International Business Exam 3
One unit of Maruna's currency (druba) was defined as equivalent to 16 grains of "fine" (pure) gold, while one unit of its neighbor, Rashumba's currency (troon) was defined as equivalent to 24 grains of "fine" (pure) gold. Using the gold par value concept (with 480 grains in an ounce), the exchange rate for converting the druba to the troon is
1 troon = 1.5 druba. The amount of a currency needed to purchase one ounce of gold was referred to as the gold par value. 30 drubas are needed to purchase 1 ounce of gold (480/16), while 20 troons are required to purchase 1 ounce of gold (480/24). Since 30 drubas purchase the same amount of gold as 20 troons, the exchange rate is 1 troon is equal to 1.5 druba.
How does the International Monetary Fund (IMF) provide loans to deficit-laden countries?
A pool of gold and currencies contributed by its members provides the resources for lending operations. The International Monetary Fund (IMF) stood ready to lend foreign currencies to members to tide them over during short periods of balance-of-payments deficits, when a rapid tightening of monetary or fiscal policy would hurt domestic employment. A pool of gold and currencies contributed by IMF members provided the resources for these lending operations.
Certovia and Norkland are two neighboring countries that actively trade goods and services with each other. Under the gold standard, there will be a net flow of gold from Norkland to Certovia when
Certovia is in a trade surplus with Norkland. Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. Under the gold standard, when country A has a trade surplus with country B, there will be a net flow of gold from country B to country A. These gold flows automatically reduce the money supply of country B and swell country A's money supply.
Three countries, close to each other in the Pacific Rim, enter into an agreement to remove all tariffs and trade barriers between them. They decide on a common trade policy with regard to nonmembers. Faced with political backlash, the countries stop short of allowing mobility of factors of production such as labor and capital. Which of the following levels of economic integration best describes this arrangement?
Custom's Union. A customs union is a group of countries committed to (1) removing all barriers to the free flow of goods and services between each other and (2) the pursuit of a common external trade policy.
Which of the following has no impediments to the free flow of goods and services, such as trade barriers?
Efficient Market. An efficient market has no impediments to the free flow of goods and services, such as trade barriers, and prices reflect all available public information. 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.
Where has the movement toward regional economic integration been most successful?
Europe. Nowhere has the movement toward regional economic integration been more successful than in Europe. Today, the EU has a population of almost 500 million and a gross domestic product of more than $18.5 trillion, making it slightly larger than the United States in economic terms.
Which of the following is responsible for proposing European Union legislation, implementing it, and monitoring compliance with European Union laws by member-states?
European Commission. The European Commission is responsible for proposing EU legislation, implementing it, and monitoring compliance with EU laws by member-states. Headquartered in Brussels, Belgium, the commission has more than 24,000 employees.
The emphasis of the European Free Trade Association has been on free trade in consumer goods.
False The emphasis of the European Free Trade Association (EFTA) has been on free trade in industrial goods. Agriculture was left out of the arrangement, each member being allowed to determine its own level of support. Members are also free to determine the level of protection applied to goods coming from outside the EFTA.
When a firm enters into a spot exchange contract, it is taking out insurance against adverse future exchange rate movements.
False. A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future. Exchange rates governing such future transactions are referred to as forward exchange rates. When a firm enters into a forward exchange contract, it is taking out insurance against the possibility that future exchange rate movements will make a transaction unprofitable by the time that transaction has been executed.
The foreign exchange market offers complete insurance against foreign exchange risk.
False. Although the foreign exchange market offers some insurance against foreign exchange risk, it cannot provide complete insurance. It is not unusual for international businesses to suffer losses because of unpredicted changes in exchange rates
A disadvantage of the euro is that the development of a pan-European, euro-denominated capital market will decrease the range of investment options open to both individuals and institutions.
False. An advantage of the euro is that the development of a pan-European, euro-denominated capital market will increase the range of investment options open to both individuals and institutions. This will enable European investors to better diversify their risk, which again lowers the cost of capital, and should also increase the efficiency with which capital resources are allocated.
Under a currency board system, the government has the absolute authority to set interest rates.
False. Currency boards have their drawbacks. Under a currency board system, government lacks the ability to set interest rates.
Assume that the euro/dollar exchange rate is €1 = $1.20. If it costs $36 to buy a European product, the stated price of the product would be €36.
False. Since the euro/dollar exchange rate is €1 = $1.20, 36 dollars would be equal to 30 euros (36 × 1/1.2).
The International Monetary Fund can force countries to adopt the policies required to correct economic mismanagement.
