Chapter 10 International Business

An efficient market has many impediments to the free flow of goods and services.

False. An efficient market has no impediments to the free flow of goods and services, such as trade barriers.

A lead strategy involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate.

False. Lagging involves accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries.

The PPP theory tells us that a country with a high inflation rate will see an appreciation in its currency exchange rate.

False. The PPP theory tells us that a country with a high inflation rate will see depreciation in its currency exchange rate.

A firm needs to develop a mechanism for ensuring it maintains an appropriate mix of tactics and strategies for minimizing its foreign exchange exposure. Which of the following is one of the common tactics that should be employed?

Firms need to, as far as possible, model and forecast future exchange rate movements. A firm needs to develop a mechanism for ensuring it maintains an appropriate mix of tactics and strategies for minimizing its foreign exchange exposure. Although there is no universal agreement as to the components of this mechanism, a number of common themes stand out. First, central control of exposure is needed to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies. Second, firms should distinguish between, on one hand, transaction and translation exposure and, on the other, economic exposure. Third, the need to forecast future exchange rate movements cannot be overstated. Fourth, firms need to establish good reporting systems so the central finance function (or in-house foreign exchange center) can regularly monitor the firm's exposure positions. Finally, on the basis of the information it receives from exchange rate forecasts and its own regular reporting systems, the firm should produce monthly foreign exchange exposure reports.

What is the name of the market in which the currency of one country is converted into currency of another country?

Foreign exchange market. The foreign exchange market is a market for converting currency of one country into that of another country.

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

Fundamental analysis. Fundamental analysis draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements. The variables contained in these models typically include relative money supply growth rates, inflation rates, and interest rates.

A pen costs £50 in Britain. An identical pen costs $70 in the United States when the exchange rate is £1 = $1.50. Which of the following is correct?

The U.S. offers a better deal. All else being equal, at an exchange rate £1 = $1.50, the pen should have cost $75 (50 × 1.5) in the U.S. At $70 for a pen, the U.S. offers a better deal.

The rate at which one currency is converted into another is known as the exchange rate.

True. An exchange rate is the rate at which one currency is converted into another.

If the spot rate is $1 = ¥120, and the 30-day forward rate is $1 = ¥130, the dollar is selling at a premium in the forward market.

True. In this case, the dollar is selling at a premium on the 30-day forward market.

The concept of carry trade involves borrowing money in one currency where interest rates are low and then using the proceeds to invest in other currency where interest rates are high.

True. The carry trade 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.

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

True. The efficient market school argues that forward exchange rates do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of money.

Which of the following is the most important vehicle currency by trade volume?

US Dollar. Due to its central role in so many foreign exchange deals, the dollar is a vehicle currency. In 2010, 85 percent of all foreign exchange transactions involved dollars on one side of the transaction.

When is a currency said to be externally convertible?

When only nonresidents can convert it into a foreign currency without any limitations. A currency is said to be externally convertible when only nonresidents may convert it into a foreign currency without any limitations.

If lots of people want euros and euros are in short supply, and a few people want Japanese yen and yen are in plentiful supply, the yen is likely to _____ against the euro.

depreciate. 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.

Assuming the 60-day forward exchange rate was $1 = ¥110 and the spot exchange rate was $1 = ¥120, the dollar is selling at a(n) _____ on the 60-day forward market.

discount. $1 would buy less yen with a forward exchange than with a spot exchange. In such a case, we say the dollar is selling at a discount on the 60-day forward market.

The extent to which a firm's future international earning power is affected by changes in exchange rates in the long-run is known as _____.

economic exposure. Economic exposure is concerned with the long-run effect of changes in exchange rates on future prices, sales, and costs.

When a firm insures itself against foreign exchange risk, it is

engaging in hedging. A function of the foreign exchange market is to provide insurance against foreign exchange risk, which is the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm. When a firm insures itself against foreign exchange risk, it is engaging in hedging.

The risk that arises from volatile changes in exchange rates is commonly referred to as

foreign exchange risk. Foreign exchange risk is the adverse consequences of unpredictable changes in exchange rates.

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

purchasing power parity theory. If the law of one price were true for all goods and services, the PPP exchange rate could be found from any individual set of prices. By comparing the prices of identical products in different currencies, it would be possible to determine the "real" or PPP exchange rate that would exist if markets were efficient.

A Japanese tourist in New York goes to a bank to convert his yens into dollars. The exchange rate that will be used for conversion will be the _____.

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