Ch 10
True or false: The foreign exchange market is essentially open 24 hours per day.
True
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.
________ 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
True or false: Empirical evidence suggest that the International Fisher effect does NOT explain short-term exchange rate movements well.
True
Buying a currency low and immediately selling it high to make a profit from the price discrepancy is called _____.
arbitrage
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
In theory, if a country's price inflation is rising rapidly, it should expect to see its currency ___ against that of countries in which inflation rates are lower.
depreciate
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
An economist who believes that the foreign exchange market is effective at setting forward rates is a part of the _____ market school.
efficient
A tactic that reduces translation and economic exposure is
entering into forward exchange rate contracts.
When a country allows both residents and nonresidents to purchase unlimited amounts of a foreign currency, the country's currency is
freely convertible
The method of forecasting that draws on economic theory to construct sophisticated models is called the ______ approach.
fundamental
Which approach to forecasting draws on economic theory to develop models that predict exchange rate movements?
fundamental
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
Which school of thought on exchange rate forecasting does NOT believe that forward exchange rates are the best predictors of future spot exchange rates?
inefficient
What are the two schools of thought regarding the prediction of future exchange rates?
inefficient market school efficient market school
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
The impact of psychological factors and investor expectations make it difficult for exchange rate theories to predict ______ changes in exchange rates.
short-term
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.
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
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: Spot against forward is a common type of currency swap.
True
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
To protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies, firms should aim for ___ control of exposure. (Choose centralized or decentralized.)
centralized
What are the two main functions of the foreign exchange market?
currency conversion provide insurance against foreign exchange risk
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
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
A(n) ______ convertible currency allows only nonresidents to convert it into a foreign currency without any limitations.
externally
In an efficient market, prices are said to
fully reflect all available information.
A(n) ______ is based on the theory that prices don't reveal all available information and more is needed to predict future spot exchange rates.
inefficient market
The text suggests that as a way to take control of exchange rate risk, firms should produce ______ foreign exchange reports.
monthly
Currency ______ involves buying, selling and holding currencies in order to make a profit from favorable fluctuations in exchange rates.
speculation
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.
Firms should only rely on what four things to predict exchange rate movements?
transaction and translation exposure forecasting future exchange rates monthly foreign exchange exposure reports establishing good reporting systems
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 Economists's version of the PPP uses ______ as a proxy for a "basket of goods."
the Big Mac
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
What is hyperinflation?
An explosive and seemingly uncontrollable price inflation in which money loses value very rapidly
What is the transaction called where two parties agree to exchange currency at some specific date in the future?
Forward exchange
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.
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 three moderately decent predictors of long-term changes in exchange rates? (Check all that apply.)
Nominal interest rate differentials Relative inflation rates Relative monetary growth
______ exposure involves the present measurement of past events using currency exchange rate changes on a company's financial statements.
Translation
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
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.
An investment made to profit from future currency movements is called
currency speculation.
The extent to which income from individual transactions is affected by fluctuations in foreign exchange values is known as transaction ______.
exposure
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
The ______ market school believes that forward exchange rates are NOT the best predictors of future spot exchange rates.
inefficient
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.
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
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 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
Two strategies that can be used to reduce translation and transaction exposure are: (Check all that apply.)
lag strategy lead strategy
Economic exposure is concerned with the ___ - term effect of changes in exchange rates on future prices, sales, and costs.
long
What are considered the two most prominent features of the foreign exchange market? (Check all that apply.)
The market never sleeps. The trading centers are integrated.
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
If the demand for the yen outstrips its availability and if the supply of the dollar outweighs the demand, the yen will ___ against the dollar.
appreciate
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
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 high inflation rates Countries with underdeveloped capital markets
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: Economic exposure is concerned with the long-run effect of changes in exchange rates on future prices, sales, and costs.
The extent to which a firm's future international earning power will be affected by exchange rate changes is called ______ exposure.
economic
When a country experiences hyperinflation, money ___ value very rapidly.
loses
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