Instructor’s Manual
CHAPTER 11
FOREIGN EXCHANGE
CHAPTER OVERVIEW
This chapter discusses the nature and operation of the foreign exchange market. The chapter begins by describing
the foreign exchange market and the types of foreign exchange transactions. Emphasis is placed on the interbank
market for foreign exchange.
Next we consider the forward market and futures market and also the market for foreign currency options. The role
of the International Monetary Market of the Chicago Mercantile Exchange is emphasized in this section.
After completing this chapter, the student should be able to:
• Discuss the operation of the foreign exchange market.
• Understand the foreign exchange quotations of
The Wall Street Journal
.
BRIEF ANSWERS TO STUDY QUESTIONS
1. The foreign exchange market refers to the organizational setting within which individuals, firms, and banks buy
Instructor’s Manual
2. The spot market permits the buying and selling of foreign exchange for immediate delivery. Future contracts
are made by those who will make or receive foreign exchange payments in the weeks or months ahead.
4. Exchange-rate quotations throughout the world are brought into harmony via exchange arbitrage.
6. The relation between the spot rate and forward rate is a reflection of the interest rate differential between
7. Exchange market speculators deliberately assume foreign exchange risk with the hope of profiting from
exchange rate fluctuations over time. Most speculation is conducted in the forward market.
8. Stabilizing speculation refers to the purchase of a foreign currency with the domestic currency when there
10. Arbitragers will buy pounds in New York, at $1.69 per pound, and sell pounds in London, at $1.71 per pound,
11. a. $1.50 per pound. 30 pounds are purchased at a cost of $45.
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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
13. a. The U.S. investor would purchase pounds on the spot market at $2 per pound, and use the
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.
15. a. The U.S. speculator should sell francs today for delivery in 6 months at today’s forward rate of the
$0.40 each and deliver them for the previously contracted rate of $0.50 per franc; the speculator
realizes a profit of $0.10 on each franc which the forward contract specifies. If the franc’s spot
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.