Chapter 7: Exchange Rates
TRUE/FALSE
1. Polish consumers were wise to take out their home mortgages in 2007 in Swiss Francs.
2. Purchasing power parity is the price of one currency in terms of another.
3. Since foreign exchange is such a unique commodity, its markets are influenced only by economic
factors and free from the effect of social or political pressures.
4. The rise of a country’s productivity is usually accompanied by increased demand for its home
currency.
5. The UK current account balance consists of exports minus imports of merchandise and services, plus
income on UK assets abroad minus payments on foreign assets in the United Kingdom, plus unilateral
government transfers and private remittances.
6. A deficit in the current account does not have to be balanced by other financial accounts.
7. In the year 2008, the British pound lost 28 per cent of its value relative to the euro.
8. Fixed exchange rate policy fixes the exchange rate of a country relative to other currencies.
9. While theories on PPP, interest rates, and money supply give often-accurate predictions about
long-term movements, investor psychology is regarded as the determinant behind short-term
movements.
10. A large number of individuals and companies exchanging domestic currencies for euros or US dollars
in order to exit their home country is referred to as capital flight.
11. Bandwagon effect refers to the effect of investors investing in opposite directions.
12. There is no benefit to peg a country’s currency to a key currency (such as the euro).
13. Before 1914, to be able to redeem its currency in gold at a fixed price, every central bank needed to
maintain gold reserves.
14. The Bretton Woods system is a system in which all currencies have floating exchange rates.
15. The Institution-based view implies the IMF can create secure macro-economic stability.
16. The gold standard propelled the US dollar to commanding heights in the global economy.
17. The International Monetary Fund offers both loans and free grants to countries depending on the
stability and need of the borrower.
18. The foreign exchange market has no central physical location but operates 24/7 and is the largest and
most active market in the world.
19. Currency hedging is one way to minimize the foreign exchange risk inherent in all nonspot
transactions.
20. Forward discount is a condition under which the forward rate of one currency relative to another
currency is lower than the spot rate.
21. Forward transactions allow participants to buy and sell currencies now for future delivery.
22. A currency swap is the conversion of one currency into another currency.
23. Forward transaction is a type of spot transaction.
24. Strategic hedging means organizing your operations in such a way that the currencies of your expected
expenditures match the costs of your expected revenues.
25. Both currency hedging and strategic hedging help companies to cope with the currency risks.
26. Only managers in large firms have to worry about foreign exchange issues because small firms are
immune to risks of changing currencies.
27. A floating exchange rate is often criticized for not allowing other countries to adjust their rate if the
country they are pegged to experiences high inflation.
28. Many proponents of fixed exchange rates argue that these rates impose monetary discipline by
preventing governments from engaging in inflationary monetary policies.
29. A floating exchange rate allows each country to make its own monetary policy.
30. Floating exchange rates are less volatile than fixed rates.
31. The most extreme fixed rate policy is through a currency board.
32. A weak US dollar hurts exporters in Asia and Europe, but it helps improve the US balance of
payments and helps create a greater global balance.
33. It is only crucial that managers just pay attention to long-run movements informed by PPP,
productivity changes, and balance of payments because short-run fluctuations will equal themselves
again as quickly as they changed.
34. Even though a country may have a high currency risk, the country might still be worthy of investment.
35. The best practice for facing currency risk is to have a well thought-out currency management strategy
and plan for both long-run movements and short-run movements.
MULTIPLE CHOICE
1. Which statement about East European currencies during the 2008 crisis is correct?
a.
The Polish zloty was fixed against the euro.
b.
Many home-owners in Poland had taken out loans in Swiss currency before the crisis.
c.
Polish home-owners with loans in Swiss currency benefited from the financial crisis of
2008.
d.
None of these statements are correct.
2. In the period 2005 to 2009, the biggest year-on-year change of the US$/€ rate was:
a.
A 5.16% appreciation of the value of the euro
b.
A 12.63% depreciation of the value of the euro
c.
A 25.16% appreciation of the value of the euro
d.
