chapter 10-11

The investment manager at Solar Electric Inc. reminds the board that the foreign exchange market is a mixed system. The investment manager wants the board to realize that rates are driven by

a combination of government intervention and speculative activity.

An American company sold construction equipment to the government of Singapore. Instead of receiving payment in U.S. dollars, the company agreed to take payment in the form of goods. This is an example of

countertrade.

In countries that adopt a __________ exchange rate system, the values of currencies are set against each other at some mutually agreed-on exchange rate.

fixed

The Bretton Woods agreement created which two multinational institutions?

International Monetary Fund and the World Bank

A country is said to be in __________ when the income its residents earn from exports is equal to the money its residents pay to other countries for imports.

balance-of-trade equilibrium

An example of transaction exposure is when

companies have obligations for the purchase of goods at previously agreed prices.

A lag strategy involves

delaying the collection of foreign currency receivables when a foreign currency is expected to appreciate.

The purchasing power parity (PPP) theory best predicts exchange rate changes for countries with

high rates of inflation.

Assume that the interest rate on borrowings in Chile is 4 percent, but the interest rate on deposits in British banks is 8 percent. A trader borrows 1 million Chilean pesos, then converts the money into British pounds and deposits it in a British bank. What is the trader involved in?

carry trade

The nominal interest rate is 9 percent in Brazil and 6 percent in Japan. Applying the international Fisher effect, the Brazilian real should

depreciate by 3 percent against the Japanese yen.

What is meant by economic exposure?

extent to which a firm's future international earning power is affected by changes in exchange rates

Translation exposure refers to the

impact of currency exchange rate changes on the reported financial statements of a company.

The architects of the Bretton Woods agreement built limited flexibility into the fixed exchange rate system in order to

avoid high unemployment.

A(n) __________ refers to the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

currency swap

Assume that the exchange rate between the euro and the dollar is €1.00 = $1.50. Jenna is an American tourist in Italy buying a leather wallet whose price is €60. How much in U.S. dollars will Jenna have to pay to buy the product?

$90

One unit of a peso in a Latin American country was defined as equivalent to 12 grains of "fine" (pure) gold, while one unit of its neighboring countries currency, a dollar, was defined as equivalent to 18 grains of "fine" (pure) gold. Using the gold par value concept (with 480 grains in an ounce), the exchange rate for converting the peso to the dollar is

1 peso = 1.5 dollar.

According to the Fisher effect, if the "real" rate of interest in a country is 5 percent and the expected annual inflation is 9 percent, what would the "nominal" interest rate be?

14 percent

How was the global monetary system affected by major events in the 1970s, including the OPEC oil crisis in 1971 and the loss of confidence in the U.S. dollar in the late 1970s?

Exchange rates became much more volatile.

Which institution helped contain the global financial crisis of 2008-2009 by rescuing Iceland, Ireland, Greece, and Latvia?

IMF

Assume that a European nation operates under a fixed exchange rate regime. What would occur if this nation rapidly increased its money supply by printing more currency?

The prices of imports would become more attractive in the country.

In terms of foreign exchange, why would a firm rely on leading and lagging strategies?

They can help firms minimize their transaction and translation exposure.

How does increased foreign exchange risk affect business?

This has a negative effect on a business.

_________ is concerned with the present measurement of past events.

Translation exposure

The collapse of the fixed exchange rate system has been traced to the

U.S. macroeconomic policy package of 1965-1968.

Alayna feels it is best for her company to pay their foreign supplier in Argentina this month even though they will not receive products they ordered from the supplier for another six months. She recently learned that the currency in Argentina is expected to appreciate and, by paying the supplier now, her company will save money. This is an example of

a lead strategy.

The Simpson Group converts $1,000,000 into euros when the exchange rate is $1 = €0.75. After three months, the company converts this back into dollars when the exchange rate is $1 = €0.80. What is the outcome of this transaction?

a loss of $62,500

All the major office furniture manufacturers within a country realize the industry is in trouble. Their costs have become out of control and foreign manufacturers are gaining market share because they have lower prices. The office furniture manufacturers all agree to cut off ties with all foreign imports and focus only on domestic suppliers as a way to cut costs. They agree to try it for six months and if it doesn't work out, it really doesn't matter because the government will bail out the industry. This is an example of

a moral hazard.

