members with the lowest inflation rates in the previous year. D) Government debt should be no more than 60% of GDP. Answer: A “Topic: The Euro Skil: Recognition 42) Which of the following groups of countries have replaced their individual currencies with the Euro? ‘A) France, Germany, and the United Kingdom. B) Sweden, Denmark, and Greece C) The United Kingdom, The Netherlands, and Austria D) Germany, The Netherlands, and Italy Answer: D Topic: The Euro Skill Recognition 43) The tremendous international mobility of financial capital is forcing emerging market, nations to adopt one of two polarized choices, free float or currency board, for their foreign currency exchange regimes. Which of the following would NOT be a reason for an emerging, nation to choose to have their currency freely float? A) The country desires to lose political influence on the valuation of their currency. B) The emerging nation desires an independent monetary policy. ) The emerging nation is willing to tradeoff exchange rate stability to gain free movement of capital. D) All ofthe above. Answer: A Topic: Emerging Merkets Skil: Conceptual 44) According to the authors, what is the single most important mandate of the European Central Bank? A) Promote international trade for countries within the European Union. B) Price, in euros, all products for sale in the European Union, ) Promote price stability within the European Union. D) Establish an EMU trade surplus with the United States. Answer: C ‘Topic: The Euro Skill: Conceptual45) Ignoring transaction costs and based solely on the change in currency exchange rates, a speculator who sold short a two-year contract for the euro (receiving dollars) in January 2006 would have realized a profit upon the exercise of the contract in January 2008. ‘Answer: FALSE ‘Topic: The Euro Skil: Analytical 46) Which of the following is a way in which the euro affects markets? A) Countries within the Euro zone enjoy cheaper transaction costs, B) Currency risks and costs related to exchange rate uncertainty are reduced. © Consumers and business enjoy price transparency and increased price-based competition. D) Allof the above. Answer: D ‘apie: The Euro Skil: Conceptual 47) A special Drawing Right isa unit of account established by A) the Federal Reserve Bank. B) the World Bank. ©) the International Monetary Fund. D) the European Central Bank. Answer: C Topic: International Monetary Fund Skil: Recognition 48) A currency is considered hard if A) itis expected to be revalued or appreciate. B) itis expected to be devalued or depreciate. ) it is backed in part by a precious metal such as gold D) itis difficul to trade on the international currency exchange markets, Answer: A Topic: Currency Terminology Skil: Recognition 49) Under a fixed exchange rate regime, the government of the country is officially responsible for A) intervention in the foreign exchange markets using gold and reserves. B) setting the fixed/parity exchange rate. C) maintaining the fixed/parity exchange rate. D) all of the above. Answer: D “Topic: Currency Regimes Skill: Recognition 1050) are domestic currencies of one country on deposit in a second country. ‘A) LIBORs: B) Eurocurrencies C) Global Federal Funds D) FOREX Funds Answer: B Topic: Eurocurrency Market Skill: Recognition 51) Which of the following is NOT an example of a Eurocurrency deposit? A) British pounds deposited outside of the United Kingdom B) Japanese yen deposited outside of Japan ©) US. dollars deposited outside of the United States D) All of the above could be considered Furocurrency deposits, Answer: D ‘Topic: Eurocurrency Market Skil: Recognition 52) Which of the following would NOT be a valuable Eurocurrency market transaction? A) Ford Motor Company holds temporary excess dollars in a London bank. B) Dell Computer borrows dollars from a German bank to fund accounts receivable. ) Volkswagen borrows Euros in France to finance working capital 1D) A Russian oil firm deposits dollars in Moscow Narodny Bank in London. Answer: C Topic: Eurocurrency Market Skill: Conceptual 153) Generally, Eurocurrency loans are based on the London Interbank Offered Rate (LIBOR) and have a lower offering rate because A) Eurocurrency markets are a wholesale market. B) transaction sizes are for very large amounts of money. ) market participants have very good credit ratings. D) all of the above. Answer: D Topic: Eurocurrency Market Skil: Conceptual 54) Eurocurrency markets are subject to more stringent reserve requirements than those imposed on US. banks by the Federal Reserve. Answer: FALSE Topic: Eurocurrency Market Skill: Conceptual u55) For at least two years from early 2006 to early 2008, the euro maintained a strong and steady rise in value against the U.S. dollar (USD). Which of the following were NOT a contributing, factor in the assent of the euro and the decline in the dollar? A) severe US. balance of payments deficits B) a general weakening of the dollar after the attacks of September 11, 2001 ©) large U.S. balance of payment surpluses D) All of the above were contributing factors Answer: C Topic: Dollar Depreciation Skil: Conceptual 56) In London an investor can buy a US. dollar for £0.5956. In New York the £/$ exchange rate is the same as found in London. Given this information, what is the $/£ exchange rate in New York? A) $1.8671/6 B) £0.5356/5 ©) £1. 8671/5 D) $0.5356/€ Answer: A Topic: Exchange Rates Skill: Analytical 57) What was the annualized forward premium on the pound if the spot rate on January 20, 2005 was £0.5156$ and the 180 day forward rate was £.5000/S? A) 6.24% B) 3.12% ©) 1.56% D) 6.05% Answer: A “Topic: Forward Premium Skil: Analytical3.2. Essay Questions 1) The mobility of international capital flows is causing emerging market nations to choose between a free-floating currency exchange regime and a currency board (or taken to the limit, dollarization). Describe how each of the regimes would work and identify at least two likely economic results for each regime. Answer: With free float the exchange rate is market determined and beyond the control of the country’s central bank or government. The economic results are likely to be an independent monetary policy, free movement of capital, but less stability in the exchange rate, Such instability may be more than an emerging market country’s small financial market can bear. A currency board on the other hand is an implied legislative commitment to fix the foreign exchange rate with a specific currency, «generally the country's major trading partner. Dollarization is taking this policy to the extreme whereby the emerging market nation forgoes its currency for that of its major trading partner. An example of Dollarization is Panama using U.S. dollars as the official Panamanian currency. With such a regime, independent monetary policy is lost and political influence on monetary policy is eliminated. Further, the benefits accruing to countries as a result ofthe ability to print its own money, seignorage, is lost, 2) On January 4, 1999 the member nations of the EMU introduced a new unified currency, the euro, to replace the individual national currencies of many member nations. Identify and explain several of the arguments made both for and against the euro, Do you think the euro has proven to be a "good" idea? Why/Why not? Answer: Arguments for the euro include a stable currency for trading among the several ‘member nations and eliminating the need to exchange currencies to make «cross-border transactions among member nations thus increasing transactional efficiency and eliminating exchange rate risk. Other advantages include unification of the several European markets, transparency of prices in the member countries, and a larger market to compete against the United States, Arguments against the euro include a loss of national heritage and pride in losing a long-held domestic currency. Governments