A 2.63% depreciation of the value of the euro
3. ________ is an international organization of 185 member countries established to promote monetary
cooperation, exchange stability, and provide temporary financial assistance to countries.
a.
World Bank
c.
Grameen Bank
b.
International Monetary Fund
d.
Bretton Woods System
4. In the trade relationship with China, why is the US dollar in more demand than the Chinese yuan?
a.
More people demand the yuan domestically in China, so it is not used for imports and
exports.
b.
The yuan is pegged to the US dollar.
c.
Formal institutions and regulations demand the trade be conducted in the dollar.
d.
The USA is running a long-run trade deficit with China.
5. What is the “law of one price,” where the price for identical products in different countries should be
the same if trade barriers are absent?
a.
Fixed exchange rate policy
c.
Currency swap
b.
Purchasing power parity
d.
Balance of payments
6. Which of the following is the concept behind the Big Mac index?
a.
Balance of payments
c.
Currency swap
b.
Fixed exchange rate policy
d.
Purchasing power parity
7. If a country’s interest rate is high relative to other countries, the country will:
a.
Experience depreciation in its home currency
b.
Attract foreign funds
c.
Develop a trade deficit
d.
Discourage foreign investing
8. Which of the following is NOT one of the components of the balance of payments?
a.
Capital movement
c.
Currency trade
b.
Merchandise trade
d.
Service trade
9. A country experiencing a current account surplus will see its currency ________, while a country
experiencing a current account deficit will see its currency ________.
a.
Depreciate…..appreciate
c.
Appreciate…..depreciate
b.
Appreciate…..appreciate
d.
Depreciate…..depreciate
10. Which of the following best describes a rate where selective government intervention works
hand-in-hand with allowing markets the freedom to work themselves out?
a.
Managed float rate
c.
Fixed rate
b.
Target exchange rate
d.
Floating rate
11. ________ are the specified upper and lower bounds within which the exchange rate is allowed to
fluctuate.
a.
Floating exchange rates
c.
Target exchange rates
b.
Dirty exchange rates
d.
Fixed exchange rates
12. The currency board used in Estonia is an example of:
a.
Fixed exchange rate policy
c.
Target exchange rate policy
b.
Managed float rate policy
d.
Floating rate policy
13. Which of the following is a benefit to peg a country’s currency to a key currency such as the euro?
a.
It stabilizes export prices for developing countries.
b.
Domestic inflation could be restrained.
c.
It stabilizes import prices for developing countries.
d.
All of these answers
14. Investors may move like a “herd” at the same time in the same direction, resulting in a:
a.
Big Mac effect
c.
Bandwagon effect
b.
Stabilized effect
d.
Capital flight effect
15. Capital flight is a phenomenon in which a large number of individuals and companies exchange
________ for ________.
a.
Domestic properties…..foreign properties
b.
Foreign currencies…..domestic currencies
c.
Domestic currencies…..foreign currencies
d.
Foreign properties…..domestic properties
16. What was one of the major reasons the gold standard fell apart?
a.
Gold lost its value and was no longer reliable.
b.
Military campaigns during World War I stole much of the gold from foreign central banks.
c.
Gold became too rare and costly to maintain adequate reserves.
d.
Countries fighting in World War I printed excessive amounts of money to finance their
war efforts.
17. Which of the following is correct about Bretton Woods system?
a.
Most countries still adopt the system now.
b.
All currencies in the system were pegged at a fixed rate to the US dollar.
c.
All currencies in the system had floating exchange rates.
d.
All currencies in the system were required to be gold convertible.
18. Why was the US dollar chosen in 1944 as the currency to which other currencies would be pegged?
a.
The US had high levels of productivity.
b.
The US contributed approximately 70% of the global GDP.
c.
The US was experiencing a large trade surplus.
d.
All of these answers
19. Which of the following is NOT one of the three primary activities of the International Monetary Fund?
a.
Lending
b.
Providing technical assistance to developing countries
c.
Pegging exchange rates
d.
Monitoring the global economy
20. Where does the International Monetary Fund receive its funds?
a.
Subsidiary investing
c.
Member countries quota
b.
Foreign direct investment
d.
Currency trading
21. Which is NOT one of the primary types of foreign exchange transactions?
a.
Spot transactions
c.
Strategic transactions
b.
Swaps
d.
Forward transactions
22. ________ allow participants to buy and sell currencies now for future delivery.
a.
Spot markets
c.
Strategic markets
b.
Swaps
d.
Forward markets
23. Traders and investors trading in a forward transactions market are most concerned about:
a.
Political and social stability of the foreign country
b.
Fluctuations of the spot rate
c.
Regulation from the International Monetary Fund
d.
Currency hedging
24. Currency hedging is a transaction that protects traders and investors from exposure to the fluctuations
of the:
a.
Spot rate
c.
Currency swap
b.
Forward transaction
d.
Forward discount
25. Which of the following is best defined by “the conversion of one currency into another at Time 1, with
an agreement to revert it back to the original currency at a specific Time 2 in the future”?
a.
Forward currency transaction
c.
Currency swap
b.
Direct currency transaction
d.
Spot currency transaction
26. A condition under which the forward rate of one currency relative to another currency is higher than
the spot rate is:
a.
Forward discount
c.
Forward premium
b.
Currency swap
d.
Backward swap
27. The ________ is defined as the difference between the offered price and the bid price.
a.
Discount
c.
Offer rate
b.
Premium
d.
Spread
28. Which of the following is can be achieved by currency diversification?
a.
Strategic hedging
c.
Trading risk
b.
Currency hedging
d.
Spot transactions
29. Strategic hedging can be achieved by spreading out activities in a number of countries in:
a.
Political regimes
c.
Continents
b.
Currency zones
d.
Geographic areas
30. Multinational enterprises looking to expand to another foreign market with potentially risky exchange
rates should:
a.
Manage the risk using strategic or financial hedging
b.
Go ahead with the investment because most all foreign firms are able to use other
intangible resources to find a profit
c.
Patiently wait until the foreign market is no longer as risky
d.
Focus solely on domestic issues
31. Which strategies do companies use to minimize their exposure to exchange rate risk?
a.
Diversification of business activity across many currency areas
b.
Matching the currencies of expected expenditures and revenues
c.
Invoicing in their own currency
d.
All of these answers
32. Which of the following is NOT an advantage of a strong euro?
a.
Euro-zone tourists benefit from lower prices when traveling abroad.
b.
Euro-zone firms in import-competing industries face more low-cost imports.
c.
Lower prices on foreign goods help keep euro-zone prices level and inflation low.
d.
Euro-zone consumers benefit from low prices on imports.
33. A manager arguing against currency hedging would most likely argue:
a.
Currency hedging increases stability of cash flows and earnings
b.
That currency hedging is not necessary because in a free market everything balances in the
end
c.
That currency hedging eats into profits
d.
Currency hedging is mainly a practice of very large MNEs
34. A currency board is a monetary authority that issues notes and coins convertible into a key foreign
currency at:
a.
A fixed exchange rate
c.
A managed floating exchange rate
b.
A clean floating exchange rate
d.
A target exchange rate
35. The bandwagon effect is an example of ________ that affects foreign exchange rates.
a.
Purchasing power parity
c.
Investor psychology
b.
Exchange rate policy
d.
Balance of payments
ESSAY
1. Identify the concept behind the (Economists) Big Mac index and provide an example why this index
should be used with caution. Summarize the main issues to consider when analyzing the relationship
of PPP to the Big Mac Index.
2. Describe what it means for a country to peg its currency to another, and give two benefits to this
policy.
3. Briefly explain the cause for the fall of the Bretton Woods System.
4. Discuss the three criticisms voiced against the International Monetary Fund.
5. Identify the difference between fixed and floating exchange rates. Provide an example of a situation
where the fixed and floating exchange rates are used.
6. Discuss why a manager may not want to practice currency hedging.
7. Explain how company can reduce their exposure to foreign exchange rate risk without engaging in
financial market transactions.
8. Compare the two primary strategies companies use to cope with the currency risks.
