Ch7 Test Bank Government Policy and International Trade

Student name:__________

1) With the help of an example, explain how a tourist participates in the foreign exchange market.

2) What are the main uses of foreign exchange markets for international business?

3) What is meant by the phrases “the dollar is selling at a discount” on the 30-day forward market and “the dollar is selling at a premium” on the 30-day forward market?

4) Where is the foreign exchange market located? What is the nature of the market? Is the market growing or shrinking on a global basis?

5) What is the law of one price?

6) Discuss the failure of PPP theory to predict exchange rates accurately. What is the purchasing power parity puzzle?

7) Compare and contrast the Fisher Effect and the International Fisher Effect.

8) Consider the role of investor psychology and bandwagon Effects on how well purchasing power parity and the international Fisher effect explain short-term movements in exchange rates.

9) Discuss the two schools of thought on exchange rate forecasting.

10) Explain the difference between fundamental analysis and technical analysis.

11) Compare and contrast currencies that are freely convertible, externally convertible, and nonconvertible.

12) Describe translation exposure. How can translation exposure be minimized?

13) Explain the notion of economic exposure. How can economic exposure be minimized?

14) How can a firm minimize its foreign exchange exposure?

15) The rate at which one currency is converted into another is known as the

A) exchange rate.
B) currency swap rate.
C) fluctuation rate.
D) carry over rate.

16) ________ arises from volatile changes in exchange rates.

A) Translational exposure
B) Foreign exchange risk
C) Economic exposure
D) Transactional exposure

17) Currency _____ typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.

A) hedging
B) risk mitigation
C) speculation
D) arbitrage

18) What are the two main functions of the foreign exchange market?

A) trading foreign company equities and converting currency
B) reducing currency volatility and setting interest rates
C) insuring companies against interest rate risk and enabling imports and exports
D) converting currency and providing some insurance against foreign exchange risk

19) A pair of shoes costs £40 in Britain. An identical pair costs $50 in the United States when the exchange rate is £1 = $1.50. Which of the following is correct?

A) The United States offers a better deal.
B) The deal is the same in both countries.
C) Britain offers a better deal.
D) A trader can make money by buying the shoes in Britain and selling in the United States at $50.

20) An exchange rate of €1 = $1.30 indicates that

A) $1 is worth 1.30 euros.
B) one could get 1.30 euros for $1.
C) one euro buys 1.30 dollars.
D) one euro buys 0.77 dollars.

21) The _____ helps consumers compare the relative prices of goods and services in different countries.

A) interest rate
B) GDP growth rate
C) exchange rate
D) tariff rate

22) An American company today invests some of its spare cash in a Hungarian money market account that will earn 8 percent for two months. Which of the following, if it happens during the next two months, would imply that the company will earn less than 8 percent on its investment?

A) The Hungarian forint rises in value against the dollar.
B) Interest rates in the United States move down.
C) Short-term interest rates in Hungarian money markets shoot up.
D) The dollar appreciates against the Hungarian forint.

23) Which term refers to the rate at which one currency is converted into another?

A) basis point
B) spread
C) exchange rate
D) interchange rate

24) The short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates is known as

A) currency arbitrage.
B) currency speculation.
C) currency hedging.
D) currency risk mitigation.

25) Which of the following involves borrowing in one currency where interest rates are low, and then using the proceeds to invest in another currency where interest rates are high?

A) carry trade
B) swing trade
C) channel trade
D) price action trade

26) Assume that the interest rate on borrowing in Japan is 1 percent, while the interest rate on deposits in Australian banks is 5 percent. A trader borrows in yen and then converts the money into Australian dollars and deposits it in an Australian bank to make a 4 percent margin. Which type of trade is this an example of?

A) swing trade
B) carry trade
C) channel trade
D) price action trade

27) When a tourist goes to a bank in a foreign country to convert money into the local currency, the exchange rate used is the

A) currency swap rate.
B) forward rate.
C) carry trade.
D) spot rate.

28) _____ are reported on a real-time basis on many financial websites and are continually changing—their value being determined by supply and demand for that currency relative to others.

A) Spot exchange rates
B) Currency swaps
C) Forward exchange rates
D) Future exchange rates

29) When two parties agree to exchange currency and execute the deal immediately, the transaction is a

A) futures exchange.
B) carry trade.
C) spot exchange.
D) forward exchange.

