Multinational Business Finance, 15e, Global Edition (Eiteman/Stonehill/Moffett)
Chapter 5 The Foreign Exchange Market
5.1 Functions of the Foreign Exchange Market
1) 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.
2) 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
3) The ________ is the mechanism by which participants transfer purchasing power between
countries, obtain or provide credit for international trade transactions, and minimize exposure to
the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR
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4) 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.
5) Business firms in countries with exchange controls, for example, China (mainland), often
must surrender foreign exchange earned from exports to the central bank at the daily fixing price.
6) The foreign exchange market provides the physical and institutional structure through which
three typical functions are accomplish. List and explain three functions of the foreign exchange
market.
5.2 Structure of the Foreign Exchange Market
1) 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.
2) 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.
3) 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.
4) 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 arbitrageurs
D) all of the above
5) ________ 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 arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries
6) 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; arbitrageurs
D) dealers; brokers
7) 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; arbitrageurs
8) ________ are agents who facilitate trading between dealers without themselves becoming
principals in the transaction.
A) Central banks
B) Foreign exchange brokers
C) Arbitrageurs
D) Foreign exchange dealers
9) Because the market for foreign exchange is worldwide, the volume of foreign exchange
currency transactions is level throughout the 24-hour day.
10) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement
at Bretton Woods.
11) Dealers in foreign exchange departments at large international banks act as market makers
and maintain inventories of the securities in which they specialize.
12) Currency trading lacks profitability for large commercial and investment banks but is
maintained as a service for corporate and institutional customers.
13) The primary motive of foreign exchange activities by most central banks is profit.
14) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank
markets.
15) Dealers in the foreign exchange departments of large international banks often function as
“market makers.” Such dealers stand willing at all times to buy and sell those currencies in which
they specialize and thus maintain an “inventory” position in those currencies.
16) Currency trading is a service center rather than a profit center for commercial and investment
banks.
17) For individuals and firms involved in the import and export of goods and services, using the
foreign exchange market is necessary, but incidental, to their underlying commercial or
investment purpose.
18) Most transactions in the interbank foreign exchange trading are primarily conducted via
telecommunication techniques and little is conducted face-to-face.
19) 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) ________ is NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Futures transactions
2) A ________ transaction in the foreign exchange market requires an almost immediate delivery
(typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above
3) A ________ transaction in the foreign exchange market requires delivery of foreign exchange
at some future date.
A) spot
B) forward
C) swap
D) currency
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) 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”
6) 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
7) 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.
8) A ________ transaction in the interbank market is the simultaneous purchase and sale of a
given amount of foreign exchange for two different value dates.
A) spot
B) forward-forward
C) swap
D) futures
9) Daily trading volume in the foreign exchange market was about ________ per ________ in
2015.
A) $5,100 billion; month
B) $3,100 billion; month
C) $5,100 billion; day
D) $3,100 billion; day
10) The greatest volume of daily foreign exchange transactions are:
A) spot transactions.
B) forward transactions.
C) swap transactions.
D) This question is inappropriate because the volume of transactions are approximately equal
across the three categories above.
11) The United Kingdom and United States together make up nearly ________ of daily currency
trading.
A) 30%
B) 40%
C) 50%
D) 60%
12) The top three currency pairs traded with the U.S. dollar are:
A) U.K. pound, Chinese Yuan, Japanese yen.
B) Swiss franc, euro, Japanese yen.
C) U.K. pound, euro, Japanese yen.
D) euro, Chinese Yuan, Japanese yen.
13) The greatest amount of foreign exchange trading takes place in the following three cities:
A) New York, London, and Tokyo.
B) New York, Singapore, and London.
C) London, Frankfurt, and Paris.
D) London, Tokyo, and Zurich.
14) The four currencies that constitute about 80% of all foreign exchange trading are:
A) U.K pound, Chinese yuan, euro, and Japanese yen.
B) U.S. dollar, euro, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, euro, and U.K. pound.
