Int B Chapter 10 The Foreign Exchange Market

If a basket of goods costs $400 in the US and 40,000 yen in Japan, PPP theory predicts that the dollar/yen exchange rate should be

$.01 per Japanese yen.

If the exchange rate is 1 British pound to $1.35, an American in London will need ______ to purchase a purse priced at 20 pounds.

$27

An American tourist in Japan is interested in buying a souvenir that costs 1800 yen. How much is this in dollars if the exchange rate is $1 to Y400.

$4.50

True or false: Government intervention in the foreign exchange markets does NOT affect the ability of PPP in predicting exchange rate movements.

False

True or false: Like transaction exposure, economic exposure is concerned with the effect of exchange rates changes on individual transactions, most of which are short-term situations.

False

What is the transaction called where two parties agree to exchange currency at some specific date in the future?

Forward exchange

The most important foreign exchange trading center is ______ with 37% of the activity.

London

The five most important foreign exchange trading centers in terms of level of activity are

London, New York, Zurich, Tokyo and Singapore.

What are considered the two most prominent features of the foreign exchange market? (Check all that apply.)

The trading centers are integrated. The market never sleeps.

________ exposure is the risk, faced by companies involved in international trade, that currency exchange rates will change after the companies have already entered into financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for firms.

Transaction

______ exposure involves the present measurement of past events using currency exchange rate changes on a company's financial statements.

Translation

True or false: Empirical evidence suggest that the International Fisher effect does NOT explain short-term exchange rate movements well.

True

True or false: Spot against forward is a common type of currency swap.

True

True or false: The foreign exchange market is essentially open 24 hours per day.

True

If the demand for the yen outstrips its availability and if the supply of the dollar outweighs the demand, the yen will (appreciate or depreciate?) against the dollar.

appreciate

Buying a currency low and immediately selling it high to make a profit from the price discrepancy is called _____.

arbitrage

The New York yen/dollar exchange rate was Y125=$1. Through ______, a dealer can make a profit on this currency transaction by buying it low and selling it high.

arbitrage

According to the Fisher effect, if the real interest rate in country #1 is 8% and it is 5% in country #2, an investor would take advantage of this by

borrowing from #2 and investing in #1.

Residents of the hypothetical nation of Jarna feared that the country's economy was failing. They rushed to convert their domestic currency into US dollars and investors in businesses in Jarna also converted their financial holdings. This mass conversion of currency is known as _____.

capital flight

Tyson is a trader and borrows money in Japanese yen (where the interest rate is 1%). He then invests the money in a Canadian bank, where the rate is 5%. This is an example of a(n) ______.

carry trade

Economic exposure is concerned with the affect of ______ on a firm's international earning power.

changes in exchange rates

Jameson Electric Corp. would use the foreign exchange market when it needs to

convert currency.

When a country's currency is nonconvertible, a company may engage in ______, where goods and services will be traded for other goods and services.

countertrade

A foreign exchange market is where one country's ______ is converted into that of another country.

currency

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

currency conversion provide insurance against foreign exchange risk

An investment made to profit from future currency movements is called

currency speculation.

Feldman Technology Group has international holdings in India. The company often needs to fund large orders in India for parts with the knowledge that an Indian importer will soon buy completed product from Feldman. These transactions require large sums of capital in both dollars and rupee and as a way to move from one currency to another without incurring foreign exchange risk, the company should use a(n) _____.

currency swap

The value of a currency is determined by the ______ of that currency relative to other currencies.

demand and supply

In theory, if a country's price inflation is rising rapidly, it should expect to see its currency (appreciate or depreciate?) against that of countries in which inflation rates are lower.

depreciate

A lead strategy occurs when a firm attempts to collect foreign currency receivables early when a currency is expected to ______ and pay foreign currency payables before they are due when a currency is expected to ______.

depreciate; appreciate

What is the key way a company can reduce economic exposure?

distribute production facilities and assets to various locations

Company A is based in Europe and does a large amount of business in the US. The company fears that the euro will gain in strength against the dollar, so it sets up a local production facility in the United States. This is a way to reduce ______ exposure.

economic

The extent to which a firm's future international earning power will be affected by exchange rate changes is called ______ exposure.

economic

The extent to which income from individual transactions is affected by fluctuations in foreign exchange values is known as transaction ______.

exposure

A(n) ______ convertible currency allows only nonresidents to convert it into a foreign currency without any limitations.

externally

When only nonresidents can convert a currency into a foreign currency with no limitations, the currency is considered

externally convertible.

