Chapter 10 The Foreign Exchange Market
True / False Questions
1.
The foreign exchange market is a market for converting the currency of one
country into that of another country.
TRUE
The foreign exchange market is a market for converting the currency of one
country into that of another country.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the functions of the foreign exchange market.
Topic: Introduction
2.
Currency fluctuations can make seemingly profitable trade and investment
deals unprofitable and vice versa.
TRUE
Currency fluctuations can make seemingly profitable trade and investment
deals unprofitable, and vice versa.
AACSB: Analytic
Topic: Introduction
3.
The rate at which one currency is converted into another is known as the
fluctuation rate.
FALSE
An exchange rate is the rate at which one currency is converted into
another.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the functions of the foreign exchange market.
Topic: Introduction
4.
The risk that arises from volatile changes in exchange rates is known as
foreign exchange risk.
TRUE
Foreign exchange risk refers to the adverse consequences of unpredictable
changes in exchange rates.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the functions of the foreign exchange market.
Topic: The Functions of the Foreign Exchange Market
5.
Currency speculation typically involves the long-term movement of funds
from one currency to another in the hopes of profiting from shifts in
exchange rates.
FALSE
Currency speculation typically involves the short-term movement of funds
from one currency to another in the hopes of profiting from shifts in
exchange rates.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the functions of the foreign exchange market.
Topic: The Functions of the Foreign Exchange Market
6.
Carry trade is non-speculative in nature.
FALSE
The speculative element of carry trade is that its success is based upon a
belief that there will be no adverse movement in exchange rates (or interest
rates for that matter) that will make the trade unprofitable.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the functions of the foreign exchange market.
Topic: The Functions of the Foreign Exchange Market
7.
When a tourist goes to a bank in a foreign country to convert money into the
local currency, the exchange rate used is the forward rate.
TRUE
When a tourist goes to a bank in a foreign country to convert money into the
local currency, the exchange rate used is the spot rate fort that day.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-02 Understand what is meant by spot exchange rates.
Topic: The Functions of the Foreign Exchange Market
8.
The value of a currency is determined by the interaction between the
demand and supply of that currency relative to the demand and supply of
other currencies.
TRUE
The value of a currency is determined by the interaction between the
demand and supply of that currency relative to the demand and supply of
other currencies.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-02 Understand what is meant by spot exchange rates.
Topic: The Functions of the Foreign Exchange Market
9.
If the spot exchange rate is £1=$1.50 when the market opens, and
£1=$1.48 at the end of the day, the pound has appreciated, and the dollar
has depreciated.
FALSE
Each pound now buys fewer dollars than at the start of the day. The dollar
has appreciated, and the pound has depreciated.
AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Understand what is meant by spot exchange rates.
Topic: The Functions of the Foreign Exchange Market
10.
A spot exchange rate is quoted for 30 days, 90 days, and 180 days into the
future.
FALSE
Forward exchange rates are quoted for 30 days, 90 days, and 180 days into
the future.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
11.
When two parties agree to exchange currency and execute the deal at some
specific time in the future, a forward exchange occurs.
TRUE
A forward exchange occurs when two parties agree to exchange currency
and execute the deal at some specific date in the future.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
12.
To minimize the risk of an unanticipated change in exchange rates, a
company can protect itself by entering into a forward exchange contract.
TRUE
When a firm enters into a forward exchange contract, it is taking out
insurance against the possibility that future exchange rate movements will
make a transaction unprofitable by the time that transaction has been
executed.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
13.
If $1 bought more yen with a spot exchange than with a 30-day forward
exchange it indicates the dollar is expected to depreciate against the yen in
the next 30 days. When this occurs, we say the dollar is selling at a
premium on the 30-day forward market.
FALSE
If $1 bought more yen with a spot exchange than with a 30-day forward
exchange indicates foreign exchange dealers expected the dollar to
depreciate against the yen in the next 30 days. When this occurs, we say
the dollar is selling at a discount on the 30-day forward market.
AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
14.
Differences in the spot exchange rate and the 30-day forward rate are
normal and reflect the expectations of the foreign exchange market about
future currency movements.
TRUE
Such differences are normal; they reflect the expectations of the foreign
exchange market about future currency movements.
Topic: The Functions of the Foreign Exchange Market
15.
If the spot rate is $1 = ¥120, and the 30–day forward rate is $1 = ¥130, the
dollar is selling at a discount in the forward market.
FALSE
In this case, the dollar is selling at a premium on the 30-day forward
market.
AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
16.
A currency swap is the rate at which a foreign exchange dealer converts one
currency into another on a particular day.
FALSE
A currency swap is the simultaneous purchase and sale of a given amount
of foreign exchange for two different value dates.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
17.
A currency swap deal enables companies to insure themselves against
foreign exchange risk.
TRUE
A currency swap deal enables companies to insure themselves against
foreign exchange risk.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Functions of the Foreign Exchange Market
18.
The foreign exchange market is a global network of banks, brokers, and
foreign exchange dealers connected by electronic communications
systems.
TRUE
The foreign exchange market is not located in any one place. It is a global
network of banks, brokers, and foreign exchange dealers connected by
electronic communications systems.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Nature of the Foreign Exchange Market
19.
The most important trading centers for currencies are Zurich, Frankfurt,
Paris, Hong Kong, and Sydney.
FALSE
The most important trading centers are London (37 percent of activity),
New York (18 percent of activity), and Zurich, Tokyo, and Singapore (all
with around 5 to 6 percent of activity). Major secondary trading centers
include Frankfurt, Paris, Hong Kong, and Sydney.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Nature of the Foreign Exchange Market
20.
The foreign exchange market is open for only 12 hours in a day.
FALSE
A key feature of the foreign exchange market is that the market never
sleeps. Tokyo, London, and New York are all shut for only 3 hours out of
every 24.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
21.
