Fundamentals of Multinational Finance, 5e (Moffett et al.)
Chapter 8 Foreign Exchange Rate Determination
Multiple Choice and True/False Questions
8.1 Exchange Rate Determination: The Theoretical Thread
1) The important thing to remember about foreign exchange rate determination is that parity
conditions, asset approach, and balance of payments approaches are ________ theories rather
than ________ theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing
2) It is safe to say that most determinants of the spot exchange rate are also affected by changes
in the spot rate. i.e., they are linked AND mutually determined.
3) The ________ approach states that the exchange rate is determined by the supply and demand
for national currency stocks, as well as the expected future levels and rates of growth of
monetary stock
A) balance of payments
B) monetary
C) asset market
D) law of one price
4) The ________ approach argues that exchange rates are determined by the supply and demand
for a wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price
5) Technical analysis of exchange rates was developed in part due to the forecasting
inadequacies of fundamental exchange rate theories.
6) The ________ approach to the determination of spot exchange rates hypothesizes that the
most important factors are the relative real interest rate and a country’s outlook for economic
growth and profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market
7) The authors compromise as to the key factors for exchange rate determination. They conclude
that ________ are important in the short run, but that ________ determines long run exchange
rates.
A) Fisher effect; PPP
B) asset markets, interest rates, and expectations; PPP
C) PPP; Fisher effect
D) Fisher effect; asset prices, interest rates, and expectations
8) ________, traditionally referred to as chartists, focus on price and volume data to determine
past trends that are expected to continue into the future.
A) Mappists
B) Trappist Monks
C) Filibusters
D) Technical analysts
9) The longer the time horizon of the technical analyst the more accurate the prediction of
foreign exchange rates is likely to be.
10) Short-term foreign exchange forecasts are often motivated by such activities as ________
whereas long-term forecasts are more likely motivated by ________.
A) long-term investment; long-term capital appreciation
B) long-term capital appreciation; desire to hedge a receivable
C) the desire to hedge a payable; the desire for long-term investment
D) the desire for long-term investment; the desire to hedge a payable
11) The more efficient the foreign exchange market is, the more likely it is that exchange rate
movements are random walks.
12) A major U.S. multinational firm has forecast the euro/dollar rate to be euro1.10/$ one year
hence, and an exchange rate of $1.40 for the British pound (£) in the same time period. What
does this imply the company’s expected rate for the euro per pound to be in one year?
A) euro 1.40/£
B) £1.40/euro
C) £1.54/euro
D) euro 1.54/£
8.2 Currency Market Intervention
1) The Chinese government announces that on December 31, 2006 the value of the Yuan will
officially change from 6.40 Yuan/$ to 6.00 Yuan/$. This would be an official ________ of the
Chinese currency of ________.
A) revaluation; 6.25%
B) revaluation; 6.67%
C) devaluation; 6.25%
D) devaluation; 6.67%
2) Indirect intervention is
A) the alteration of economic and financial fundamentals driving currency capital flows.
B) Central Bank implementing restrictive monetary policy aiming to drive real rates up.
C) the sharp increase in Turkish repo rates from 4.5% to 10% in 2014.
D) All of the above
3) “Overshooting” exchange rate changes in response to an action of the Federal Reserve would
be an example of
A) a market inefficiency.
B) a market efficiency.
C) the Fisher Effect.
D) none of the above.
4) The fall in the value of the domestic currency will sharply reduce the purchasing power of its
people.
5) There is a long-standing saying that “what worries bankers is unemployment, but what worries
elected officials is inflation.”
6) A country’s Central Bank may have the policy to
A) fight inflation.
B) fight slow economic growth.
C) either A or B
D) none of the above
7) The Central Bank practice of the active buying and selling of the domestic currency against
foreign
currencies is the process of
A) direct intervention.
B) indirect intervention.
C) coordinated intervention.
D) capital controls.
8) If the Central Bank’s goal was to decrease the value of its currency, or to fight an appreciation
of its currency’s value on the foreign exchange market, the bank could
A) buy its own currency with foreign currency.
B) sell its own currency in exchange for foreign currency.
C) sell foreign currency.
D) do all of the above
9) When country Central banks work together to intervene and push a particular currency’s value
in
a desired direction, this is known as coordinated intervention.
6
10) ________ is the alteration of economic or financial fundamentals which are thought to be
drivers of capital to flow in and out of specific currencies.
A) Proportional intervention
B) Direct intervention
C) Indirect intervention
D) Hopeless intervention
8.3 Disequilibrium: Exchange Rates in Emerging Markets
1) Which of the following was NOT an international currency crisis in the 1990s and early
2000s?
A) the Asian Crisis
B) the Russian Crisis
C) the Argentine Crisis
D) All of the above were currency crises in the 1990s and 2000s.
2) A currency board is
A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the
economy.
B) a recipe for conservative and prudent financial management.
C) designed to eliminate the power of politicians to exercise judgment by relying on an
automatic and unbendable rule.
D) all of the above.
3) The Asian economic Crisis was
A) direct result of hedge fund speculators.
B) routed in structural deficiencies of the fast growing Asian economies.
C) began when Thai government imposed capital controls.
D) typical for transitions of net importer to net exporter countries.
4) Which of the following did NOT contribute to the exchange rate collapse in emerging markets
in the 1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.
5) The Asian Currency crisis appeared to begin in
A) South Korea.
B) Taiwan.
C) Thailand.
D) Japan.
6) Prior to July 2, 1997, the Thai government
A) allowed the Thai Bhat to float against major currencies.