lose exclusive control over seignorage, lack of national autonomy in fiscal and monetary policy, and inequality among member states in their production and financial market strengths and. weaknesses, Member nations are forced to go along with the group even if a particular action does not maximize value to the individual countries. As for whether the euro has been good or bad, this is an opinion piece for each student.3) Most Western nations were on the gold standard for currency exchange rates from 1876 until 1914, Today we have several different exchange rate regimes in use, but most larger economy nations have freely floating exchange rates today and are not obligated to convert their currency into a predetermined amount of gold on demand. Occasionally several parties still call for the "good old days” and a retum to the gold standard. Develop an argument as to why this is a good idea. Answer: The gold standard forces a nation to maintain sufficient reserves of gold to back its currency's value. This helps control inflation, as a country cannot print additional money without sufficient gold to back it up. The gold standard eases international transactions as there is little uncertainly about exchange rates for trade with foreign countries. A stable currency could also act as a deterrant to the large trade deficits developed by some countries such as the United States. 4Fundamentals of Multinational Finance, 3e (Moffett) Chapter 4 The Balance of Payments 4.1. Multiple Choice and True/False Questions 1) The balance of payments as applied to a course in international finance may be defined as ‘A) the amount still owed by an exporting firm after making an initial down payment, B) the amount still owed by governments to the International Monetary Fund. ) the measurement of all international economic transactions between the residents of a country and foreign residents. D) the amount of a country’s merchandise trade deficit or surplus. Answer: C Topic: BOP Intraducton Skil: Conceptual 2) Balance of payment (BOP) data may be important for any of the following reasons: A) BOP data helps to forecast a country's market potential, especially in the short run. B) The BOP is an important indicator of a country’s foreign exchange rate. C) Changes in a country's BOP may signal a change in controls over payment of dividends and interest. D) All of the above. Answer: D Topic: BOP Introduction Skill: Conceptual 3) A country experiencing a serious BOP otherwise. A) surplus; contract B) deficit; contract ©) deficit; expand D) none of the above Answer: A Topic: BOP Understanding Skil: Analytical is more likely to exports than 4) Which of the following would NOT be considered a typical BOP transaction? A) Toyota U.S.A. is a U.S. distributor of automobiles manufactured in Japan by its parent company, B) The US. subsidiary of European financial giant, Credit Suisse, pays dividends to its, parent in Zurich. ©) AUS. tourist purchases gifts at a museum in London. D) Alll are example of BOP transactions. Answer: D Topic: BOP Understanding Skil: Conceptual 5) The authors identify a tip for understanding BOP accounting. They recommend that you “follow the cash flow." Answer: TRUE Topic: BOP Introduction Skil: Recognition6) The BOP must be in balance but the current account need not be. Answer: TRUE Topic: Current Account Skil: Recognition 7) Which of the following is NOT a part of the Current! Account of BOP? 'A) net export/import of goods B) Balance of Trade ©) net portfolio investment 1D) net exportlimport of services Answer: C Topic: Current Account Skil: Recognition 8) Which of the following is NOT part of the Financial Account of the BOP? A) net foreign direct investment. B) net import/export of services C) net portfolio investment D) other Financial items Answer: B Topic: Financial Account Skill: Recognition 9) Expenditures by U.S. tourists in foreign countries for foreign goods or services are factored into BOP calculations. Answer: TRUE Topic: BOP Understonding Skill: Recognition 10) Which of the following is NOT an item to be considered in BOP calculations? A) A foreign resident purchases a US. Treasury Bill. B) A US-based firm manages the development of an oil field in Kazakhstan, ©) A consumer buys a VCR made in Korea from a Wal-Mart store, D) AUS citizen living in Minnesota travels to Winnipeg, Canada and buys a case of LaBatt’s Canadian beer. Answer: C Topic: BOP Understending Skill: Conceptual 1) The batorce of payments is most like a(an) AA) cash flow statement B) balance sheet © income statement D) proxy statement Answer: A “Topic: Balance of payments Shll: Recognition12) The balance of payments A) determines the eligibility of countries for IMF aid, B) adds up the value of all assets and liabilities of a country on a specific date. ) records all international transactions for a country over a period of time. D) all of the above. Answer: C Topic: Balance of payments Skil: Recognition 13) According to the authors, the following types of transactions dominate the balance of payments: A) the exchange of guns for butter. B) the exchange of stocks and bonds. ©) the exchange of goods and services. D) the exchange of real and financial assets. Answer: D Topic: Balance of payments Skil: Conceptual 14) Which of the following is NOT an example of an exchange of financial assets? A) the exchange of travel services B) the exchange of stocks ) the exchange of bonds D) loans, Answer: A Topic: Current Account Skill: Conceptual 15) Because current and financial/capital account balances use double-entry book keeping it is ‘unusual to find serious discrepancies in the debits and credits. ‘Answer: FALSE ‘Topic: Balance of payments Shall: Recognition 16) Which of the following is NOT part of the balance of payments account? A) the current account B) the financial/capital account ) the official reserves account D) All of the above are BOP accounts, Answer: D Topic: Balance of payments Skill: Recognition17) The includes all international economic transactions with income or payment flows occurring within the year. A) capital account B) current account ©) financial account D) IMF account Answer: B Topi: Current Account Skil: Recognition 18) If your company were to import and export textiles, the transactions would be recorded in the current account subcategory of A) services trade B) income trade ©) goods trade D) current transfers Answer: C Topic: Current Account Ski: Conceptual 19) The travel services provided to international travelers by United Airlines would be recorded in the current account subcategory of A) services trade B) income trade ©) goods trade D) current transfers Answer: A Topic: Current Account Skill: Conceptual 20) Anaconda Copper Inc. created a subsidiary in Chile last year to mine copper ore. The proportion of net income paid back to the parent company as a dividend would be recorded in the current account subcategory of A) services trade B) income trade ©) goods trade D) current transfers Answer: B Topic: Current Account Skil: Conceptual 21) The subcategory that typically dominates the current account is A) goods (merchandise) trade B) services trade ©) income trade D) transfer accounts Answer: A Topic: Current Account Skill Recognition22) Over the last several years, the United States has run a in the goods trade balance anda in the services trade balance, A) surplus; deficit B) surplus; surplus ©) deficit; deficit D) deficit; surplus Answer: D Topic: Current Account Skil: Conceptual 23) In general, the United States goods trade balance has grown increasingly positive over the last Answer: FALSE Topic: Current Account Skil: Recognition 24) In 2001 the United States posted a current account deficit of -$393 billion. The bulk of the negative value came from A) anet transfer deficit. B) an income balance deficit. C) a goods trade deficit. D) an income trade deficit. Answer: C Topic: Current