30) The _____ is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day.

A) spot exchange rate
B) forward exchange rate
C) futures exchange rate
D) spread

31) Assume that the current exchange rate is €1 = $1.50. If you exchange 1,000 euros for dollars, you will receive

A) $1,000.
B) $750.
C) $1,500.
D) $667.

32) _____ are exchange rates governing some specific future date foreign exchange transactions.

A) Spot exchange rates
B) Forward exchange rates
C) Future exchange rates
D) Currency swaps

33) Assuming the 30-day forward exchange rate was $1 = 130 and the spot exchange rate was $1 = ×120, the dollar is selling at a _____ on the 30-day forward market.

A) premium
B) margin
C) discount
D) subsidy

34) Which of the following refers to the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates?

A) currency pairing
B) carry trade
C) currency exchange
D) currency swap

35) Which of the following is the most important foreign exchange trading center?

A) London
B) New York
C) Tokyo
D) Singapore

36) Assume that the yen/dollar exchange rate quoted in Tokyo at 3:00 p.m. is ¥120 = $1, and the yen/dollar exchange rate quoted in New York at the same time is ¥123 = $1. A dealer in New York uses dollars to purchase yen and then immediately sells the yen to buy dollars in Tokyo, thereby making a profit. The dealer has engaged in

A) a currency swap.
B) an arbitrage.
C) atrade.
D) a straddle.

37) _____ is quoted for 30 days, 90 days, and 180 days into the future.

A) A forward exchange rate
B) A currency swap
C) A spot exchange rate
D) An arbitrage

38) When two parties agree to exchange currency and execute the deal at some specific time in the future, a _____ occurs.

A) currency swap
B) forward exchange
C) hedging
D) spot exchange

39) Differences in the spot exchange rate and the 30-day forward rate are normal and reflect the expectations of the foreign exchange market about

A) anticipated currency swap rates.
B) stability in the global marketplace.
C) future currency movements.
D) the carry trades that will occur.

40) _____ is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

A) An arbitrage
B) A carry trade
C) A spot exchange
D) A currency swap

41) The _____ is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems.

A) foreign exchange market
B) united global database
C) global marketplace
D) foreign market database

42) The foreign exchange market is

A) open for only 12 hours in a day.
B) the market never sleeps.
C) open for most of the day, but closes for three hours each day—between 2:00 a.m. and 5:00 a.m. Greenwich Mean Time.
D) open during normal business hours (9:00 a.m. to 5:00 p.m., local time) in each of the primary locations from which it operates: Tokyo, London, and New York.

43) Although a foreign exchange transaction can involve any two currencies, most transactions involve _____ on one side.

A) pounds
B) yen
C) dollars
D) euros

44) _____ are transacted between international businesses and their banks, between banks, and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange risk.

A) Carry trades
B) Currency swaps
C) Arbitrages
D) Currency pairing

45) Which of the following is one of the most important trading centers in the foreign exchange market?

A) Beijing
B) Sau Paulo
C) London
D) Seoul

46) The purchasing power parity (PPP) theory argues that the exchange rate will

A) increase if a country is experiencing inflation.
B) change even if relative prices remain unchanged.
C) increase if a country is experiencing deflation.
D) change if relative prices change.

47) Purchasing power parity theory states that given relatively efficient markets, the price of a “basket of goods” should be

A) much less in industrialized countries.
B) much less in third world countries.
C) variable depending upon the current rate of exchange between the producer and consumer of the products in the “basket.”
D) roughly equivalent in each country.

48) Inflation occurs when

A) the quantity of money in circulation rises faster than the stock of goods and services.
B) the stock of goods and services increases and the quantity of money in circulation decreases.
C) output increases faster than the money supply.
D) the money supply decreases and the output increases.

49) The purchasing power parity (PPP) theory tells us that a country with a high inflation rate will

A) export more goods to other countries.
B) see depreciation in its currency exchange rate.
C) import more goods from other countries.
D) see an appreciation in its currency exchange rate.

50) The Fisher Effect states that

A) 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.
B) there is a weak relationship between inflation rates and interest rates.
C) 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.
D) when investors are free to transfer capital between countries, “nominal” interest rates will be the same in every country.

