AGB 302: Week 5 Quiz

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

$1,500

The U.S. and Canada would benefit from NAFTA because of

-Access to a large and prosperous market -Lower prices for consumers from goods produced in Mexico -Low cost labor and the ability to be more competitive on world markets

Mercosur

-Brazil, Argentina, Paraguay, and Uruguay -May be diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis

Association of Southeast Asian Nations (ASEAN)

-Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodia -Wants to foster freer trade between member countries and to achieve some cooperation in their industrial policies

Single European Act

-Committed the EC countries to work toward establishment of a single market by December 31, 1992

The main institutions in the EU:

-European Council -European Commission -European Parliament -Court of Justice

Foreign Exchange Market

-Is used to convert the currency of one country into the currency of another -Provides some insurance against foreign exchange risk

Critics of NAFTA claim that

-Jobs would be lost and wage levels would decline in the U.S. and Canada -Pollution would increase due to Mexico's more lax standards -Mexico would lose its sovereignty

What does economic integration mean for managers?

-Opens new markets -Allows firms to realize cost economies by centralizing production in those locations where the mix of factor costs and skills is optimal

Benefits of the euro

-Savings from having to handle one currency, rather than many -It is easier to compare prices across Europe, so firms are forced to be more competitive

North American Free Trade Area

-United States, Canada, and Mexico -Abolished tariffs on 99% of the goods traded between members -Protects intellectual property rights

Three factors that impact future exchange rate movements

1. A country's price inflation 2. A country's interest rate 3. Market psychology

To minimize transaction and translation exposure, managers should

1. Buy forward 2. Use swaps 3. Lead and lag payables and receviables

Managers need to consider these three types of foreign exchange risk:

1. Transaction exposure 2. Translation exposure 3. Economic exposure

Country X and Country Y reach an agreement to boost bilateral trade. They agree to remove all barriers to the trade of goods and services. They, however, are free to determine their own trade policies with regard to nonmembers. Which level of economic integration is this an example of?

A Free trade area

Capital Flight

A large and sudden reduction in the demand for assets located in a country

Efficient Markets

A market with no impediments to the free flow of goods and services

Which feature of a common market differentiates it from a customs union?

Ability of factors of production to move freely between members

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

Currency swap

Vehicle Currency

Currency used as an intermediary to convert funds between two other currencies

Free Trade Area

Eliminates all barriers to the trade of goods and services among member countries

Customs Union

Eliminates trade barriers between member countries and adopts a common external trade policy

The movement toward regional economic integration been most successful in ________.

Europe

The emerging role of the ________ in competition policy suggests the EU is increasingly willing and able to intervene and impose conditions on companies proposing mergers and acquisitions.

European Commission

The ________ is primarily a consultative rather than legislative body.

European Parliament

Europe's two trade blocs

European Union and European Free Trade Area

A currency is ______________ when non-residents can convert their holdings of domestic currency into a foreign currency, but when the ability of residents to convert currency is limited in some way.

Externally convertible

Forward Exchanges

Firms engage in this to insure or hedge against a possible adverse foreign exchange rate movement

________ are exchange rates governing some specific future date foreign exchange transactions.

Forward exchange rates

Efficient Market School

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

A currency is _______________ when a government of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency.

Freely convertible

Common Market

Has no barriers to trade between member countries, a common external trade policy, and the free movement of the factors of production

Economic Union

Has the free flow of products and factors of production between members, a common external trade policy, a common currency, a harmonized tax rate, and a common monetary and fiscal policy

A country with ____________ inflation should see its currency depreciate relative to others.

High

A(n) ________ has no barriers to trade between member countries, includes a common external trade policy, and allows factors of production to move freely between members.

common market

Linking neighboring countries economically and making them interdependent:

creates incentives to increase political cooperation as well.

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

currency speculation.

A(n) ________ entails even closer economic integration and cooperation than a common market.

economic union

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.

premium

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

spot exchange rate

Translation Exposure

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

Arbitrage

The process of buying a currency low and selling it high

Spot Exchange rate

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

Exchange Rate

The rate at which one currency is converted into another

What is the risk of economic integration for managers?