D) U.S. dollar, U.K. pound, yen, and Chinese yuan.
15) 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.
16) Nondeliverable Forwards were originally envisioned as a method of currency speculation,
but it is now estimated that 70% of NDFs are trading for hedging purposes.
17) In general, NDF markets normally develop for country currencies having large cross-border
capital movements, but still subject to convertibility restrictions.
18) NDFs are traded and settled inside the country of the subject currency, and therefore are
within the control of the country’s government.
19) A contract to deliver dollars for euros in six months is both “buying euros forward for
dollars” and “selling dollars forward for euros.”
20) As you might expect, the foreign exchange daily trading volume in in New York City is
roughly twice as large as the daily trading volume in London.
21) The low level of interest rates around the globe in recent years, combined with slowing
economic growth and new debt issuances, has had a dampening impact on the swap market.
22) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the
most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar
trading pairs.
23) Swap and forward transactions account for an insignificant portion of the foreign exchange
market.
24) Define spot, forward, and swap transactions in the foreign exchange market and give an
example of how each could be used.
5.4 Foreign Exchange Rates and Quotations
1) 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
2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed
as the foreign currency per dollar this 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
3) The following is an example of an American term foreign exchange quote:
A) $20/£
B) €0.85/$
C) ¥100/€
D) none of the above
4) 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/€
D) $0.90/€
5) 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
6) 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/$; $1.43/£
7) ________ make money on currency exchanges by the difference between the ________ price,
or the price they offer to pay, and the ________ price, or the price at which they offer to sell the
currency.
A) Dealers; ask; bid
B) Dealers; bid; ask
C) Brokers; ask; bid
D) Brokers; bid; ask
TABLE 5.1
Use the table to answer following question(s).
8) Refer to Table 5.1. The current spot rate of dollars per pound as quoted in a newspaper is
________ or ________.
A) £1.4484/$; $0.6904/£
B) $1.4481/£; £0.6906/$
C) $1.4484/£; £0.6904/$
D) £1.4487/$; $0.6903/£
9) Refer to Table 5.1. The one-month forward bid price for dollars as denominated in Japanese
yen is:
A) -¥20.
B) -¥18.
C) ¥129.74/$.
D) ¥129.62/$.
10) 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) -$238.
11) Refer to Table 5.1. According to the information provided in the table, the 6-month yen is
selling at a forward ________ of approximately ________ per annum. (Use the mid rates to
make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%
12) Given the following exchange rates, which of the multiple-choice choices represents a
potentially profitable intermarket arbitrage opportunity?
¥129.87/$
€1.1226/$
€0.00864/¥
A) ¥115.69/€
B) ¥114.96/€
C) $0.8908/€
D) $0.0077/¥
13) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of
0.8909/€ to $0.8709/€. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%
14) A German firm is attempting to determine the euro/pound exchange rate and has the
following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate =
$1.2194/€. Therefore, the euro/pound rate must be:
A) £1.2719/€.
B) €1.2719/£.
C) €0.7316/£.
D) €0.7863/£.
15) The European and American terms for foreign currency exchange are square roots of one
another.
16) 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.
17) A confusing “quirk” of international exchange rates occurs when calculating the percentage
change in spot rates from one period to another. The percent change in the spot rate from one
period to another when quoted using foreign currency terms is always greater than the percent
changes quoted when using home currency terms.
18) The most commonly quoted currency exchange is that between the U.S. dollar and the
European euro. For example, a quotation of EUR/USD 1.2174. The euro is the base currency and
the dollar the price currency.
19) Since in the U.S. the home currency is the dollar and the foreign currency is the euro, in New
York USD 1.2174 = EUR 1.00 would be a direct quote on the euro and an indirect quote on the
dollar.
20) A bid is the price in one currency at which a dealer will buy another currency. An ask is the
price at which a dealer will sell the other currency. Dealers bid (buy) at one price and ask (sell) at
a slightly higher price, making their profit from the spread between the prices. List and explain
three reasons/factors that could make the spread small.