Some country's governments do not put any limits on the purchase of foreign currency for residents and nonresidents. These country's have a _____ currency.

freely convertible

When a country allows both residents and nonresidents to purchase unlimited amounts of a foreign currency, the country's currency is

freely convertible.

Forward exchange rates are exchange rates that govern _____ transactions.

future

The chief financial officer of Linwell Corp. is concerned that since he can't predict changes in future exchange rates, there could be adverse consequences for the firm. One way the company can insure itself against this possibility is by engaging in _____.

hedging

When a country's money supply grows faster than the output of goods and services, this causes

inflation

In the context of the Fisher Effect, different interest rates between countries reflect differing expectations about ______ between those countries.

inflation rates

The Fisher effect predicts that there is a strong relationship between ______ and interest rates.

inflation rates

A business is using hedging when it

insures itself against foreign exchange risk.

One main reason why the IFE is NOT good at explaining short-term exchange rate movements is the impact of ______ in determining the expectations of market traders.

investor psychology

When the growth in a country's money supply is faster than the growth in its output of goods, ______ tends to increase.

price inflation

The adverse consequences of unpredictable changes in exchange rates is called foreign exchange .

risk

The impact of psychological factors and investor expectations make it difficult for exchange rate theories to predict ______ changes in exchange rates.

short-term

Currency ______ involves buying, selling and holding currencies in order to make a profit from favorable fluctuations in exchange rates.

speculation

A(n) ______ exchange rate is the price to exchange one currency for another for immediate delivery.

spot

The Fisher effect equates the nominal interest rate as

the required real interest rate + expected rate of inflation.

At the simplest of levels, exchange rates are determined by _____.

the supply and demand of currencies

Capital flight is most likely to occur when

the value of domestic currency is rapidly depreciating.

The effect of currency exchange rate changes on the reported financial statements of companies is called ______ exposure.

translation

When a government intervenes in cross-border trade by implementing a trade barrier, it ______ the link between relative price changes and changes in exchange rates predicted by PPP theory.

weakens

A(n) ______ currency is one that neither residents nor nonresidents are allowed to convert into a foreign currency.

nonconvertible

When neither residents nor nonresidents are allowed to convert a currency to a foreign currency, the currency is considered

nonconvertible.

Identical products sold in different countries must sell for the same price in competitive markets when their price is expressed in terms of the same currency. This is called the law of .

one price

The law of ______ is the economic theory that the price of a given security, asset or commodity must have the same price when exchange rates are taken into consideration.

one price

What is hyperinflation?

An explosive and seemingly uncontrollable price inflation in which money loses value very rapidly

Which type of control of exposure is MOST effective at protecting resources efficiently and ensuring that each subunit adopts the correct mix of tactics and strategies?

Centralized

______ agreements are barter-like agreements used by companies in countries whose currency is nonconvertible.

Countertrade

PPP theory, according to research, seems to predict exchange rate movements best for countries in which two situations? (Check all that apply.)

Countries with underdeveloped capital markets Countries with high inflation rates

What causes inflation to occur in a country?

Inflation occurs when the money supply in a country out paces the level of production of goods and services.

What are three moderately decent predictors of long-term changes in exchange rates? (Check all that apply.)

Nominal interest rate differentials Relative monetary growth Relative inflation rates

Borrowing in a currency from a country with low interest rates and then investing in another currency where interest rates are high is called ______.

a carry trade

PPP theory predicts that changes in relative prices will result in

a change in exchange rates.

According to PPP theory, a country with a high inflation rate will see ______ in its currency exchange rate.

a depreciation

A(n) (lead or lag?) strategy is when a firm attempts to collect foreign currency receivables early when a currency is expected to depreciate and pay foreign currency payables before they are due when a currency is expected to appreciate.

lead

Economic exposure is concerned with the - term effect of changes in exchange rates on future prices, sales, and costs. (Choose short or long.)

long

According to research, PPP theory is a relatively good predictor of ______ exchange rate movements, but is not as good a predictor of ______ movements.

long-run; short-run

When a country experiences hyperinflation, money value very rapidly. (Choose gains or loses.)

loses

The Economists's version of the PPP uses ______ as a proxy for a "basket of goods."

the Big Mac