Account Skill: Recognition 25) In general, as a country's income increases, 50 does the demand for imports. Answer: TRUE Topic: Economic Theory Skill: Conceptual 26) In general, a country’s exports decrease as foreign income decreases, Answer: TRUE Topic: Economic Theory Skill: Conceptual 27) Over the last two decades the surplus on USS. services trade has typically been the deficit on US. goods trade. A) greater than B) equal to ) less than. D) The relationship is constantly shifting from greater than to less than. Answer: C ‘Topic: Balance of Trade Skill Recognition28) The of the balance of payments measures all international economic transactions of financial assets. A) current account B) merchandise trade account ) services account D) capital/financial account Answer: D opie: Capital/Financil Account Skil: Recognition 28) The financial account consists COMPLETELY of which three components? A) stock investment, bond investment, and mutual fund investment B) direct investment, stock investment, and bond investment ©) direct investment, portfolio investment, and other asset investment D) mutual fund investment, portfolio investment, and stock investment Answer: C Topic: Capta/Financal Account Still: Recognition 30) When categorizing investments for the financial account component of the balance of payments the. is an investment where the investor has no control whereas the isan investment where the investor has control over the asset. A) direct investment; portfolio investment B) direct investment; indirect investment © portfolio investment; indirect investment D) portfolio investment; direct investment Answer: D ‘Topic: Capital Financial Account Skil: Recognition 31) Which of the following would NOT be considered a direct investment either into or from the United States? A) the purchase of U.S. Treasury (debt) securities B) Ford Motor Company building, an assembly plant in Mexico ) Honda of Japan building a manufacturing plant in Alabama D) intel purchasing a chip manufacturing plant in Thailand Answer: A ‘opi: Coptal/Financial Account Skil: Conceptual 32) International debt security purchases and sales are defined as portfolio investments for financial account purposes because by definition debt securities do not provide the buyer with ownership or control. Answer: TRUE ‘Topi: Copital/Financial Account Skil: Recognition33) In general there is consensus that should be free but there is no such consensus that should be free. ‘A) international investment; international goods tracle B) international investment; international trade ) international trade; international goods trade D) international trade; international investment Answer: D “opie: lnternational Investment Skil: Conceptual 34) The two major concerns about foreign direct investment are A) national defense and taxes. B) who controls the assets and who receives the profits. ©) who receives the profits and taxes. D) who pays the taxes and who receives the taxes. Answer: B Topic: International Investment Skill: Conceptual 35) Portfolio investment is capital invested in activities that are rather than made for |A) short term; the long term. B) long term; profit C) profit motivated; control D) control motivated; profit, Answer: C Topic: CapitallFinancial Account Skil: Recognition 36) Most U.S, debt purchased by foreigners is denominated in__ and most foreign debt issued by countries such as Russia, Mexico, and Brazil is issued in A) US. dollars; the purchasing investor's domestic currency B) the purchasing investor's domestic currency; the issuing country’s domestic currency ©) USS, dollars; the issuing country's domestic currency D) US. dollars; US. dollars Answer: D ‘pi: Copital/Financial Account Shall: Recognition 37) Significant amounts of United States Treasury issues are purchased by foreign investors, therefore the U.S. must earn foreign currency to repay this debt, Answer: FALSE “Topic: Capital Financial Account Skil: Conceptual38) The role of official reserves is under a exchange rate regime. A) enhanced; floating B) diminished; fixed ©) enhanced; fixed D) None of the above apply. Answer: C opie: Capital/Financial Account Skil: Conceptual 39) If most major economies are operating under a regime of fixed exchange rates, then a in a country’s balance of payments suggests that the country should its currency. A) surplus; revalue B) surplus; devalue © deficit; revalue D)all of the above Answer: A Topic: Captal/ Financial Account Skil: Conceptual 40) Under an international regime of fixed exchange rates, countries with a BOP should consider their currency while countries with a BOP should consider their currency. A) deficit; revaluing; surplus; revaluing B) deficit; devaluing; surplus; devaluing © surplus; devaluing; deficit; revaluing D) surplus; revaluing; deficit; devaluing Answer: D Topic: Copital/Financial Account Skil: Conceptual 41) The era between 1880 and 1914, when the gold standard was in use, was characterized by increasing capital mobility. Answer: TRUE “Topic: Capital Mobility Skil: Recognition 42) The time from 1971 to today has predominately used a regime of variable exchange rates. It has also seen a decrease in capital mobility. Answer: FALSE Topic: Capital Mobility Skill: Recognition43) Which of the following is the best definition of money laundering? A) legal transfer of funds through the usual international payments mechanisms B) the transfer of cash into collectibles that are then transferred across borders ©) the cross-border purchase of assets that are then managed in a way that hide the movement of money and its ownership D) false invoicing of international trade transactions Answer: C Topic: Capital Mobility Skil: Recognition 44) The s the difference between merchandise imports and exports and a measure of a country’s international trade in goods and services. ‘A) balance of payments B) current account ©) capital account D) balance of trade Answer: D Topic: Balance of Trade Skill: Recognition 45) The United States experienced a balance of trade ‘uring the 1980s andl a balance of trade during the 1990s. A) surplus; surplus B) surplus; deficit ©) deficit; deficit D) deficit; surplus Answer: C Topic: Balance of Trade Skil: Recognition 46) The largest single component of the United States current account is. A) current transfers B) income payments and receipts ©) goods (merchandise) imports and exports D) services imports and exports Answer: C ‘Topic: Current Account Shall: Recognition 47) An excess of merchandise exports over merchandise imports results in a balance of trade deficit, Answer: FALSE Topic: Balance of Trade Skill: Conceptual 48) Portfolio investments are transactions that involve long-term financial assets and affect the transfer of control. Answer: FALSE Topic: Capital/Financial Account Skil: Recognition49) Which of the following does NOT represent a possible mechanism by which capital can be ‘moved from country to country? A) transfers via the usual international payments mechanism such as regular bank transfers B) transfers via a physical bearer such as smuggling ©) the transfer of cash into collectibles D) All of the above are mechanisms for moving capital from country to country. Answer: D Topic: Capital Mobility Skil: Recognition 50) Which of the following statements about the balance of payments is not true? A) The BOP is the summary statement of all international transactions between one country and all other countries. B) The BOP is a flow statement, summarizing all international transactions that occur across the geographic borders over a period of time, typically a year. ©) Although the BOP must always balance in theory, in practice there are substantial imbalances as a result of statistical errors and misreporting of current account and financial account flows. D) All of the above are true. Answer: D Topic: Balance of payments Shll: Recognition 51) Which of the following is not