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Instructor’s Manual
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in
1. The foreign exchange market refers to the organizational setting within which individuals, firms, and
banks buy and sell foreign currencies. The three largest foreign exchange markets are located in New
2. In the forward market, foreign exchange is bought/sold for delivery at future date. This exists mainly for
widely traded currencies. The spot market permits the buying and selling of foreign exchange for
3. The supply and demand for foreign exchange is derived from the credit (debit) items on the balance of
payments, such as exports or investment flows.
4. Exchange-rate quotations throughout the world are brought into harmony via exchange arbitrage.
5. Traders and investors often participate in the forward exchange market to protect their expected profits
from the risk of exchange rate fluctuations. Speculators also participate in the forward market.
6. The relation between the spot rate and forward rate is a reflection of the interest rate differential
Instructor’s Manual
between countries. Currencies of countries whose interest rates are relatively low tend to sell at a
7. Exchange market speculators deliberately assume foreign exchange risk with the hope of profiting
8. Stabilizing speculation refers to the purchase of a foreign currency with the domestic currency when
there occurs a fall in the foreign exchange rate. The anticipation is that the exchange rate will soon
9. The dollar appreciates against the pound; the pound depreciates against the dollar. The dollar
depreciates against the pound; the pound appreciates against the dollar.
10. Arbitragers will buy pounds in New York, at $1.69 per pound, and sell pounds in London, at $1.71 per
pound, thus making a profit of 2 cents on each pound. As pounds are bought in New York, their prices
11. a. $1.50 per pound. 30 pounds are purchased at a cost of $45.
b. Excess supply, 20 pounds. Dollar price of the pound decreases, decrease, increase.
12. a. The U.S. importer can cover her foreign exchange risk by purchasing 20,000 pounds for
three-month delivery at today's three-month forward rate of $1.75 per pound. The importer is
willing to pay 5 cents more per pound (or $1000 more for the 20,000 pounds) than today's
spot rate to guard against the possibility that the spot rate in three months will exceed $1.70
13. a. The U.S. investor would purchase pounds on the spot market at $2 per pound, and use the
pounds to buy U.K. treasury bills in London; he would earn 4 percent per annum (1 percent
14. a. 1.7090, 1.7105, 1.7084, 1.7099, 1.7081, 1.7096, 1.7090, 1.7103.
b. $0.5851 per franc, $1.7090 francs per dollar.
c. Depreciated, appreciated.
15. a. The U.S. speculator should sell francs today for delivery in 6 months at today's forward rate
of the franc, which equals $0.50.
b. After 6 months, if the franc's spot rate is $0.40, the speculator can purchase francs at the
Instructor’s Manual
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in
of $0.60 per franc and resell them at a price of $0.50 per franc; the speculator would suffer
losses of $0.10 on each franc specified in the forward contract. If the franc's spot rate after 6
16. An arbitrager could purchase 3 francs for $1, purchase 6 schilling with 3 francs, and sell 6 schilling for
$1.50. Ignoring transaction costs, the arbitrager realizes a $0.50 profit on the transactions.