Arbitrage opportunities abound in the foreign exchange markets and they
tend to be available for long periods of time.
FALSE
Because foreign exchange dealers are always watching their computer
screens for arbitrage opportunities, the few that arise tend to be small, and
they disappear in minutes.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Nature of the Foreign Exchange Market
22.
Although a foreign exchange transaction can involve any two currencies,
most transactions involve pounds on one side.
FALSE
Although a foreign exchange transaction can involve any two currencies,
most transactions involve dollars on one side.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-03 Recognize the role that forward exchange rates play in insuring against foreign exchange risk.
Topic: The Nature of the Foreign Exchange Market
23.
If the law of one price were true for all goods and services, the purchasing
power parity (PPP) exchange rate could be found from any individual set of
prices.
TRUE
If the law of one price were true for all goods and services, the purchasing
power parity (PPP) exchange rate could be found from any individual set of
prices.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
24.
There are no impediments to the free flow of goods and services in an
efficient market.
TRUE
An efficient market has no impediments to the free flow of goods and
services, such as trade barriers.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
25.
The PPP theory argues that the exchange rate will change even if relative
prices remain unchanged.
FALSE
The PPP theory argues that the exchange rate will change if relative prices
change.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
26.
Inflation occurs when output increases faster than the money supply.
FALSE
Inflation is a monetary phenomenon. It occurs when the quantity of money
in circulation rises faster than the stock of goods and services, that is, when
the money supply increases faster than output increases.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
27.
The PPP theory tells us that a country with a high inflation rate will see
depreciation in its currency exchange rate.
TRUE
The PPP theory tells us that a country with a high inflation rate will see
depreciation in its currency exchange rate.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
28.
The PPP theory is a strong predictor of short-run movements in exchange
rates covering time spans of five years or less.
FALSE
While PPP theory seems to yield relatively accurate predictions in the long
run, it does not appear to be a strong predictor of short-run movements in
exchange rates covering time spans of five years or less.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
29.
The Fisher Effect states that a country’s “real” rate of interest is the sum of
the “nominal” interest rate and the expected rate of inflation over the period
for which the funds are to be lent.
FALSE
The Fisher Effect states that a country’s “nominal” interest rate is the sum
of the required “real” rate of interest and the expected rate of inflation over
the period for which the funds are to be lent.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
30.
The International Fisher Effect states that for any two countries, the spot
exchange rate should change in an equal amount but in the opposite
direction to the difference in nominal interest rates for the two countries.
TRUE
The International Fisher Effect states that for any two countries, the spot
exchange rate should change in an equal amount but in the opposite
direction to the difference in nominal interest rates between the two
countries.
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
31.
The International Fisher Effect has proven to have substantial power at
predicting short-run changes in spot exchange rates.
FALSE
The International Fisher Effect is not a good predictor of short-run changes
in spot exchange rates.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
32.
There is no evidence that psychological factors play an important role in
determining the expectations of market traders as to likely future exchange
rates.
FALSE
Evidence reveals that various psychological factors play an important role in
determining the expectations of market traders as to likely future exchange
rates. 20
AACSB: Analytic
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
33.
The efficient market school argues that investing in exchange rate
forecasting services would be a waste of money.
TRUE
The efficient market school argues that forward exchange rates do the best
possible job of forecasting future spot exchange rates, and, therefore,
investing in forecasting services would be a waste of money.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
34.
An inefficient market is one in which prices do not reflect all available
information.
TRUE
An inefficient market is one in which prices do not reflect all available
information. In an inefficient market, forward exchange rates will not be the
best possible predictors of future spot exchange rates.
AACSB: Analytic
Blooms: Remember
Topic: Exchange Rate Forecasting
35.
Technical analysis draws on economic theory to construct sophisticated
econometric models for predicting exchange rate movements.
FALSE
Fundamental analysis draws on economic theory to construct sophisticated
econometric models for predicting exchange rate movements.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
36.
If a country has an externally convertible currency, neither residents nor
nonresidents are allowed to convert it into a foreign currency.
FALSE
A currency is said to be externally convertible when only nonresidents may
convert it into a foreign currency without any limitations.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
37.
Capital flight is most likely to occur when the value of the domestic
currency is depreciating rapidly because of hyperinflation, or when a
country’s economic prospects are shaky in other respects.
TRUE
Capital flight is most likely to occur when the value of the domestic
currency is depreciating rapidly because of hyperinflation, or when a
country’s economic prospects are shaky in other respects.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
38.
Transaction exposure includes obligations for the purchase or sale of goods
and services at previously agreed prices and the borrowing or lending of
funds in foreign currencies.
TRUE
Transaction exposure is the extent to which the income from individual
transactions is affected by fluctuations in foreign exchange values. Such
exposure includes obligations for the purchase or sale of goods and
services at previously agreed prices and the borrowing or lending of funds in
Difficulty: 2 Medium
Learning Objective: 10-06 Compare and contrast the differences between translation; transaction; and economic exposure;
and explain what managers can do to manage each type of exposure.
Topic: Implications for Managers
39.
The impact of currency exchange rates on the reported financial statements
of a company is called economic exposure.
FALSE
Economic exposure is the extent to which a firm’s future international
earning power is affected by changes in exchange rates.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-06 Compare and contrast the differences between translation; transaction; and economic exposure;
and explain what managers can do to manage each type of exposure.
Topic: Implications for Managers
40.
A lag strategy involves attempting to collect foreign currency receivables
early when a foreign currency is expected to depreciate and paying foreign
currency payables before they are due when a currency is expected to
appreciate.
FALSE
A lag strategy involves delaying collection of foreign currency receivables if
that currency is expected to appreciate and delaying payables if the
currency is expected to depreciate.