a component of the financial accounts? A) direct investment abroad B) direct investment domes ©) goods imports D) portfolio investment Answer: C Topi: BOP Sl: Recognition 52) The BOP should always balance. Answer: TRUE Topic: BOP Skill: Recognition 53) san entry in the balance of payments measuring the difference between the ‘monetary value of merchandise exports and merchandise imports. A) Balance of payments B) Balance of trade ©) Import-export spread 1D) None of the above Answer: B Topic: BOT Shill: Recognition 1054) The beauty of the J-curve adjustment path for trade balance adjustments is that the process is very quick, typically taking only a month or so to complete. Answer: FALSE, ‘Topic: BOT Skill: Recognition 55) The J-curve adjustment path for trade balance adjustments assumes that export products are predominantly priced in the currency and that import products are predominantly priced in the curreney. A) domestic; domestic B) domestic; foreign ©) foreign; foreign D) foreign: domestic Answer: B Topic: BOT Sill: Recognition 56) The J-curve adjustment path for trade balance adjustments assumes that products are predominantly priced in the domestic currency and that products are predominantly priced in the foreign currency A) import; import B) import; export C) export; export D) export; import Answer: D Topic: BOT Skil: Recognition 57) Assume that a country is experiencing a balance of trade deficit and then suffers a rapid depreciation of i's currency. J-curve theory suggests that the trade balance will adjust in three distinct periods in the following order: ‘A) quantity adjustment period; pass-through period; currency contract period B) pass-through period; currency contract period; quantity adjustment period ©) currency contract period; pass-through period; quantity adjustment period. D) pass-through period; quantity adjustment period; currency contract period Answer: C Topic: BOT Skil: Conceptual '58) The immediate impact on the balance of trade (BOT) for a country in deficit when there is an immediate devaluation of it's currency is likely to be an even larger BOT deficit than prior to devaluation. Answer: TRUE ‘Topic: BOT Skil: Recognition u59) Itis possible that the J-curve path for BOT adjustments may be be elongated or even inapplicable if exports are NOT predominately priced in the domestic currency and/or imports are NOT predominately priced in the foreign currency. Answer: TRUE Topic: BOT Skil: Conceptual 60) The United States, as of May 2007, had the largest official foreign exchange reserves of any nation, Answer: FALSE, Topic: BOT Skill: Recognition 61) China, as of May 2007, had the largest official foreign exchange reserves of any nation. Answer: TRUE Topic: BOT Skil: Recognition 4.2 Essay Questions 1) What is a country’s balance of (merchandise) trade and why is it so widely reported in the financial and popular press? Answer: The balance of trade (BOT) is the largest and most important subset of a country's current account, It measures the difference in a country’s imports and exports over a specified time period, Its often reported because itis intuitively easy to understand (ie, we either sell more or buy more from foreign countries) and itis a reasonable representation of the total current account balance. (For example, for the U.S. the BOT was -$779B in 2005 while the current account balance was -$792B. 2) What is the Official Reserves Account (ORA) and why is it more important for countries under a fixed exchange rate regime than for ones under a floating exchange rate regime? Answer: The ORA is the total reserves held by official monetary authorities within the country. Under a fixed exchange regime a country’s currency is convertible into a fixed amount of another country's currency. To keep the relationship between currencies at equilibrium, it may become necessary for the government to buy or sell official reserves until the equilibrium is restored. Under a variable rate regime this is not necessary as exchange rates are allowed to change and official reserves no longer serve the same purpose as under the fixed rate regime.Fundamentals of Multinational Finance, 3e (Moffett) Chapter 5 The Foreign Exchange Market 5.1 Multiple Choice and True/False Questions 1) Which of the following is NOT true regarding the market for foreign exchange? A) The market provides the physical and institutional structure through which the money of one country is exchanged for another. B) The rate of exchange is determined in the market. ©) Foreign exchange transactions are physically completed in the foreign exchange market. D) Alllof the above are true. Answer: D “Topic: Introduction to the Foreign Exchange Market Skill: Recognition 2) A/An is an agreement between a buyer and seller that a fixed amount of one curreney will be delivered at a specified rate for some other currency. A) Eurodollar transaction B) import/export exchange ) foreign exchange transaction 1D) interbank market transaction Answer: C opie: Intraduction to the Foreign Exchange Market Sill: Recognition 3) While trading in foreign exchange takes place worldwide, the major currency trading centers are located in A) London, New York, and Tokyo. B) New York, Zurich, and Bahrain, ©) Paris, Frankfurt, and London, D) Los Angeles, New York, and London. Answer: A Topic: Introduction tothe Foreign Exchange Market Shall: Recognition 4) Because the market for foreign exchange is worldwide, the volume of foreign exchange currency transactions is level throughout the 24-hour day. Answer: FALSE ‘Topic: introduction to the Foreign Exchange Market Skil: Recognition 5) Which of the following is NOT a motivation identified by the authors as a function of the foreign exchange market? A) The transfer of purchasing power between countries, B) Obtaining or providing credit for international trade transactions. C) Minimizing the risks of exchange rate changes, D) All of the above were identified as functions of the foreign exchange market. Answer: D Topic: Foreign Exchange Market Functions Skill: Recognition6) The authors identify two tiers of foreign exchange markets: ‘A) bank and nonbank foreign exchange. B) commercial and investment transactions. ) interbank and client markets. D) client and retail market. Answer: C Topic: Foreign Exchange Market Tiers Skil: Recngnition 7) The foreign exchange market is NOT efficient because A) market participants do not compete with one another due to the fact that exchange takes place around the world and not in a single centralized location. B) dealers have ask prices that are higher than bid prices. ©) central governments dominate the foreign exchange market and everybody knows that by definition, central governments are inefficient D) none of the reasons listed are accurate because the foreign exchange market is efficient. Answer: D Topic: Foreign Exchange Market Efficiency Skil: Conceptual 8) Dealers in foreign exchange departments at large international banks act as market makers and maintain inventories of the securities in which they specialize. Answer: TRUE ‘Topic: Foreign Exchange Market Dealers and Brokers Skill: Recognition 9) Currency trading lacks profitability for large commercial and investment banks but is maintained as a service for corporate and institutional customers. Answer: FALSE “Topic: Foreign Exchange Market Proftebilty Skil: Recognition 10) It is characteristic of foreign exchange dealers to A) bring buyers and sellers of currencies together but never to buy and hold an inventory of currency for resale. B) act as market makers, willing to buy and sell the currencies in which they specialize. ©) trade only with clients in the retail market and never operate in the wholesale market for foreign exchange. D) All of the above are characteristics of foreign exchange dealers, Answer: B Topic: Foreign Exchange Market Dealers Skil: Recognition 11) Which of the following