False. The International Monetary Fund (IMF) cannot force countries to adopt the policies required to correct economic mismanagement. While a government may commit to taking corrective action in return for an IMF loan, internal political problems may make it difficult for a government to act on that commitment.
When companies wish to convert currencies, they typically enter the foreign exchange market directly.
False. The foreign exchange market is not located in any one place. It is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems. When companies wish to convert currencies, they typically go through their own banks rather than entering the market directly.
The international monetary system refers to a system to regulate fixed exchange rates before the introduction of the euro.
False. The international monetary system refers to the institutional arrangements that govern exchange rates.
As the only currency that could be converted into gold, the British pound occupied a central place in the fixed exchange rate system.
False. The system of fixed exchange rates established at Bretton Woods worked well until the late 1960s, when it began to show signs of strain. As the only currency that could be converted into gold, and as the currency that served as the reference point for all others, the dollar occupied a central place in the system.
Trade creation occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area.
False. Trade creation occurs when high-cost domestic producers are replaced by low-cost producers within the free trade area. It may also occur when higher-cost external producers are replaced by lower-cost external producers within the free trade area.
What happens in the foreign exchange market does not directly impact the sales, profits, and strategy of a multinational enterprise.
False. What happens in the foreign exchange market can have a fundamental impact on the sales, profits, and strategy of an enterprise. Accordingly, it is very important for managers to understand the foreign exchange market, and what the impact of changes in currency exchange rates might be for their enterprise.
When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a pegged exchange rate regime.
False. When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a floating exchange rate regime. Four of the world's major trading currencies—the U.S. dollar, the European Union's euro, the Japanese yen, and the British pound—are all free to float against each other.
The forward exchange rate refers to the rate at which a foreign exchange dealer converts one currency into another currency on a particular day.
False. When two parties agree to exchange currency and execute the deal immediately, the transaction is referred to as a spot exchange. Exchange rates governing such "on the spot" trades are referred to as spot exchange rates. The spot exchange rate refers to the rate at which a foreign exchange dealer converts one currency into another currency on a particular day.
Spot exchange rates and the 30-day forward rates are the same.
False. Differences in spot exchange rates and the 30-day forward rates are normal; they reflect the expectations of the foreign exchange market about future currency movements.
Which of the following enables organizations to conduct international trade without having to resort to barter?
Foreign Exchange Market. Without the foreign exchange market, international trade and international investment on the scale that we see today would be impossible; companies would have to resort to barter. The foreign exchange market is the lubricant that enables companies based in countries that use different currencies to trade with each other.
Which of the following is the most popular form of regional economic integration, accounting for almost 90 percent of regional agreements?
Free Trade Agreements. In a free trade area, all barriers to the trade of goods and services among member countries are removed. Free trade agreements are the most popular form of regional economic integration, accounting for almost 90 percent of regional agreements.
Omega, Inc., a U.S.-based firm entered into an agreement with another party to exchange currency and execute the deal at a specific date in the future. What is Omega, Inc. engaging in when it insures itself against foreign exchange risk?
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.
Which of the following refers to the institutional arrangements that govern exchange rates?
International Monetary System. The international monetary system refers to the institutional arrangements that govern exchange rates.
Which of the following is true of the Court of Justice?
It is the supreme appeals court for the European Union law. The Court of Justice, which is comprised of one judge from each country, is the supreme appeals court for EU law. Like commissioners, the judges are required to act as independent officials, rather than as representatives of national interests.
Which of the following is a reason for London's dominance in the foreign exchange market?
London's location making it the link between the East Asian and New York markets. London's dominance in the foreign exchange market is due to both history and geography. As the capital of the world's first major industrial trading nation, London had become the world's largest center for international banking by the end of the nineteenth century, a position it has retained. Today, London's central position between Tokyo and Singapore to the east and New York to the west has made it the critical link between the East Asian and New York markets. Due to the particular differences in time zones, London opens soon after Tokyo closes for the night and is still open for the first few hours of trading in New York.
Which of the following foreign exchange trading centers has the highest percentage of activity?
London. The foreign exchange market has been growing at a rapid pace, reflecting a general growth in the volume of cross-border trade and investment. The most important trading centers are London (37 percent of activity), New York (18 percent of activity), and Zurich, Tokyo, and Singapore (all with around 5 to 6 percent of activity). Major secondary trading centers include Frankfurt, Paris, Hong Kong, and Sydney.
Which of the following is true about the European Commission?
The European Union's competition commissioner has been gaining influence as the chief regulator of competition policy in the member nations of the European Union. The European Commission's role in competition policy has become increasingly important to business in recent years. Since 1990 when the office was formally assigned a role in competition policy, the European Union's competition commissioner has been steadily gaining influence as the chief regulator of competition policy in the member nations of the European Union.
