Fundamentals of Multinational Finance, 5e (Moffett et al.)
Chapter 5 The Foreign Exchange Market
Multiple Choice and True/False Questions
5.1 Functions of the Foreign Exchange Market
1) 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.
2) What are the typical functions of money?
A) a unit of account, a store of value, a medium of exchange
B) a substitute for debt, symbol of purchasing power
C) instrument for payment of goods and services
D) None of the above
5.2 Structure of the Foreign Exchange Market
1) 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.
2) 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.
3) 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
4) 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.
5) Because the market for foreign exchange is worldwide, the volume of foreign exchange
currency transactions is leveled throughout the 24-hour day.
6) The greatest amount of foreign exchange trading takes place in which of the following three
cities?
A) New York, London, and Tokyo
B) New York, Singapore, and Zurich
C) London, Frankfurt, and Paris
D) London, Tokyo, and Zurich
7) ________ 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
8) The foreign exchange market is NOT efficient because
A) market participants do not compete with one another due to the fact that trading takes place
around the world and not in a single centralized location.
B) dealers have ask prices that are higher than bid prices.
C) 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.
9) Dealers in foreign exchange departments at large international banks act as market makers and
maintain inventories of the securities in which they specialize.
10) Currency trading lacks profitability for large commercial and investment banks but is
maintained as a service for corporate and institutional customers.
11) 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.
12) 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 arbitragers
D) All of the above.
13) ________ 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
C) Central banks
D) Treasuries
14) 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; arbitragers
D) dealers; brokers
15) 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; arbitragers
16) The primary motive of foreign exchange activities by most central banks is profit.
17) Dealers sometimes use brokers in the foreign exchange market because the dealers desire
A) speed.
B) accuracy.
C) to remain anonymous.
D) all of the above.
18) Liquidity seekers profit of the profit seekers because
A) profit seekers are usually much better informed about the market and share that information
with liquidity seekers.
B) profit seekers simply wish to secure enough of currency for their transactions.
C) profit seekers are inducing exceptional growth of the foreign exchange market.
D) None of the above. Profit seekers generally profit from liquidity seekers.
5.3 Transactions in the Foreign Exchange Market
1) 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
2) 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”
3) Forward exchange rates are normally quoted for value date of
A) two days.
B) one, two, three, six and twelve months.
C) two years.
D) do not have specific maturity date.
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) 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.
6) A ________ transaction in the foreign exchange market requires an almost immediate delivery
of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above
7) A ________ transaction in the foreign exchange market requires delivery of foreign exchange
at some future date.
A) spot
B) forward
C) swap
D) currency
8) 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.
9) NDFs are traded and settled outside the country of the subject currency, and therefore are
beyond the control of the country’s government.
5.4 Size of the Foreign Exchange Market
1) Daily trading volume in the foreign exchange market was about ________ per ________ in
2007.
A) $3,200 billion; month
B) $1,000 billion; month
C) $3,200 billion; day
D) $1,000 billion; day
2) Daily trading volume of foreign exchange had actually decreased in 2010 from the levels
reported in 2007.
3) ________ are NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Futures transactions
4) Swap and forward transactions account for an insignificant portion of the foreign exchange
market.
5) New York City has the greatest volume of foreign exchange activity in the world.
6) Although the “big three” (dollar, euro, and yen) continue to dominate global trades, it will
probably not be long before a fourth, not yet on the map—the Chinese renminbi—will move into
greater prominence.
7) According to the Bank for International Settlements,
A) the Financial Crisis of 2008 has significantly decreased the Global Foreign Exchange Market
Turnover.
B) FX options and other derivates percentage share of FX market has significantly declined
compared to traditional market instruments.
C) the primary driver behind market rapid growth is electronic trading and easier market access.
D) None of the above
5.5 Foreign Exchange Rates and Quotations
1) The three currencies that dominate foreign exchange trading are
A) U.K pound, Chinese yuan, and Japanese yen.
B) U.S. dollar, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, and the euro.
D) U.S. dollar, U.K. pound, and Japanese yen.