may be participants in the foreign exchange markets? ‘A) bank and nonbank foreign exchange dealers B) central banks and treasuries ) speculators and arbitragers D) Alll ofthe above. Answer: D ‘Topic: Foreign Exchange (FX) Market Participants Skil: Recognition2) seek to profit from trading in the market itself rather than having the foreign exchange transaction being incidental to the execution of a commercial or investment transaction, A) Speculators and arbitragers B) Foreign exchange brokers ©) Central banks D) Treasuries Answer: A Topic: Foreign Exchange (EX) Market Participants Skill: Recognition 1) In the foreign exchange market, seek all of their profit from exchange rate changes while seek to profit from simultaneous exchange rate differences in different markets. A) wholesalers; retailers B) central banks; treasuries ) speculators; arbitragers D) dealers; brokers Answer: C “Topic: Foreign Exchange (FX) Market Participants Skil: Recognition 14) Foreign exchange earn a profit by a bid-ask spread on currencies they purchase and sell. Foreign exchange on the other hand, earn a profit by bringing together buyers and sellers of foreign currencies and earning a commission on each sale and purchase. A) central banks; treasuries B) dealers; brokers ©) brokers; dealers D) speculators; arbitragers Answer: B opie: Foreign Exchange (FX) Market Participants Shll: Recognition 15) The primary motive of foreign exchange activities by most central banks is profit. Answer: FALSE “Topic: Foreign Exchange (FX) Market Participants Skill: Recognition 16) Dealers sometimes use brokers in the foreign exchange market because the dealers desire A) speed. B) accuracy. ©) to remain anonymous. D)all of the above. Answer: D Topic: Foreign Exchange (EX) Market Participants Skil: Recognition17) Daily trading volume in the foreign exchange market was about per in 2007. A) $3,200 billion; month B) $1,000 billion; month ) $3,200 billion; day D) $1,000 billion; day Answer: C Topic: FX Trading Volume Skil: Recognition 18) Daily trading volume of foreign exchange had actually decreased in 2004 from the levels reported in 2001 Answer: FALSE Topic: FX Trading Volume Skil: Recognition 19) are NOT one of the three categories reported for foreign exchange. A) Spot transactions. B) Swap transactions ) Strip transactions D) Futures transactions Answer: C Topic: FX Trading Volume Skil: Recognition 20) Foreign exchange swaps were larger in 1998 than in 2001. The Bank for International Settlements attributes this to A) the introduction of the euro. B) growing electronic brokering in the spot interbank market. ©) consolidation in general D) all of the above. Answer: D Topic: EX Trading Volume Skil: Recognition 21) The greatest amount of foreign exchange trading takes place in the following three cities: A) New York, London, and Tokyo. B) New York, Singapore, and Zurich ©) London, Frankfurt, and Paris, D) London, Tokyo, and Zurich. Answer: A Topie: Foreign Exchange Market Locations Shill: Recognition22) The four currencies that constitute about 80% of all foreign exchange trading are A) UK pound, Chinese yuan, euro, and Japanese yen. B) U.S. dollar, euro, Chinese yuan, and U.K, pound. ©) US. dollar, Japanese yen, euro, and U.K. pound. D) US. dollar, UK. pound, yen, and Chinese yuan, Answer: C Topic: Foreign Exchange Market Currencies Skil: Recognition 23) A transaction in the foreign exchange market requires an almost immediate delivery of foreign exchange. A) spot B) forward ©) futures D) none of the above Answer: A ‘pc: Foreign Exchange Market Transactions Skil: Recognition 24) A transaction in the foreign exchange market requites delivery of foreign exchange at some future date, A) spot 8) forward ©) swap D) currency Answer: B Topic: Foreign Exchange Market Transactions Sl: Recognition 25) A spot transaction in the interbank market for foreign exchange would typically involve a ‘two-day delay in the actual delivery of the currencies, while such a transaction between a bank and its commercial customer would not necessarily involve a two-day wait. Answer: TRUE Topic: Foreign Exchange Market Spot Transactions Skil: Recognition 26) A forward contract to deliver British pounds for U.S. dollars could be described either as ‘A) buying dollars forward; buying pounds forward B) selling pounds forward; selling dollars forward ©) selling pounds forward; buying dollars forward D) selling dollars forward; buying pounds forward Answer: C ‘Topic: Foreign Exchange Market Foroard Transactions Skil: Recognition27) A common type of swap transaction in the foreign exchange market is the where the dealer buys the currency in the spot market and sells the same amount back to the same bank in the forward mark A) "forward against spot” B) "forspot” ©) "repurchase agreement” D) "spot against forward Answer: D Topic: Foreign Exchange Market Stops Skil: Recognition 28) Swap and forward transactions account for an insignificant portion of the foreign exchange market. Answer: FALSE, ‘Topic: Foreign Exchange Market Stoaps Skil: Recognition 29) The sa derivative forward contract that was created in the 1990s. It has the same characteristics and documentation requirements as traditional forward contracts except that they are only settled in US. dollars and the foreign currency involved in the transaction is not delivered. A) nondeliverable forward B) dollar only forward ) virtual forward D) internet forward Answer: A Topic: Foreign Exchange Market Derivatives Skil: Recognition 30) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts? A) NDFs are used primarily for emerging market currencies: B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged for dollar settlement, ©) NDFs can only be traded by central banks, D) All of the above are true. Answer: C ‘Topic: Foreign Exchange Marke! NDEs Skil: Conceptual 31) A foreign exchange isthe price of one currency expressed in terms of another currency. A foreign exchange isa willingness to buy or sell at the announced rate. A) quote; rate B) quote; quote ©) rate; quote D) rate; rate Answer: C ‘Topic: Foreign Exchange Market Rates and Quotes Skil: Recognition32) Most foreign exchange transactions are through the U.S. dollar. Ifthe transaction is expressed as the foreign currency per dollar this known as whereas, are expressed as dollars per foreign unit, ‘A) European terms; indirect B) American terms; direct, ©) American terms; European terms D) European terms; American terms Answer: D Topi: Foreign Exchange Markel Terms Skil: Recognition 33) The following is an example of an American term foreign exchange quote: A) S20/6. B) 0.85 euro/, C) 100¥/euro. D) None of the above. Answer: A Topic: Foreign Exchange Market Terms Skill: Recognition 34) The European and American terms for foreign currency exchange are square roots of one another. “Answer: FALSE, Topic: Foreign Exchange Market Terms Skill: Recognition 35) With several exceptions, most interbank quotes are stated in European terms (meaning, foreign currency unit per USS. dollar), Answer: TRUE “Topic: Foreign Exchange Market Terms Skil: Recognition 36) American and British meanings differ for the word billion. Therefore, when traders refer to an American billion, they call it a/an A) Kiwi B) Loony ©) Unele Sam D) Yard Answer: D Topic: ition Sill: Recognition 37) Major exceptions to using European terms in foreign exchange include A) trading yen and euros. B) pounds and euros. C) Mexican Pesos and euros. D) all of the above. Answer: B Topic: Foreign Exchange Terms Skil: Recognition38) From the viewpoint of a British investor, which of the following would be a direct quote in the foreign exchange market? A) SF2A0/E B) S1.50/¢ ©) £0.53/euro D) $0.90/euro Answer: C Topic: Direct Quote Skil: Recognition 39) A/an_quote in the United States would be foreign units per dollar, while a/an. quote would be in dollars per foreign currency unit, ‘A) direct; direct