B) fixed the Bhat’s value against the Korean won only.
C) fixed the Bhat’s value against major currencies especially the U.S. dollar.
D) None of the above.
7) The “tequila effect” is a slang term used to describe a form of financial panic called
A) run on the market.
B) speculation.
C) contrary investing.
D) contagion.
8) The authors did not identify which of the following as a root of the Asian currency crisis?
A) the collapse of some Asian currencies.
B) the rate of inflation in the United States.
C) corporate socialism.
D) banking stability and management.
9) Corporate socialism in the Asian markets could be contributed in part
A) to the relatively short and stable post-WWII history of capitalism in their markets.
B) a belief by the owners of Asian companies that their governments would not allow them to
fail.
C) the practice of lifetime employment at many corporations.
D) all of the above.
10) The authors refer to the practice of many Asian firms being largely controlled by families of
groups related to the governing body of the country as
A) illegal.
B) insider trading.
C) cronyism.
D) not in my backyard.
11) The principle focus of the IMF bailout efforts during the Asian financial crisis was
A) banking liquidity.
B) shareholder’s wealth.
C) reestablishing fixed currency exchange rates in Asia.
D) dollarization of Asian currencies.
12) In the years immediately preceding 1998 the Russian Ruble operated under a ________ type
of exchange rate regime.
A) fixed
B) free floating (market determined)
C) managed floating
D) pegged (to the U.S. dollar)
13) ________ is the official Chinese currency.
A) Baht
B) Won
C) Ringgit
D) Renminbi
14) The stability of the Russian Ruble in the 1990s (until the Russian debt crisis) was considered
an observable success of the Yeltsin administration.
15) The Russian crisis of 1998
A) occurred because of the inability of the Russian Government to lower the taxes.
B) ended when President Yeltsin announced there will be no devaluation.
C) was a culmination of continuing deterioration of economic conditions.
D) was a result of a sharp price increase of Russian export commodities.
16) When the Russian Ruble reached the limits of the bands about its managed float targets
(Ru5.70/$ to Ru6.35/$) in 1997, the Russian government would intervene in the markets to
stabilize the Ruble. If the exchange rate approached Ru5.70/$ the government would ________
Rubles using foreign exchange and gold, or if the exchange rate approached Ru6.35/$ they
would ________ Rubles.
A) buy; sell
B) sell; buy
C) buy; buy
D) sell; sell
17) After the Russian government (in August 1998) allowed the Ruble to move outside its
official trading range of between Ru5.70/$-Ru6.35/$, the value of the Ruble eventually
________ to around ________ by May 1999.
A) increased; Ru13/$
B) increased; Ru4.50/$
C) decreased; Ru13/$
D) decreased; Ru25/$
18) It is safe to say that the Russian transition from a communist economy to a capitalist
economy has been smooth for the Russian people.
19) The ________ is the Argentine currency unit.
A) peso
B) dollar
C) real
D) peseta
20) The Asian currency crisis was primarily a
A) parity conditions problem.
B) an asset markets problem.
C) balance of payments problem.
D) PPP problem.
21) The Russian Ruble crisis of 1998 was a complex combination of speculative pressures best
explained by ________ to exchange rate determination.
A) parity conditions approach
B) asset approach
C) balance of payments approach
D) PPP approach
22) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.
23) Argentina’s economic performance in the 1990s while their peso was pegged to the U.S.
dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.
A) high; high
B) low; low
C) low; high
D) high; low
24) During the 1990s Argentina’s exports became some of the least expensive in all of South
America thanks in part to the pegging of the Argentine peso to the U.S. dollar.
8.4 Forecasting in Practice
1) Which of the following is a driver in the determination of foreign exchange rates under the
Asset Market Approach to forecasting?
A) relative inflation rates
B) relative real interest rates
C) forward exchange rates
D) the current account balance
2) Short-term forecasts are typically motivated by a desire to hedge a receivable, payable, or
dividend for perhaps a period of three months.
3) The asset market approach to exchange rate determination
A) suggests that investors will hold monetary claims if the rates are low.
B) suggests that investors will hold monetary claims if they feel optimistic about country’s
outlook for growth and profitability.
C) states that equilibrium exchange rate is found when the net inflow (outflow) from current
account matches the net outflow (inflow) from financial account.
D) discards the importance of corporate governance to cross-border portfolio investors.
4) The more INEFFICIENT the market is, the more likely it is that exchange rates are “random
walks,” with past price behavior providing no clues to the future.
5) The authors claim that the theories of international currency values hold better for less liquid
and poorly capitalized markets.
6) The authors claim that random events, institutional frictions, and technical factors may cause
currency values to deviate significantly from their long-term fundamental path.
7) The authors claim that theoretical and empirical studies appear to show that fundamentals do
apply to the long-term for foreign exchange.
8) In the long run, exchange rates will never follow a fundamental equilibrium path as suggested
by the fundamental theories of exchange rate determination.
Essay Questions
8.1 Exchange Rate Determination: The Theoretical Thread
1) Describe the asset market approach to exchange rate determination. How is this consistent
with economic theory of (say, security) prices in general?
8.2 Currency Market Intervention
1) Assume your country has a balance of payments surplus. How would the government and
markets react to “correct” this imbalance under a fixed exchange rate regime? Under a floating
exchange rate regime?
8.3 Disequilibrium: Exchange Rates in Emerging Markets
1) Describe the Russian ruble collapse through August of 1998.
8.4 Forecasting in Practice
1) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and
contrast the motivation for and the techniques a forecaster might use for each of the time periods.