The risk of being shut out of the single market by the creation of a "trade fortress"

Currency Speculation

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

Currency Swap

The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates

Court of Justice

The supreme appeals court for EU law

European Council

The ultimate controlling authority within the EU

CARICOM

To establish a customs unit

Caribbean Single Market and Economy (CSME)

To lower trade barriers and harmonize macroeconomic and monetary policy between members

Central American Trade Agreement (CAFTA)

To lower trade barriers between the U.S. and members

North American Free Trade Agreement (NAFTA)

U.S., Canada, and Mexico

Hedging

When a firm is insuring itself against foreign exchange risk

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 ________.

arbitrage

Regional Economic Integration

Agreements between countries in a geographic region to reduce tariff and non-tariff barriers to the free flow of goods, services, and factors of production between each other

Purchasing Power Parity Theory (PPP)

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

The ________ was established to increase multinational cooperation in view of the economic rise of the Pacific nations and the growing interdependence within the region.

Asia-Pacific Economic Cooperation

Lead Strategy

Attempt to collect foreign currency receivables early when a foreign currency is expected to depreciate and pay foreign currency payables before they are due when a currency is expected to appreciate

Countertrade

Barter-like agreements where goods and services are traded for other goods and services

Andean Community

Bolivia, Colombia, Ecuador, and Peru

Technical Analysis

Charts trends with the assumption that past trends and waves are reasonable predictors of future trends and waves

Maastricht Treaty

Committed the EU to adopt a single currency

Inefficient Market School

Companies can improve the foreign exchange market's estimate of future exchange rates by investing in forecasting services

European Parliament

Debates legislation proposed by the commission and forwarded to it by the council

Lag Strategy

Delay collection of foreign currency receivables if that currency is expected to appreciate and delay payables if the currency is expected to depreciate

Three long-term EU members, Great Britain, ________, and Sweden, have not adopted the euro.

Denmark

Fundamental Analysis

Draws upon economic factors like interest rates, monetary policy, inflation rates, or balance of payments information to predict exchange rates

Regional economic integration is only beneficial

If the amount of trade it creates exceeds the amount it diverts

Mexico would benefit from NAFTA because of

Increased jobs as low cost production moves south and will see more rapid economic growth as a result

Political Union

Involves a central political apparatus that coordinates the economic, social, and foreign policy of member states

How well does PPP work?

It is more accurate in the long run, and for countries with high inflation and underdeveloped capital markets

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

London

A currency is ______________ when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency.

Nonconvertible

European Free Trade Association (EFTA)

Norway, Iceland, Liechtenstein, and Switzerland

Free Trade of The Americas (FTAA)

Not established -U.S. wants stricter enforcement of intellectual property rights -Brazil and Argentina want the US to eliminate agricultural subsidies and tariffs

Bandwagon Effect

Occurs when expectation on the part of traders turn into self-fulfilling prophecies

Trade Diversion

Occurs when higher cost suppliers within the free trade area replace lower cost external suppliers

Trade Creation

Occurs when low cost producers within the free trade area replace high cost domestic producers

Inefficient Market

One in which prices do not reflect all available information

Efficient Market

One in which prices reflect all available information

EU is not an

Optimal currency area

A _____________ relationship exists between the inflation rate and the level of money supply.

Positive

The devastation of two world wars on Western Europe ___________________.

Prompted the formation of the EU

European Commission

Responsible for proposing EU legislation, implementing it, and monitoring compliance with EU laws by member states

Andean Pact (Andean Community)

Signed an agreement with Mercosur to restart negotiations towards the creation of a free trade area

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 two countries

Law of One Price

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

Treaty of Rome

The European Economic Community was formed here with the goal of becoming a common market

Foreign Exchange Risk

The adverse consequences of unpredictable changes in exchange rates

Exchange rates are determined by

The demand and supply for different currencies

Assume that an American company today invests some of its spare cash in a Hungarian money market account that will earn 8 percent for a period of 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?

The dollar appreciates against the Hungarian forint.

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?

The dollar will appreciate against the yen

Economic Exposure

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

Transaction Exposure

The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values