B) direct; indirect ) indirect; indirect D) indirect; direct, Answer: D Topic: Direct and Indirect Quotes Skill: Recognition 40) If the direct quote for a U.S. investor for British pounds is $1.43/¢, then the indirect quote for the USS. investor would be and the direct quote for the British investor would be A) £0,699 /8; £0,699/5 B) $0.699/¢; £0.699/5 ©) ELAS /E; €0.699/S D) £0.699/8; $1.49/6, Answer: A Topic: Direct Quote Skill: Analytical a) make money on currency exchanges by the difference between the price, or the price they offer to pay, and the price, or the price at which they offer to sell the currency. ‘A) Dealers; ask; bid B) Dealers; bid; ask C) Brokers; ask; bid D) Brokers; bid; ask Answer: B ‘Topic: Dealers Skil: RecognitionTABLE 6.1 Use the table to answer following question(s). Yen: Spotand Forward W/$) _Pound: Spotand Forward $£) MidRates Bid Ask _ Mid Rates Ask Spat rs a sa87 Forward Rates month 129.68 -200 18 14459 26 6 months 12853 0-136-132-1327 -160 Swaps 2year 11765 = 12321212, 1.4250 -238 3year u 14521422 1.42: 265 42) Refer to Table 6.1. The current spot rate of dollars per pound as quoted in a newspaper is or A) £1.4484/5; $0.6904/6 B) $1.4481/€; £0.6906/$ ©) $1.4484/€; £0.6904/$ D) £1.4487/8; $0.6903/6 Answer: C Topic: Spot Rate Calutation Skil: Analytical 43) Refer to Table 6.1. The one-month forward bid price for dollars as denominated in Japanese yen is A) 320 B) 418 Qvi974/8, D) ¥129.62/8 Answer: D Topic: Forward Rate Shall: Analytical 44) Refer to Table 6.1. The ask price for the two-year swap for a British pound is, A) $1.4250/6 B) $1.4257/€ ©) $230 D) $238 Answer: B Topic: Swap Rates Skill: Analytical45) Refer to Table 6.1. According to the information provided in the table, the 6-month yen is, selling at a forward of approximately per annum, (Use the mid rates to make your calculations) A) discount; 2.09% B) discount; 2.06% ©) premium; 2.09% D) premium; 2.06% Answer: C Topi: Forward Premium Calculation Sl: Analytical 46) Refer to Table 6.1. Cross rates ‘A) are often reported in the form of a matrix in the financial newspapers. B) can be used to check on opportunities for intermarket arbitrage. C) for the spot market in the table are *188.10/° (using the mid rates). D) are all of the above. Answer: D Topic: Cross Rates Skill: Recognition 47) Given the following exchange rates, which of the multiple-choice choices represents a potentially profitable intermarket arbitrage opportunity? ¥12987/8 euro 1.1226). euro 0,00864/¥ A) ¥I15.69/eur0 B) ¥114.96/euro ©) $0.8908/eux0 1D) 80.0077 Answer: B opie: Currency Arbitrage Shll: Analytical 48) For arbitrage opportunities to be practical, ‘A) participants must have instant access to quotes. B) participants must have instant access to executions. ©) bank traders must be able to execute the arbitrage trades without an initial sum of money relying on their bank's credit standing, D)all of the above must be true Answer: D Topic: Currency Arbitrage Skill: Conceptual 1049) The US. dollar suddenly changes in value against the euro moving from an exchange rate of $0,8909/euro to $0.08709/euro. Thus, the dollar has by A) appreciated; 2.30% B) depreciated; 230% ©) appreciated; 2.24% D) depreciated; 2.24% Answer: A Topic: Foreign Exchange Shill: Analytical 50) When the cross rate for currencies offered by two banks differs from the exchange rate offered by a third bank, a triangular arbitrage opportunity exists. Answer: TRUE Topic: Triangular Arbitrage Skil: Recognition 51) Most transactions in the interbank foreign exchange trading are primarily conducted via telecommunication techniques and litte is conducted face-to-face. Answer: TRUE “Topic: Interbank Foreign Exchange Skill: Recognition 52) Global daily foreign exchange turnover (combined swaps, spot, and forward transactions) has declined from roughly $1,500 billion in 2001, to $1,200 in 2004, to $1,000 in 2007. Answer: FALSE, Topic: Daily Foreign Exchange Skil: Recognition 53) Given the following pair wise exchange rates, estimate the cross-rate of pounds per euro. SO.8K10/6 $1.2223/euro A) £1.000/eur0 B) £1.5062/eur0 ©) £0.6699/eur0 D) euro 1.5062/€ Answer: C Topic: Cross Rates Skil: Analytical 54) Given the following quotations (where the dollar is the home currency), what is the annualized forward premium (discount) on the U‘S. dollar? Spot rate: $1.305/euro_ 6-month forward rate: $1.335/euro A) premium; 4.4944% B) premium; 4.5977% ©) discount; 4.4944% D) discount; 4.5977% Answer: D Topic: Cross Rates Skil: Analytical u55) The article in the text about an intern's first day on the job as a currency trader relates how ‘what he/she had learned in business school had very little to do with how trading decisions ‘were made on the floor of the exchange. Answer: TRUE ‘Topic: Foreign Exchange Skil: Recognition 56) The Continuous Linked Settlement system (CLS) links with the Real-Time Gross Settlement (RTGS) systems and is expected to eventually result in same-day settlement rather than the current two-day settlement required for foreign exchange spot market transactions. Answer: TRUE “Topic: Foreign Exchange Skill: Recognition 57) Currency trading increased tremendously between 2004 and 2007 with daily trading volume jumping from $1.9 trillion to $3.2 trillion. Which of the following do experts think was a ‘major driving force behind the increased daily volume? A) increased activity by specialized investment groups such as hedge funds B) institutional investors holding more internationally diversified portfolios thus requiring more currency transactions C) increased use of technical computer-based trading D) all of the above Answer: D Topic: Foreign Exchange Skill: Recognition 158) New York City has the greatest volume of foreign exchange activity in the world. Answer: FALSE “Topic: Foreign Exchange Skil: Recognition 5.2. Essay Questions 1) What are some of the reasons central banks and treasuries enter the foreign exchange ‘markets, and in what important ways are they different from other foreign exchange participants? Answer: Central banks and treasuries enter the foreign exchange market to acquire/spend their ‘own foreign exchange reserves and to influence the price at which their own currency is traded. Unlike other market participants, they are not profit oriented. Instead, they may willingly take a loss if they think itis in their best national interest.2) Define spot, forward, and swap transactions in the foreign exchange market and give an example of how each could be used. Answer: Spot transactions are exchanging one currency for another right now. Spot transactions are typically entered into because the parties need to exchange foreign currencies that they have received into their domestic currency, or because they have ‘an obligation that requires them to obtain foreign currency. Forward foreign exchange transactions are agreements entered into today to exchange currencies at a particular price at some point in the future. Forwards may be speculative or a hedge against unexpected changes in the price of the other currency. ‘Swaps are the simultaneous purchase and sale of a given amount ofa foreign exchange for two different dates. Both transactions are conducted with the same ‘counterparty. A swap may be considered a technique for borrowing another currency ‘ona fully collateralized basis,Fundamentals of Multinational Finance, 3e (Moffett) Chapter 6 International Parity Conditions 6.1 Multiple Choice and True/False Questions 1) If an identical product can be sold in two different markets, and no restrictions exist on the sale or transportation costs, the products price should be the same in both markets. This know as A) relative purchasing power parity. B) interest rate parity, ©) the law of one price D) equilibrium. Answer: C Topic: The Law of One Price Skil: Recognition 2 states that the spot exchange rate is determined by the relative prices of similar