Multinational Business Finance, 14e (Eiteman)
Chapter 5 The Foreign Exchange Market
5.1 Functions of the Foreign Exchange Market
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.
C) Foreign exchange transactions are physically completed in the foreign exchange market.
D) All of the above are true.
2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one
currency will be delivered at a specified rate for some other currency.
A) Eurodollar transaction
B) import/export exchange
C) foreign exchange transaction
D) interbank market transaction
3) The ________ is the mechanism by which participants transfer purchasing power between
countries, obtain or provide credit for international trade transactions, and minimize exposure to
the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR
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4) 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.
5) Business firms in countries with exchange controls, for example, China (mainland), often
must surrender foreign exchange earned from exports to the central bank at the daily fixing price.
6) The foreign exchange market provides the physical and institutional structure through which
three typical functions are accomplish. List and explain three functions of the foreign exchange
market.
Answer: The foreign exchange market is the mechanism by which participants transfer
purchasing power between countries by exchanging money, obtain or provide credit for
5.2 Market Participants
1) 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.
C) Paris, Frankfurt, and London.
D) Los Angeles, New York, and London.
2) The authors identify two tiers of foreign exchange markets:
A) bank and nonbank foreign exchange.
B) commercial and investment transactions.
C) interbank and client markets.
D) client and retail market.
3) 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.
C) 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.
4) Which of the following may be participants in the foreign exchange markets?
A) bank and nonbank foreign exchange dealers
B) central banks and treasuries
C) speculators and arbitrageurs
D) all of the above
5) ________ 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 arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries
6) 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
C) speculators; arbitrageurs
D) dealers; brokers
7) 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
C) brokers; dealers
D) speculators; arbitrageurs
8) ________ are agents who facilitate trading between dealers without themselves becoming
principals in the transaction.
A) Central banks
B) Foreign exchange brokers
C) Arbitrageurs
D) Foreign exchange dealers
9) Because the market for foreign exchange is worldwide, the volume of foreign exchange
currency transactions is level throughout the 24-hour day.
10) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement
at Bretton Woods.
11) Dealers in foreign exchange departments at large international banks act as market makers
and maintain inventories of the securities in which they specialize.
12) Currency trading lacks profitability for large commercial and investment banks but is
maintained as a service for corporate and institutional customers.
13) The primary motive of foreign exchange activities by most central banks is profit.
14) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank
markets.
15) Dealers in the foreign exchange departments of large international banks often function as
“market makers.” Such dealers stand willing at all times to buy and sell those currencies in which
they specialize and thus maintain an “inventory” position in those currencies.
16) Currency trading is a service center rather than a profit center for commercial and investment
banks.
17) For individuals and firms involved in the import and export of goods and services ,using the
foreign exchange market is necessary, but incidental, to their underlying commercial or
investment purpose.
18) Most transactions in the interbank foreign exchange trading are primarily conducted via
telecommunication techniques and little is conducted face-to–face.
19) 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?
1) ________ are NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Futures transactions
2) A ________ transaction in the foreign exchange market requires an almost immediate delivery
(typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above
3) A ________ transaction in the foreign exchange market requires delivery of foreign exchange
at some future date.
A) spot
B) forward
C) swap
D) currency
4) A forward contract to deliver British pounds for U.S. dollars could be described either as
________ or ________.
A) buying dollars forward; buying pounds forward
B) selling pounds forward; selling dollars forward
C) selling pounds forward; buying dollars forward
D) selling dollars forward; buying pounds forward
5) 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 market.
A) “forward against spot”
B) “forspot”
C) “repurchase agreement”
D) “spot against forward”
6) The ________ is a 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 U.S. dollars and the foreign currency involved in the transaction is not
delivered.
A) nondeliverable forward
B) dollar only forward
C) virtual forward
D) internet forward
7) 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.
C) NDFs can only be traded by central banks.
D) All of the above are true.
8) A ________ transaction in the interbank market is the simultaneous purchase and sale of a
given amount of foreign exchange for two different value dates.
A) spot
B) forward-forward
C) swap
D) futures
9) 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.
10) Nondeliverable Forwards were originally envisioned as a method of currency speculation,
but it is now estimated that 70% of NDFs are trading for hedging purposes.
11) In general, NDF markets normally develop for country currencies having large cross-border
capital movements, but still subject to convertibility restrictions.
12) NDFs are traded and settled inside the country of the subject currency, and therefore are
within the control of the country’s government.