51) The International Fisher Effect has

A) proven to have substantial power at predicting long-run changes in forward exchange rates.
B) proven to have substantial power at predicting short-run changes in spot exchange rates.
C) not proven to be a good predictor of long-run changes in forward exchange rates.
D) not proven to be a good predictor of short-run changes in spot exchange rates.

52) If the demand for dollars outstrips its supply and if the supply of Japanese yen is greater than the demand for it, what will happen?

A) The dollar will appreciate against the yen.
B) The dollar will depreciate against the yen.
C) The exchange rates will remain the same.
D) The yen will appreciate against the dollar.

53) The _____ states that in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.

A) law of one price
B) principle of consistent pricing
C) model of fair pricing
D) rational price theory

54) According to the law of one price, if the exchange rate between the British pound and the dollar is £1 = $1.50, a shirt that retails for $120 in New York should sell for _____ in London.

A) £180
B) £50
C) £60
D) £80

55) Assume that the law of one price holds. A shirt that retails for $120 in New York sells for £60 in London. The exchange rate between the British pound and the dollar is £1 = $1.50. Assuming away transportation costs and trade barriers, this creates a profit-making opportunity called

A) currency swap.
B) arbitrage.
C) currency trade.
D) straddle.

56) The _____ suggests that given relatively efficient markets, the price of a “basket of goods” should be roughly equivalent in each country.

A) random walk theory
B) theory of competitive advantage
C) theory of price inflation
D) purchasing power parity theory

57) Suppose the price of a Big Mac in New York is $3.00 and the price of a Big Mac in Paris is equivalent to $3.75 at the prevailing euro/dollar exchange rate. Using the concept of purchasing power parity, the euro is

A) undervalued by 25 percent against the dollar.
B) overvalued by 25 percent against the dollar.
C) appreciating relative to the dollar.
D) depreciating relative to the dollar.

58) Identify the correct statement about the PPP theory.

A) It predicts that exchange rates are determined by relative prices.
B) It yields accurate predictions of short-run movements in exchange rates.
C) It best predicts exchange rate changes for countries with low rates of inflation.
D) It includes transportation costs and trade tariffs.

59) Which of the following occurs when the quantity of money in circulation in a country rises faster than the country’s stock of goods and services?

A) inflation
B) credit squeeze
C) deflation
D) production surplus

60) Which of the following is referred to as the purchasing power parity puzzle?

A) reduced levels of inflation in countries where the growth in the money supply is faster than the growth in its output
B) the reason countries with high inflation rates see depreciation in their currency exchange rates
C) identical products being sold in different countries for the same price when their price is expressed in terms of the same currency
D) the failure to find a strong link between relative inflation rates and exchange rate movements

61) The _____ 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.

A) PPP theory
B) efficient market theory
C) law of one price
D) Fisher Effect

62) It follows from the Fisher Effect that if the real interest rate is the same worldwide, any difference in interest rates between countries reflects differing expectations about

A) foreign exchange rates.
B) inflation rates.
C) unemployment rates.
D) GDP growth rates.

63) The _____ 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.

A) purchasing power parity theory
B) efficient market theory
C) International Fisher Effect
D) law of one price

64) Which of the following occurs when traders start moving as a herd in the same direction at the same time?

A) Fisher Effect
B) bandwagon effect
C) arbitrage
D) decoupling of markets

65) The _____ school of thought argues that forward exchange rates do the best possible job of forecasting future spot rates and therefore investing in forecasting services would be a waste of money.

A) inefficient market
B) efficient market
C) random walk
D) speculative

66) With which of the following would a follower of the inefficient market school of thought agree?

A) Companies would be better off investing in foreign exchange forecasting services.
B) Forward exchange rates do the best possible job of forecasting future spot exchange rates.
C) Companies can optimize their foreign exchange transactions by using forward markets.
D) Forward rates reflect all available information about likely future changes in exchange rates.

67) _____ uses price and volume data to determine past trends, which are expected to continue into the future.

A) Technical analysis
B) Fundamental analysis
C) Efficient market theory
D) Value investing

68) A currency is said to be freely convertible when

A) its exchange rate with respect to other currencies is decided by the central bank of the country.
B) residents alone are allowed to convert it into a foreign currency without any limitations.
C) neither residents nor nonresidents are allowed to convert it into a foreign currency.
D) both residents and nonresidents are allowed to purchase unlimited amounts of a foreign currency with it.

69) _____ is one in which prices do not reflect all available information.