baskets of goods ‘A) Absolute purchasing power parity B) Relative purchasing power parity C) Interest rate parity D) The Fisher Effect Answer: A Topic: PPP Skil: Recognition 3) The Economist publishes annually the "Big Mac Index” by which they compare the prices of the McDonald's Corporation's Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should! be the same. If Big Mac costs $2.54 in the United States and 294 yen in Japan, what is the estimated exchange rate of yen. per dollar as hypothesized by the Hamburger index? A) 80,0086 B) 1245 ©) $0.0081/¥ 1D) 115.75¥/8 Answer: D Topic: PPP Sill: Analytical 4) Ifthe current exchange rate is 113 Japanese yen per U'S. dollar, the price of a Big Mac hamburger in the United States is $3.41, and the price of a Big Mac hamburger in Japan is 280 yen, then other things equal, the Big Mac hamburger in Japan is A) correctly priced B) under priced ©) over priced D) not enough information to determine if the price is appropriate or not Answer: B Topic: PPP Skil: Analytical5) The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What is the implied PPP of the Peso per dollar? A) Peso 8.50/51 B) Peso 108/81 ) Peso 11.76/81 D) None of the above Answer: A Topic: PPP Shill: Analytica! 6) The implied PPP rate of exchange of Mexican Pesos per US. dollar is 8.50 according to the Big Mac Index. The current exchange rate is Peso 10.8/$1. Thus, according to PPP and the Law of One Price, at the current exchange rate the peso is A) overvalued B) undervalued ) correctly valued D) not enough information to answer this question Answer: B Topic: PPP Skil: Analytical 7) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but the actual exchange rate is peso10.80/$1. Thus, at current exchange rates the peso appears to be by A) overvalued; approximately 21% B) overvalued; approximately 27% ©) undervalued; approximately 21% D) undervalued; approximately 27% Answer: C Topic: PPP Skil: Analytical 8) Ifa market basket of goods cost $100 is the US and 70 euros in France, then the PPP exchange rate would be $.70/euro. Answer: FALSE Topic: PPP Skil: Analytical 9) If according to the law of one price the current exchange rate of dollars per British pound is $1.75/¢, then at an exchange rate of $1.85/E, the dollar is A) overvalued B) undervalued ) correctly valued D) unknown relative valuation Answer: B “Topic: Law of One Price Skill: Analytical10) Generally speaking, the theory of absolute purchasing power parity works better for single ‘goods than for a market basket of goods. Answer: FALSE Topic: PPP Shall: Recognition 11) Other things equal, and assuming efficient markets, if a Honda Accord costs $21,375 in the US. then at an exchange rate of $1.98/¢, the Honda Accord should cost in Great Britain, A) £21,375 B) £18,365 ©) £10,795 1D) £42,322 Answer: C “Topic: Law of One Price Skil: Analytical 12) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP. “Answer: FALSE, Topic: PPP Skill: Conceptual 13) states that differential rates of inflation between two countries tend to be offset, ‘over time by an equal but opposite change in the spot exchange rate. A) The Fisher Effect B) The International Fisher Effect ) Absolute Purchasing Power Parity D) Relative Purchasing Power Parity Answer: D Topic: PPP. Skil: Recognition 14) One year ago the spot rate of US. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U'S. dollars for Canadian dollars should be approximately A) $0.96/C§ B) $1/C$1 ©) $104/C$1 D) relative PPP provides no guide for this type of question Answer: C Topic: PPP Skill: Analytical 15) Empirical tests prove that PPP is an accurate predictor of future exchange rates. Answer: FALSE Topic: PPP Skil: Recognition16) Two general conclusions can be made from the empirical tests of purchasing power parity (rrr): A) PPP holds up well over the short run but poorly for the long run and the theory holds better for countries with relatively low rates of inflation, B) PPP holds up well over the short run but poorly for the long run and the theory holds better for countries with relatively high rates of inflation. ©) PPP holds up well over the long run but poorly for the short run and the theory holds better for countries with relatively low rates of inflation, 1D) PPP holds up well over the long run but poorly for the short run and the theory holds better for countries with relatively high rates of inflation. Answer: D Topic: PPP Skil: Recognition 17) A country's currency that strengthened relative to another country's currency by more than, that justified by the differential in inflation is said to be in terms of PPP. A) overvalued B) over compensating ©) undervalued D) under compensating Answer: A Topic: Currency Valuation Skill: Conceptual 18) Ifa country’s real efective exchange rate index were to be less than 100, this would suggest an. currency, ‘A) overvalued B) over compensating ©) undervalued D) under compensating Answer: C Topic: Real Efective Exchange Rate Shll: Conceptual 19) If we set the real effective exchange rate index between Canada and the United States equal to 100 in 1998, and find that the U.S. dollar has risen to a value of 112.6, then from a competitive perspective the US. dollar is A) overvalued. B) undervalued. €) very competitive. D) There is not enough information to answer this question. Answer: A Topic: Real Effective Exchange Rate Skill: Analytical20) Lf we set the real effective exchange rate index between the United Kingdom and the United States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then from a competitive perspective the U.S. dollar is A) overvalued B) undervalued ©) equally valued D) There is not enough information to answer this question. Answer: B Topic: Real Effective Exchange Rate Skil: Conceptual 21) The government just released international exchange rate statistics and reported that the real effective exchange rate index for the US. dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year. Other things equal US. ___ toffrom Japan think this is good news and U.S. __tofrom Japan think this is bad news. A) importers; exporters B) importers; importers ©) exporters; exporters D) exporters; importers Answer: D Topic: Real Eifectoe Exchange Rate Skil: Conceptual 22) Exchange rate pass-through may be defined as A) the bid/ask spread on currency exchange rate transactions, B) the degree to which the prices of imported and exported goods change as a result of exchange rate changes. ) the PPP of lesser-developed countries. D) the practice by Great Britain of maintaining the relative strength of the currencies of the Commonwealth countries under the current floating exchange rate regime. Answer: B pic: Exchange Rate Pass-through Skil: Recognition 23) Phillips NV produces DVD players and exports them to the United States. Last year the exchange rate was $1.25/euro and Plilips charged 120 euro per player in Euroland and $150 per DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD players? A) 92% B) 33.3% 47% Dj 41% Answer: C api: Exchange Rate Pass-through Skil: Analytical24) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of S2.01/€, Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of §2.15/6, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate? A) £22,803, B) £25,581 ©) £27,363 ) £55,000 Answer: B Topic: Exchange Rate Pass-Hrough Sill: Analytical 25) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $201/E. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of §2.15/E, and Jaguar has not hedged against currency changes, what is the percentage margin the company will realize given the new exchange rate? A) 20.0% B) 15.3% ©) 12.4% D) 7.2% Answer: C Topi: Exchange Rate Pass-irough Skill: Analytical 26) Consider the price elasticity of demand. If a product has price elasticity less than one it is, considered to have relatively elastic demand. Answer: FALSE ‘Topic: Price Elasticity Skil: Conceptual 27) The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the Sony DVD players in the US also rises by 10%, then other things equal, the total dollar sales, revenues of Sony DVDs would A) decline B) increase ©) stay the same D) insufficient information Answer: A Topic: Price Elasticity Skil: Analytical28) states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation, A) Absolute PPP B) Relative PPP ©) The Law of One Price D) The Fisher Effect Answer: D Topic: Fisher Efect Skil: Recognition 29) In its approximate form the Fisher effect may be written as Where: i = the nominal rale of interest, = the real rate of return and 7 = the expected rate of inflation. A)i=()K) B)i=r+n+(r\(m) Qisren Djizre2n Answer: C Topic: Fisher Effect Skil: Recognition 30) The final component of the equation for the Fisher Effect, (e)(7), where r = the real rate of return and 7= the expected rate of inflation, is often dropped from the equation because the number is simply too large for most Western economies. ‘Answer: FALSE Topic: Fisher Effect Skill: Recognition 31) Assume a nominal interest rate on one-year U‘S. Treasury Bills of 4.60% and a real rate of interest of 2.50%, Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the US. over the next year? A) 2.10% B) 2.05% ©) 2.00% D) 1.90% Answer: A “Topic: Fisher Effect Skil: Analytical 32) Assume a nominal interest rate on one-year U'S. Treasury Bills of 3.80% and a real rate of interest of 2.00% Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year? A) 1.84% B) 1.80% ©) 1.76% D) 172% Answer: C Topic: Fisher Eyfect Skil: Analytical33) Empirical studies show that the Fisher Effect works best for short-term securities. Answer: TRUE Topic: Fisher Efect Skil: Conceptual 34) The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known, A) absolute PPP B) the law of one price ©) relative PPP D) the international Fisher Effect Answer: D ‘Topic: lnternationl Fisher Effect Skil: Recognition 35) From the viewpoint of a US. investor or trader, the indirect quote for a currency exchange rate would be quoted! in A) terms of dollars per unit of foreign currency (e.g, 8/6) B) cents ©) 1isths D) terms of foreign currency units per dollar (e.g, £18) Answer: D Topic: bnternationl Fisher Effect Skil: Conceptual 36) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond that has an annual interest rate of 5% rather than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the to ata rate of at least 1% per year over the next 5 years. ‘A) British pound; appreciate B) British pound revalue ©) US. dollar; appreciate D) USS, dollar; depreciate Answer: C “Topic: International Fisher Effect Skil: Analytical 37) states that the spot exchange rate should change in an equal amount but in the ‘opposite direction to the difference in interest rates between two countries, A) Fisher-open B) Fisher-closed ©) The Fisher Effect 1D) None of the above Answer: A opie: International Fisher Eft Shill: Recognition38) A. is an exchange rate quoted today for settlement at some time in the future, A) spot rate B) forward rate C) currency rate D) yield curve Answer: B Topic: Forward Rate Skill: Recognition 39) Assume the current U.S. dollar-British spot rate is 0.6993¢/S. Ifthe current nominal one-year interest rate in the US. is 5% and the comparable rate in Britain is 6%, what is the approximate forward exchange rate for 360 days? A) LES B) 14388 ©) 0.69936) D) 0.706068 Answer: D Topic: Forward Rate Skil: Analytical 40) Assume the current U.S. dollar-yen spot rate is 125¥/$. Further, the current nominal 180-day rate of return in Japan is 3% and 4% in the United States. What is the approximate forward exchange rate for 180 days? A) 123.80¥/5 B) 124.00¥/8 ©) 12439918 D) 124.679/5 Answer: C Topic: Forward Rate Skill: Analytical 41) The current US. dollar-yen spot rate is 125Y/S. I the 90-day forward exchange rate is 127 ¥S then the yen is ata forward premium. Answer: FALSE Topic: Forward Rate Premsam/ Discount Shall: Conceptual 42) The current U.S. dollar-yen spot rate is 125¥/S. Ifthe 90-day forward exchange rate is 127, ¥/S then the yen is selling at a per annum of ‘A) premium 1.57% B) premium; 6.30% ©) discount; 157% D) discount; 6.30% Answer: D Topic: Forward Rate Premium/ Discount Skill: Analysical43) The premium or discount on forward currency exchange rates between any two countries is visually obvious when you plot the interest rates of each country on the same yield curve. ‘The currency of the country with the higher yield curve should be selling at a forward discount. Answer: TRUE ‘Topic: Forward Rate Premium/Discount Skil: Conceptual 4) The theory of states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs. A) international Fisher Effect B) absolute PPP ©) interest rate parity D) the law of one price Answer: C Topic: Interest Rate Parity Skil: Recognition 45) Use interest rate parity to answer this question. A U‘S. investor has a choice between a risk-free one-year U(S, security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/¢, the forward rate is $1.44/6, and there are no transaction costs, the investor should invest in the U.S. security. Answer: FALSE Topic: Interest Rate Parity Skill: Analytical 46) With covered interest arbitrage, A) the market must be out of equilibrium. B) a “riskless" arbitrage opportunity exists ) the arbitrageur trades in both the spot and future currency exchange markets. D)allof the above. Answer: D ‘Topi: Covered Interest Arbitrage Skil: Recognition 47) Covered interest arbitrage moves the market, equilibrium because A) toward; purchasing a currency on the spot market and selling in the forward market narrows the differential between the two. B) toward; investors are now more willing to invest in risky securities. ©) away from; purchasing a currency on the spot market and selling in the forward, market increases the differential between the two. D) away from; demand for the stronger currency forces up interest rates on the weaker security. Answer: A ‘Topic: Covered Interest Arbitrage Skil: Conceptual 1048) Both covered and uncovered interest arbitrage are risky operations in the sense that even. without default in the securities, the returns are unknown until all transactions are complete. Answer: FALSE “pic: Interest Rate Arbitrage Skil: Conceptual 49) Alll that is required for a covered interest arbitrage profit is for interest rate parity to not hold. Answer: TRUE Topic: Covered Interest Arbitrage Skill: Conceptual 50) Jennifer is considering a covered interest arbitrage investment in UK pounds. The current exchange rate is £0.50/5 and the six-month forward rate is £0.49/$. If the annual rate on riskless securities in the US is 3% then Jennifer will make a greater profit via CIA compared to the US investment. Answer: FALSE Topic: Covered Interest Artitrage Skil: Analytical 51) Ifthe forward rate is an unbiased predictor of the expected spot rate, which of the following, is NOT true? A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2 delivery, available now. B) The distribution of possible actual spot rates in the future is centered on the forward rate. ©) The future spot rate will actually be equal to what the forward rate predicts. D) Allof the above are true. Answer: C ‘Topi: Forward Rate Ski: Recognition 52) Which of the following is NOT an assumption of market efficiency? A) Instruments denominated in other currencies are perfect substitutes for one another. B) Transaction costs are low or nonexistent C) All relevant information is quickly reflected in both spot and forward exchange markets, D) All of the above are true. Answer: D Topic: Market Esfciency Skil: Recognition 53) Empirical tests have yielded evidence about market efficiency with a general consensus that developing foreign markets are A) conflicting; not efficient B) conflicting; efficient ©) consistent; inefficient D) None of the above Answer: A Topic: Market Efciency Skil: Recognition u