Chapter 16—Foreign Exchange Derivative Markets
1. At any given point in time, the price at which banks will buy a currency is ____ the price at which they
sell it.
a.
higher than
b.
lower than
c.
the same as
d.
none of the above
2. Which of the following is most likely to provide currency forward contracts to their customers?
a.
commercial banks
b.
international mutual funds
c.
brokerage firms
d.
insurance companies
3. The ____ allowed for the devaluation of the dollar in 1971.
a.
Bretton Woods Agreement
b.
Louvre Accord
c.
Smithsonian Agreement
d.
none of the above
4. The Bretton Woods Era was the era
a.
of free-floating exchange rates.
b.
of floating rates without boundaries, but subject to government intervention.
c.
in which governments maintained exchange rates within 1 percent of a specified rate.
d.
in which exchange rates were maintained within 10 percent of a specified rate.
5. A system whereby exchange rates are market determined without boundaries but subject to
government intervention is called
a.
a dirty float.
b.
a free float.
c.
the gold standard.
d.
the Bretton Woods era.
6. A system whereby one currency is maintained within specified boundaries of another currency or unit
of account is a
a.
pegged system.
b.
free float.
c.
dirty float.
d.
managed float.
7. A country that pegs its currency is still able to maintain complete control over its local interest rates.
a. True
b. False
8. If the demand for British pounds ____, the pound will ____, other things being equal.
a.
increases; appreciate
b.
decreases; appreciate
c.
increases; depreciate
d.
B and C
9. A(n) ____ in the supply of euros for sale will cause the euro to ____.
a.
increase; appreciate
b.
increase; depreciate
c.
decrease; depreciate
d.
none of the above
10. Beginning with an equilibrium situation, if European inflation suddenly ____ than U.S. inflation, this
forced ____ pressure on the value of the euro.
a.
becomes much higher; upward
b.
becomes much higher; downward
c.
becomes much less; upward
d.
becomes much less; downward
e.
B and C
11. Purchasing Power Parity suggests that the exchange rate will on average change by a percentage that
reflects the ____ differential between two countries.
a.
income
b.
interest rate
c.
inflation
d.
tax
12. In reality, exchange rates do not always change as suggested by purchasing power parity.
a. True
b. False
13. If U.S. interest rates suddenly become much higher than European interest rates (and if it does not
cause concern about higher inflation there), the U.S. demand for euros would ____, and the supply of
euros to be exchanged for dollars would ____, other factors held constant.
a.
increase; increase
b.
increase; decrease
c.
decrease; increase
d.
decrease; decrease
14. Assume interest rate parity exists. If the spot rate on the British pound is $2 and the 1-year British
interest rate is 7 percent, and the 1-year U.S. interest rate is 11 percent, what is the pound’s forward
discount or premium?
a.
3.74 percent premium
b.
3.74 percent discount
c.
3.60 percent premium
d.
3.60 percent discount
15. When a government influences factors, such as inflation, interest rates, or income, in order to affect
currency’s value, this is an example of
a.
direct intervention.
b.
indirect intervention.
c.
a freely floating system.
d.
a pegged system.
16. Which of the following statements is incorrect?
a.
Central banks often consider adjusting a currency’s value to influence economic
conditions.
b.
If the U.S. central bank wishes to stimulate the economy, it could weaken the dollar.
c.
A weaker dollar could cause U.S. inflation by reducing foreign competition.
d.
Direct intervention occurs when the central bank influences the factors that determine the
dollar’s value.
17. Direct intervention is always extremely effective.
a. True
b. False
18. If the U.S. government imposed trade restrictions on U.S. imports, this would ____ the U.S. demand
for foreign currencies, and would place ____ pressure on the values of foreign currencies (with respect
to the dollar).
a.
increase; upward
b.
increase, downward
c.
limit; upward
d.
limit; downward
19. If a commercial bank expects the euro to appreciate against the dollar, it may take a ____ position in
euros and a ____ position in dollars.
a.
short; short
b.
long; short
c.
short; long
d.
long; long
20. Generally, a ____ home currency can ____ domestic economic growth.
a.
weak; dampen
b.
strong; stimulate
c.
strong; dampen
d.
A and B
21. A ____ home currency can ____ domestic inflation.
a.
strong; increase
b.
weak; decrease
c.
strong; decrease
d.
A and B
22. If the forward rate of a foreign currency ____ the existing spot rate, the forward rate will exhibit a
____.
a.
exceeds; discount
b.
is below; premium
c.
is below; discount
d.
A and B
23. ____ forecasting involves the use of historical exchange rate data to predict future values.
a.
Technical
b.
Fundamental
c.
Market-based
d.
Mixed
24. ____ forecasting is usually based on either the spot rate or the forward rate.
a.
Technical
b.
Fundamental
c.
Market-based
d.
Mixed
25. Fundamental forecasting has been found to be consistently superior to the other forecasting techniques.
a. True
b. False
26. Which of the following is not a method of forecasting exchange rate volatility?
a.
using the volatility of historical exchange rate movements
b.
using a time series of volatility patterns in previous periods
c.
using the volatility of future exchange rate movements
d.
using the exchange rate’s implied standard deviation
27. Assume the following information.
•
Interest rate on borrowed euros is 5 percent annualized
•
Interest rate on dollars loaned out is 6 percent annualized
•
Spot rate for €0.83 per dollar (one € = $1.20)
•
Expected spot rate in five days is €0.85 per dollar
•
Alonso Bank can borrow €10 million
What is the euro profit to Alonso Bank over the five-day period from shorting euros and going long on
dollars?
a.
€200,311.11
b.
€207,111.11
c.
€201,555.56
d.
none of the above
28. Which of the following statements is incorrect?
a.
Forward contracts are contracts typically negotiated with a commercial bank that allow the
purchase or sale of a specified amount of a particular foreign currency at a specified
exchange rate on a specified future date.
b.
The forward market is located in New York City.
c.
Many of the commercial banks that offer foreign exchange on a spot basis also offer
forward transactions for the widely traded currencies.
d.
Forward contracts can hedge a corporation‘s risk that a currency’s value may appreciate
over time.
29. If the spot rate of the British pound is $2, and the 180-day forward rate is $2.05, what is the annualized
premium or discount?
a.
2.5 percent discount
b.
2.5 percent premium
c.
10 percent premium
d.
5 percent discount
e.
5 percent premium
30. Currency futures contracts differ from forward contracts in that they
a.
are an obligation.
b.
are not an obligation.
c.
are standardized.
d.
can specify any amount and maturity date.
31. If the spot rate ____ the exercise price, a currency ____ option would not be exercised.
a.
remains below; call
b.
remains below; put
c.
remains below; put
d.
A and B
32. The pegged exchange rate system is no longer used by any countries.
a. True
b. False
33. If a firm planning to hedge receivables is certain of the future direction a spot rate will move, and
requires a tailor-made hedge in terms of amount and maturity date, it should use a
a.
call options contract traded on an exchange.
b.
futures contract traded on an exchange.
c.
forward contract.
d.
put options contract traded on an exchange.
34. Assume that a British pound put option has a premium of $.03 per unit, and an exercise price of $1.60.
The present spot rate is $1.61. The expected future spot rate on the expiration date is $1.52. The option
will be exercised on this date if at all. What is the expected per unit net gain (or loss) resulting from
purchasing the put option?
a.
$.01 loss
b.
$.09 loss
c.
$.09 gain
d.
$.05 gain
35. The speculative risk of purchasing a ____ is that the foreign currency value ____ over time.
a.
put option; increases
b.
put option; decreases
c.
call option; increases
d.
futures contract; increases
36. Bank A asks $.555 for Swiss francs and Banks B and C are willing to pay $.557 for francs. An
institution could capitalize on these differences by engaging in
a.
covered interest arbitrage.
b.
triangular arbitrage.
c.
locational arbitrage.
d.
witching hour arbitrage.