A country that has an exchange rate system under which its exchange rate is allowed to fluctuate against other currencies within a target zone is using a(n) __________ system.

adjustable peg

Following the global financial crisis in 2008-2009, the economy of Greece fell apart and has struggled to regain strength. What is one reason for the demise of the Greek economy?

adoption of the euro in 2001

Assume the euro/dollar exchange rate quoted in Tokyo at 6 a.m. is €1 = $1.00. If the New York euro/dollar exchange rate at the same time (5 p.m. New York time) is €1 = $1.35, a dealer could make a profit through

arbitrage

Freeman Fabricators International purchased securities on the London Stock Exchange and then immediately resold them on the New York Stock Exchange at a higher price. The profits from this transaction were used to buy new equipment for the company. This company engaged in

arbitrage.

A country in South America is adversely affected by trade deficits and the government wants to move to a floating exchange rate system to help adjust trade imbalances. However, a political group is opposing this. As critics of floating exchange rates, they claim that trade deficits are determined by the

balance between savings and investment in a country.

Jarek is investing money for his company. He notices that the interest rate on borrowing in Tokyo is 4 percent and the interest rate on bank deposits in Rome is 6 percent. In this situation, a carry trade would occur when Jarek

borrows money in Tokyo currency, converts it into Rome currency, and deposits it in a Rome bank.

The executive managers of Solo Sounds, a U.S.-based musical instrument manufacturer, want to reduce the vulnerability of the company to unpredictable exchange rate movements. What would provide the company with a hedge against currency fluctuations?

dispersing production to different locations around the globe

The extent to which a firm's future international earning power is affected by changes in exchange rates is known as

economic exposure.

A(n) __________ market is one in which prices reflect all available public information.

efficient

The purchasing power parity puzzle represents the failure to find a strong link between relative inflation rates and

exchange rate movements.

The exchange rate for converting the U.S. dollar into other currencies is continuously adjusted depending on the laws of supply and demand. This illustrates a __________ exchange rate.

floating

Advocates of the floating rate system argue that

floating rates help adjust trade imbalances.

In terms of the approaches to exchange rate forecasting, __________ draws on economic theory to construct sophisticated econometric models that are used to predict exchange rate movements.

fundamental analysis

Shreya is the chief financial officer for Home Safe Security Inc. Her company is interested in investing in a facility in Indonesia, but she is worried about unpredictable fluctuations in future exchange rates, which could cost her company millions of dollars. One way to ensure against this exchange risk is for Shreya to use

hedging

The World Bank's initial mission was to

help finance the building of Europe's economy by providing low-interest loans.

If Canada suffered from "fundamental disequilibrium," and its government choose not to devalue its currency, a likely consequence of this would be

high unemployment.

How does a country that introduces a currency board make its commitment to converting its domestic currency on demand into another currency at a fixed exchange rate credible?

holding foreign currency reserves equal at the fixed exchange rate to at least 100 percent of the domestic currency issued

One reason for the failure of purchasing power parity theory and international Fisher effect in predicting short-term movements in exchange rates is due to the

impact of investor psychology on short-run exchange rate movements.

The currency of Saudi Arabia, the riyal, is fixed relative to the U.S. dollar. As a result, the U.S. dollar exchange rate determines the exchange rate between the Saudi Arabia riyal and other currencies. This is an example of a __________ exchange rate.

pegged

The governing body of an island nation agreed to have the value of their nation's currency follow that of the U.S. dollar. This is an example of a __________ exchange rate regime.

pegged

A country in a state of fundamental disequilibrium suffers from

permanent adverse shifts in the demand for their products.

One function of the foreign exchange market is to

provide some insurance against foreign exchange risk.