A) Inefficient market
B) Speculative market
C) Efficient market
D) Externally convertible market

70) _____ draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements.

A) Lead strategy
B) Fundamental analysis
C) Lag strategy
D) Technical analysis

71) If a country has an externally convertible currency

A) neither residents nor nonresidents are allowed to convert it into a foreign currency.
B) both residents and nonresidents can purchase unlimited amounts of a foreign currency with it.
C) only nonresidents may convert it into a foreign currency without any limitations.
D) the government limits convertibility to preserve foreign exchange reserves.

72) Restrictions on external convertibility can

A) hamper foreign companies wishing to do business in that country.
B) allow domestic companies to freely invest abroad.
C) limit the amount of product a foreign company can produce in that country.
D) limit domestic companies’ ability to invest abroad.

73) Capital flight is most likely to occur when

A) the value of the domestic currency is depreciating rapidly because of hyperinflation.
B) a country’s economic prospects are solid and promising.
C) the value of the domestic currency is appreciating rapidly.
D) the value of the foreign currency is depreciating rapidly.

74) Why do governments limit currency convertibility?

A) to preserve foreign exchange reserves
B) to spend foreign exchange reserves
C) to keep domestic companies from investing abroad
D) to allow nonresidents to convert money to foreign currencies

75) _____ 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.

A) The random walk effect
B) The Fisher Effect
C) The International Fisher Effect
D) Capital flight

76) _____ refers to a range of barter-like agreements by which goods and services can be traded for other goods and services.

A) Countertrade
B) Carry trade
C) Dumping
D) Capital flight

77) The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values is known as ________ exposure.

A) economic
B) financial
C) translation
D) transaction

78) What concept is concerned with the long-run effect of changes in exchange rates on future prices, sales, and costs?

A) translation exposure
B) economic exposure
C) transaction exposure
D) trade exposure

79) A(n) _____ 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.

A) follower strategy
B) interim strategy
C) lead strategy
D) lag strategy

80) _____ 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.

A) Economic exposure
B) Transaction exposure
C) Corporate financial exposure
D) Translation exposure

81) A lag strategy involves

A) attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate.
B) delaying collection of foreign currency receivables if that currency is expected to appreciate.
C) paying foreign currency payables before they are due when a currency is expected to appreciate.
D) delaying collection of foreign currency receivables if that currency is expected to depreciate.

82) The foreign exchange market converts the currency of one country into that of another country.

⊚ true
⊚ false

83) When Krista traveled from the United States to England, she had to change her money from dollars into pounds. Krista was participating in the currency exchange market.

⊚ true
⊚ false

84) Parla liked to gamble, so she sometimes moved her funds from dollars to euros in the hope that she would make money based on the exchange rates. This demonstrates a carry trade.

⊚ true
⊚ false

85) Currency fluctuations can make seemingly profitable trade and investment deals unprofitable, and vice versa, due to currency volatility and fluctuations.

⊚ true
⊚ false

86) Carry trade is nonspeculative in nature.

⊚ true
⊚ false

87) 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
⊚ false

88) 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.

⊚ true
⊚ false

89) To minimize the risk of an unanticipated change in exchange rates, a company can protect itself by entering into a forward exchange contract.

⊚ true
⊚ false

90) 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 discount on the 30-day forward market.

⊚ true
⊚ false

91) 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.

⊚ true
⊚ false

92) A currency swap deal enables companies to insure themselves against foreign exchange risk.

⊚ true
⊚ false

93) The most important trading centers for currencies are Zurich, Frankfurt, Paris, Hong Kong, and Sydney.

⊚ true
⊚ false

94) Arbitrage opportunities in foreign exchange markets tend to be small and disappear quickly.

⊚ true
⊚ false

95) 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
⊚ false

96) There are many impediments to the free flow of goods and services in an efficient market.

⊚ true
⊚ false

97) The purchasing power parity (PPP) theory is a strong predictor of short-run movements in exchange rates covering time spans of five years or less.

⊚ true
⊚ false

98) 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.

⊚ true
⊚ false

99) There is no evidence that psychological factors play an important role in determining the expectations of market traders as to likely future exchange rates.

⊚ true
⊚ false

100) The efficient market school argues that investing in exchange rate forecasting services would be a waste of money.

⊚ true
⊚ false

101) 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
⊚ false