2) A foreign exchange ________ is the price of one currency expressed in terms of another
currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.
A) quote; rate
B) quote; quote
C) rate; quote
D) rate; rate
3) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed
as the foreign currency per dollar this is known as ________ whereas ________ are expressed as
dollars per foreign unit.
A) European terms; indirect
B) American terms; direct
C) American terms; European terms
D) European terms; American terms
4) The following is an example of an American term foreign exchange quote
A) $20/£.
B) 0.85 euro/$.
C) 100¥/euro.
D) None of the above.
5) In a standard forward terminology, “Pips” stands for
A) vulture profit seekers.
B) the last two digits of the typical forward rate.
C) a difference between the swap and forward rate.
D) a difference between the swap and the spot rate.
6) The European and American terms for foreign currency exchange are square roots of one
another.
7) With several exceptions, most interbank quotes are stated in European terms (meaning foreign
currency unit per U.S. dollar).
8) 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.
9) From the viewpoint of a British investor, which of the following would be a direct quote in the
foreign exchange market?
A) SF2.40/£
B) $1.50/£
C) £0.55/euro
D) $0.90/euro
10) 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
C) indirect; indirect
D) indirect; direct
11) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for
the U.S. investor would be ________ and the direct quote for the British investor would be
________.
A) £0.699/$; £0.699/$
B) $0.699/£; £0.699/$
C) £1.43/£; £0.699/$
D) £0.699/$; $1.43/£
TABLE 5.1
Use the table to answer the following question(s).
12) Refer to Table 5.1. The current spot rate of dollars per pound as quoted in a newspaper is
________ or ________.
A) £1.4484/$; $0.6904/£
B) $1.4481/£; £0.6906/$
C) $1.4484/£; £0.6904/$
D) £1.4487/$; $0.6903/£
13) Refer to Table 5.1. The one-month forward bid price for dollars as denominated in Japanese
yen is
A) -¥20.
B) -¥18.
C) ¥129.74/$.
D) ¥129.62/$.
14) Refer to Table 5.1. The ask price for the two-year swap for a British pound is
A) $1.4250/£.
B) $1.4257/£.
C) -$230.
D) -$238.
15) Refer to Table 5.1. According to the information provided in the table, the 6-month yen is
selling at a forward ________ of approximately ________ per annum. (Use the mid rates to
make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%
16) Refer to Table 5.1. Cross rates
A) are often reported in the form of a matrix in the financial newspapers.
B) can be used to check on opportunities for intermarket arbitrage.
C) for the spot market in the table are “188.10” (using the mid rates).
D) are all of the above.
17) Given the following exchange rates, which of the following choices represents a potentially
profitable intermarket arbitrage opportunity?
¥129.87/$
euro 1.1226/$
euro 0.00864/¥
A) ¥115.69/euro
B) ¥114.96/euro
C) $0.8908/euro
D) $0.0077/¥
18) For arbitrage opportunities to be practical,
A) participants must have instant access to quotes.
B) participants must have instant access to executions.
C) 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.
19) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of
$0.8909/euro to $0.8709/euro. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%
20) 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.
Essay Questions
5.1 Functions of the Foreign Exchange Market
1) Identify and explain the three functions of the foreign exchange market.
5.2 Structure of the Foreign Exchange Market
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?
5.3 Transactions in the Foreign Exchange Market
1) Define spot, forward, and swap transactions in the foreign exchange market and give an
example of how each could be used.
5.4 Size of the Foreign Exchange Market
1) The foreign exchange market has expanded significantly in the last 20 years. What is the
volume of swap, forward, and spot transactions in the market as of the most recent survey data
(April 2013)?
5.5 Foreign Exchange Rates and Quotations
1) Foreign exchange quotes are often confusing. Define these terms and then identify the types of
quotes that follow. Direct quote, indirect quote, American terms, European terms.
EUR0.686 = USD1, this quote found in Frankfurt, Germany
USD1.4577 = EUR1.0, this quote found in San Francisco, California