Which of the following is a key feature of the foreign exchange market?
The foreign exchange market never sleeps. A feature of the foreign exchange market that is of particular note is that the market never sleeps. Tokyo, London, and New York are all shut for only 3 hours out of every 24. During these three hours, trading continues in a number of minor centers, particularly San Francisco and Sydney, Australia.
Which of the following is true of the differences in relative demand and supply of currencies?
They cannot explain or predict when the demand of a particular currency would exceed its supply and vice versa. At the most basic level, exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another. However, it does not show under what conditions a currency is in demand or under what conditions it is not demanded.
A common market has no barriers to trade among member countries, includes a common external trade policy, and allows factors of production to move freely among members.
True. A common market has no barriers to trade between member countries, includes a common external trade policy, and allows factors of production to move freely between members. Labor and capital are free to move because there are no restrictions on immigration, emigration, or cross-border flows of capital between member countries.
Although a foreign exchange transaction can involve any two currencies, most transactions involve dollars on one side.
True. A feature of the foreign exchange market is the important role played by the U.S. dollar. Although a foreign exchange transaction can involve any two currencies, most transactions involve dollars on one side. This is true even when a dealer wants to sell a nondollar currency and buy another.
According to the Bretton Woods agreement, if a currency became too weak to defend, a devaluation of up to 10 percent would be allowed without any formal approval by the International Monetary Fund.
True. An aspect of the Bretton Woods agreement was a commitment not to use devaluation as a weapon of competitive trade policy. However, if a currency became too weak to defend, a devaluation of up to 10 percent would be allowed without any formal approval by the International Monetary Fund (IMF). Larger devaluations required IMF approval.
By adopting the euro, the European Union has created the second most widely traded currency in the world after that of the U.S. dollar.
True. By adopting the euro, the European Union has created the second most widely traded currency in the world after that of the U.S. dollar. Some believe that ultimately the euro could come to rival the dollar as the most important currency in the world.
Under the fixed exchange rate system, the dollar could be devalued only if all countries agreed to simultaneously revalue against the dollar.
True. Devaluation of the dollar was no easy matter. Under the Bretton Woods provisions, any other country could change its exchange rates against all currencies simply by fixing its dollar rate at a new level. As the key currency in the fixed exchange rate system, the dollar could be devalued only if all countries agreed to simultaneously revalue against the dollar.
The Andean Community now operates as a customs union.
True. In 1990, the heads of the five current members of the Andean Community—Bolivia, Ecuador, Peru, Colombia, and Venezuela—met in the Galápagos Islands. The resulting Galápagos Declaration effectively relaunched the Andean Pact, which was renamed the Andean Community in 1997. The declaration's objectives included the establishment of a free trade area by 1992, a customs union by 1994, and a common market by 1995. This last milestone has not been reached. A customs union was implemented in 1995—although Peru opted out and Bolivia received preferential treatment until 2003. The Andean Community now operates as a customs union.
Under a floating exchange rate regime, market forces have produced a volatile dollar exchange rate.
True. In recent history, the value of the dollar has been determined by both market forces and government intervention. Under a floating exchange rate regime, market forces have produced a volatile dollar exchange rate.
Given a common gold standard, the value of any currency in units of any other currency (the exchange rate) was easy to determine.
True. Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. By 1880, most of the world's major trading nations, including Great Britain, Germany, Japan, and the United States, had adopted the gold standard. Given a common gold standard, the value of any currency in units of any other currency (the exchange rate) was easy to determine.
With the signing of the Treaty of Rome in 1957, the European Economic Community was established.
True. With the signing of the Treaty of Rome in 1957, the European Economic Community was established. The name changed again in 1993 when the European Economic Community became the European Union following the ratification of the Maastricht Treaty.
Currency swaps 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.
True. A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. Swaps 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.
As with free trade in general, regional economic integration creates gain for consumers, but it can be challenging for some producers.
True. By regional economic integration we mean agreements among countries in a geographic region to reduce, and ultimately remove, tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other. Thus, as with free trade in general, regional economic integration creates gain for consumers, but it can be challenging for some producers. For example, the specter of the EU and NAFTA turning into economic fortresses that shut out foreign producers through high tariff barriers is worrisome to those who believe in unrestricted free trade
A pegged exchange rate means the value of the currency is fixed relative to a reference currency, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate.
True. Many of the world's developing nations peg their currencies, primarily to the dollar or the euro. A pegged exchange rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate.
Carry trade is a kind of speculation whose success is based upon a belief that there will be no adverse movement in exchange rates.