37. According to interest rate parity, if the interest rate in a foreign country is ____ than in the home
country, the forward rate of the foreign country will have a ____.
a.
higher; discount
b.
lower; premium
c.
higher; premium
d.
A and B
38. ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies
to accommodate customers.
a.
Pension funds
b.
International mutual funds
c.
Insurance companies
d.
Commercial banks
e.
None of the above
39. In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.65. The Australian
dollar (A$) is quoted for $0.60. What is the value of the Australian dollar in British pounds?
a.
A$2.75
b.
A$0.36
c.
£2.75
d.
£0.36
e.
none of the above
40. If European inflation suddenly becomes much higher than U.S. inflation, the U.S. demand for
European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces
will place ____ pressure on the value of the euro.
a.
increase; decline; upward
b.
increase; decline; downward
c.
decrease; increase; upward
d.
decrease; increase; downward
e.
none of the above
41. If British interest rates suddenly increase substantially relative to U.S. interest rates, the demand by
U.S. investors for British pounds ____, the supply of British pounds to be sold in exchange for dollars
____, and the British pound will ____.
a.
increases; decreases; appreciate
b.
increases; decreases; depreciate
c.
decreases; increases; appreciate
d.
decreases; increases; depreciate
e.
none of the above
42. Assume the following information.
•
Interest rate on borrowed euros is 5 percent annualized.
•
Interest rate on dollars loaned out is 6 percent annualized.
•
Spot rate is 1.10 euros per dollar (one euro = $0.909).
•
Expected spot rate in five days is 1.15 euros per dollar.
•
Fabrizio Bank can borrow 10 million euros.
If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is
a.
2,653,597.22 euros.
b.
455,266.81 euros.
c.
452,426.04 euros.
d.
none of the above
43. A country that pegs its exchange rate to another exchange rate does not have complete control over its
interest rates.
a. True
b. False
44. The euro is presently pegged to the British pound in order to stabilize international payments between
European countries.
a. True
b. False
45. Financial institutions rarely use the forward market.
a. True
b. False
46. If the quoted cross rate between two foreign currencies is not aligned with the two corresponding
exchange rates, investors can profit from triangular arbitrage.
a. True
b. False
47. The indirect exchange rate specifies the value of the currency in U.S. dollars.
a. True
b. False
48. The forward rate premium is dictated by the national income differential of the two currencies.
a. True
b. False
49. The potential benefits from using foreign exchange derivatives are independent of the expected
exchange rate movements.
a. True
b. False
50. The forward rate is the exchange rate for immediate delivery.
a. True
b. False
51. The Smithsonian Agreement allowed for a devaluation of the dollar and for a widening of the
boundaries within which currencies were allowed to fluctuate.
a. True
b. False
52. A country that pegs its currency does not have complete control over its local interest rates, as its
interest rates must be aligned with the interest rates of the currency to which it is tied.
a. True
b. False
53. Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory.
a. True
b. False
54. Central bank intervention can be overwhelmed by market forces and may not always succeed in
reversing exchange rate movements.
a. True
b. False
55. When countries experience substantial net outflows of funds, they commonly use indirect intervention
by raising interest rates to discourage excessive outflows of funds and therefore limit any downward
pressure on the value of their currency.
a. True
b. False
56. The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on
an annualized basis.
a. True
b. False
57. The primary advantage of currency options over forward and futures contracts is that they provide a
right rather than an obligation to purchase or sell a particular currency at a specified price within a
given period.
a. True
b. False
58. A speculator who expects a foreign currency to appreciate could purchase the currency forward and,
when received, sell it in the spot market.
a. True
b. False
59. The following information refers to Fresno Bank and Champaign Bank.
Bid Rate on Euros
Fresno Bank
$1.002
Champaign Bank
$0.997
Based on this information, locational arbitrage would be profitable.
a. True
b. False
60. Purchasing power parity suggests that the forward rate premium (or discount) should be about equal to
the differential in interest rates between the countries of concern.
a. True
b. False
61. ____ are not foreign exchange derivatives.
a.
Forward contracts
b.
Currency futures contracts
c.
Currency swaps
d.
Currency options
e.
All of the above are foreign exchange derivatives.
62. ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies
to accommodate customers.
a.
Commercial banks
b.
International mutual funds
c.
Insurance companies
d.
Pension funds
e.
All of the above
63. In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.67. The Australian
dollar (A$) is quoted for $0.62. What is the value of the Australian dollar in British pounds?
a.
A$2.69
b.
£0.37
c.
£2.69
d.
A$0.37
e.
none of the above
64. In a(n) ____ exchange rate system, the foreign exchange market is totally free from government
intervention.
a.
pegged
b.
dirty floating
c.
freely floating
d.
Bretton Woods
e.
none of the above
65. The supply and demand for a currency are influenced by all of the following, except
a.
differential interest rates.
b.
differential inflation rates.
c.
direct government intervention.
d.
indirect government intervention.
e.
The supply and demand for a currency are affected by all of the above.
66. If U.S. inflation suddenly becomes much higher than European inflation, the U.S. demand for
European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces
will place ____ pressure on the value of the euro.
a.
increase; decline; upward
b.
increase; decline; downward
c.
decrease; increase; upward
d.
decrease; increase; downward
e.
none of the above
67. Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S.
inflation suddenly decreased to 2 percent, the euro will ____ against the dollar by approximately ____
percent, according to purchasing power parity.
a.
appreciate; 2
b.
depreciate; 2
c.
appreciate; 4
d.
depreciate; 4
e.
none of the above
68. Which of the following is the least feasible strategy for a speculator who expects the Australian dollar
to depreciate?
a.
sell Australian dollars forward and then purchase them in the spot market just before
fulfilling the forward obligation
b.
sell futures contracts on Australian dollar; purchase Australian dollars in the spot market
just before fulfilling the futures obligation
c.
purchase put options on Australian dollars, at some point before the expiration date, when
the spot rate is less than the exercise price, purchase Australian dollars in the spot market
and then exercise the put option
d.
purchase call options on Australian dollars; at some point before the expiration date,
exercise the call option and then sell the Australian dollars received in the spot market
e.
All of the above are possible strategies for a speculator who expects the Australian dollar
to depreciate.
69. The act of capitalizing on the discrepancy between the forward rate premium and the interest rate
differential is called
a.
triangular arbitrage.
b.
locational arbitrage.
c.
covered interest arbitrage.
d.
interest rate parity.
70. The indirect exchange rate is always the reciprocal of the direct exchange rate.
a. True
b. False
71. The exchange rate between two foreign (nondollar) currencies is known as a(n):
a.
indirect dollar rate.
b.
forward rate.
c.
cross-exchange rate.
d.
derived exchange rate.
72. The devaluation of a country’s currency:
a.
makes foreign products more expensive for consumers in that country.
b.
increases foreign demand for that country’s exports.
c.
can lead to deflation in that country.
d.
A and B
73. Currency futures contracts are standardized, whereas forward contracts are more flexible and can
specify whatever amount and maturity date are desired.
a. True
b. False
74. When the Federal Reserve attempt to lower interest rates by increasing the U.S. money supply, it puts
upward pressure on the value of the dollar.
a. True
b. False
75. A speculator who expects the euro to depreciate might:
a.
sell euros forward and then purchase them in the spot market just before fulfilling the
forward obligation.
b.
purchase euros forward and, when they are received, sell them in the spot market.
c.
purchase futures contracts on euros and, when the euros are received, sell them in the spot
market.
d.
all of the above