All International Monetary Fund (IMF) loan packages come with conditions attached that limit

public spending.

Xanon Tech, based in Washington, buys component parts from Indonesia. The Indonesian company must be paid in rupiah. Xanon Tech will rely on _________ to convert dollars to rupiah.

the foreign exchange market

Vonnie was shopping in New York last week and saw Chanel perfume for $500. When she returned to London, she saw that same perfume for £250. She knew that the exchange rate was one pound for every two dollars. Her shopping experience demonstrates

the law of one price.

The exchange rate movements during the 1980s and 1990s proved contrary to the purchasing power parity theory because

they did not seem to be strongly influenced by inflation rates.

The United States returned to the gold standard in 1934 when more dollars were needed to buy an ounce of gold than before. This implied that the dollar

was worth less.

As an investor studying the gold standard, Kareem knows that he would need more than 1,500 euros to purchase one ounce of gold. These euros represent the

gold par value.

The law of one price states that

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

A weakness of the Bretton Woods system was that it could not work if

the U.S. dollar was under speculative attack.

How are spot exchange rates determined?

the interaction between demand and supply of a currency relative to other currencies

Currency speculation takes place when

there is short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.

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

spot exchange rate.

A currency is considered freely convertible when

the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it.

A potential downfall of the Bretton Woods system was that it would not work if

the currency of choice, the U.S. dollar, was under speculative attack.

According to the __________, there is a strong relationship between inflation rates and interest rates.

Fisher effect

What was one of the main elements included in the Jamaica Agreement?

Floating exchange rates were declared acceptable.

Hudson Oil and Gas Inc., based in Houston, has a plant in Norway that builds cargo ships used to transport the company's products around the world. Each year this plant has been profitable, but Hudson Inc. is not able to convert the profits into U.S. dollars and take them out of the country. What type of convertibility does this represent?

nonconvertible

When companies behave recklessly because they know they will be saved by a government bail-out if things go wrong, it is called a

moral hazard.

__________ occurs when two parties agree to exchange currency and execute the deal at some specific date in the future.

A forward exchange

How did the Marshall Plan overshadow efforts by the World Bank?

It let the United States loan money directly to European nations for rebuilding efforts.

Which government intervention resulted in gold being abandoned as a reserve asset?

Jamaica agreement

The U.S. dollar is selling at a discount on the 30-day forward market when what is taking place?

The current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 = ¥110 after 30 days.

What happened to the dollar following the announcement by the Group of Five that it would be desirable for most major currencies to appreciate via the U.S. dollar?

The dollar continued to decline.

Images from the Great Depression included lines of people standing at their financial institution waiting to withdraw their money because they didn't trust the money would be there when they needed it. What was this an example of?

a banking crisis

Alejandro is the manager of Polar Plastics, an American company. He expects the value of the British pound to appreciate in the near future and so delays the collection of payments from British customers until the next month. Which tactic is Alejandro using to minimize the company's foreign exchange exposure?

lag strategy

Assume that the exchange rate between the U.S. dollar and the Japanese yen is $1 = ¥150. A pair of shoes that retail for $100 in New York should sell for ¥15,000 in Tokyo, if there are no trade barriers and transportation costs, according to the

law of one price.

What two aspects of the IMF Articles of Agreement fostered the flexibility that was needed to help avoid high unemployment?

lending facilities and adjustable parities

A(n) __________ system refers to one in which a country's currency is nominally allowed to float freely against other currencies but in which the government will intervene, buying and selling currency, if it believes that the currency has deviated too far from its fair value.

managed-float

Many economists compare the process of _________ to fortune-telling because there is no rationale for the assumption of predictability.

technical analysis

Under the fixed exchange rate regime established at Bretton Woods, __________ served as the reference point for all other currencies.

the U.S. dollar

The movement of traders like a herd, all in the same direction and at the same time, in response to each other's perceived actions, is called

the bandwagon effect.

A dirty-float system differs from a clean-float system because in a dirty-float

the central bank will intervene to maintain the value of the currency.