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 speculative element of the carry trade is that its success is based on a belief that there will be no adverse movement in exchange rates (or interest rates for that matter) that will make the trade unprofitable.
A political union addresses the issue of how to make a coordinating bureaucracy accountable to the citizens of member nations of an economic union.
True. The move toward economic union raises the issue of how to make a coordinating bureaucracy accountable to the citizens of member nations. The answer is through political union in which a central political apparatus coordinates the economic, social, and foreign policy of the member-states.
In terms of regional economic integration, linking neighboring economies and making them increasingly dependent on each other creates incentives for political cooperation between the neighboring states.
True. The political case for regional economic integration also has loomed large in several attempts to establish free trade areas, customs unions, and the like. Linking neighboring economies and making them increasingly dependent on each other creates incentives for political cooperation between the neighboring states and reduces the potential for violent conflict. In addition, by grouping their economies, the countries can enhance their political weight in the world.
Many of the world's developing nations peg their currencies, primarily to the
U.S. Dollar. Many of the world's developing nations peg their currencies, primarily to the dollar or the euro. A pegged exchange rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate.
Which of the following statements is true about the various exchange rate systems?
Under the Bretton Woods system, currency devaluations over 10 percent were allowed only with the approval of the IMF. An aspect of the Bretton Woods agreement was a commitment not to use devaluation as a weapon of competitive trade policy. However, if a currency became too weak to defend, a devaluation of up to 10 percent would be allowed without any formal approval by the IMF. Larger devaluations required IMF approval.
The architects of the Bretton Woods agreement built limited flexibility into the fixed exchange rate system in order to
avoid high unemployment. Although monetary discipline was a central objective of the Bretton Woods agreement, it was recognized that a rigid policy of fixed exchange rates would be too inflexible. In some cases, a country's attempts to reduce its money supply growth and correct a persistent balance-of-payments deficit could force the country into recession and create high unemployment. The architects of the Bretton Woods agreement wanted to avoid high unemployment, so they built limited flexibility into the fixed exchange rate system.
Which of the following describes a country 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. A country is said to be in balance-of-trade equilibrium when the income its residents earn from exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in balance).
Which of the following caused a decline in the dollar/yen carry trade during 2008-2009?
decrease in interest rate differentials as the U.S. rates came down. The dollar/yen carry trade was actually very significant during the mid-2000s, peaking at more than $1 trillion in 2007, when some 30 percent of trade on the Tokyo foreign exchange market was related to the carry trade. This carry trade declined in importance during 2008-2009 because interest rate differentials were falling as U.S. rates came down, making the trade less profitable.
The European Council is considered to be the ultimate controlling authority within the European Union (EU) because
draft legislation from the European Commission can become EU law only if the council agrees. The European Council represents the interests of member-states. It is clearly the ultimate controlling authority within the EU since draft legislation from the commission can become EU law only if the council agrees.
Which of the following was the initial mission of the World Bank?
financing the building of Europe's economy by providing low-interest loans. When the Bretton Woods participants established the World Bank, the need to reconstruct the war-torn economies of Europe was foremost in their minds. The bank's initial mission was to help finance the building of Europe's economy by providing low-interest loans.
The countries of Mimbo, Juwan, and Ninot agreed to remove all barriers to the trade of goods and services among each other. However, the three countries agreed that each would be allowed to determine its own trade policies with regard to nonmembers. The economic integration among these three countries is a(n)
free trade area. Several levels of economic integration are possible in theory. From least integrated to most integrated, the levels of economic integration are a free trade area, a customs union, a common market, an economic union, and, finally, a full political union. In a free trade area, all barriers to the trade of goods and services among member countries are removed. Each country, however, is allowed to determine its own trade policies with regard to nonmembers.
In terms of the gold standard, the amount of currency needed to purchase one ounce of gold was referred to as the
gold par value. The amount of a currency needed to purchase one ounce of gold was referred to as the gold par value. From the gold par values of pounds and dollars, we can calculate what the exchange rate was for converting pounds into dollars.
Which of the following refers to currency speculation?
short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates. Currency speculation is one of the uses of foreign exchange markets. It typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.
A regional free trade agreement will benefit the world only if
the amount of trade it creates exceeds the amount it diverts. Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts.
Assume that the exchange rate between the British pound and the U.S. dollar is 1 pound = 2 dollars. An Armani jacket sells for $80 in New York and 40 pounds in London. This is an example of
the law of one price. The law of one price states that in competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.
As a result of the formation of a free trade area between six member countries in the Pacific Rim, the member country of Rimho found that its lower-cost external suppliers were replaced by higher-cost suppliers within the free trade area. This is an example of ______
trade diversion. Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts.