BUS 498 chapter 10

In countries where inflation is expected to be high, interest rates also will be high, because investors want compensation for the decline in the value of their money. This relationship is referred to as the

Fisher effect.

The U.S. dollar is selling at a discount on the 30-day forward market when what is taking place?

The current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 = ¥110 after 30 days

Assume that the dollar is selling at a premium on the 30-day dollar/euro forward market. What is true of the foreign exchange dealers' market's expectations about the dollar over the next 30 days?

The dollar will appreciate against the euro.

In terms of foreign exchange, what is true of leading and lagging strategies?

They can help firms minimize their transaction and translation exposure.

________ is concerned with the effect of exchange rate changes on individual transactions, most of which are short-term affairs that will be executed within a few weeks or months.

Transaction exposure

True or False: If many national markets are controlled by a few multinational enterprises with the power to influence prices and distribution channels, PPP theory may not hold.

True

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

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

a depreciation

Cyber Corp., based in Toronto, decided it wanted to collect all of its foreign currency receivables from Indonesia early because the currency in Indonesia was expected to depreciate. This is an example of

a lead strategy.

Countertrade is defined as

a range of barter-like agreements by which goods and services can be exchanged for other goods and services.

In theory, if inflation is at an all-time high in the United States, then its currency will

appreciate against that of other countries where inflation is lower.

A lag strategy occurs when a firm attempts to delay the collection of foreign currency receivables when a currency is expected to ______ and delay foreign currency payables when a currency is expected to ______.

appreciate; depreciate

Assume that the yen/dollar exchange rate quoted in Tokyo at 5 p.m. is ¥120 = $1, and the New York yen/dollar exchange rate at the same time (noon New York time) is ¥123 = $1. What action should a broker take to yield immediate profit?

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

Assume the euro/dollar exchange rate quoted in Tokyo at 6 a.m. is €1 = $1.00. If the New York euro/dollar exchange rate at the same time (5 p.m. New York time) is €1 = $1.35, a dealer could make a profit through

arbitrage.

Kendall Wood Products Corp. purchased securities on the London Stock Exchange and then immediately resold them on the New York Stock Exchange at a higher price. The profits from this transaction were used to buy new machinery for the mill. This company engaged in

arbitrage.

Expectations becoming a self-fulfilling prophecy when currency traders move in the same direction at the same time is called the ______ effect.

bandwagon

Traders at a stock exchange notice that five traders on the floor seem to be selling more yen and purchasing more euros because of an expected decline in the yen. As a result, all other traders started to do the same. This is an example of the ________ that creates a self-fulfilling prophecy when the yen does decline in value.

bandwagon effect

Assume that the interest rate on borrowings in Argentina is 3 percent, but the interest rate on deposits in British banks is 9 percent. A trader borrows 1 million Argentine pesos, then converts the money into British pounds and deposits it in a British bank. What is the trader involved in?

carry trade

An example of transaction exposure is when

companies have obligations for the purchase of goods at previously agreed prices.

Assume that a Big Mac costs $4.93 in the United States and that the Brazilian real is undervalued by 23 percent. According to the Big Mac Index published by The Economist, a Big Mac would

cost less in Brazil than in the United States

When General Electric won a contract for a $150 million generator project in Romania, it agreed to take payment in the form of Romanian goods that could be sold for $150 million on international markets. This is an example of

countertrade.

A(n) _____ refers to the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

currency swap

The currency in a small Asian nation is depreciating rapidly in value. As a result, residents of the country and foreign businesses with an interest in the country are converting their currency into U.S. dollars. This is an example of

currency swap.

A lag strategy involves

delaying the collection of foreign currency receivables when a foreign currency is expected to depreciate.

It would be difficult to profit through arbitrage because the ______ for a currency would increase when dealers try to profit from exchange rate discrepancies leading to ______ of that currency, and the price differential would disappear.

demand; appreciation

The purchasing power parity (PPP) theory tells us that a country with a high inflation rate will see

depreciation in its currency exchange rate.

In a forward exchange transaction, $1 buys more lira with a spot exchange than with a 30-day forward exchange. When this occurred, it is said that the dollar is selling at a _____ on the 30-day forward market. spot

discount

While many companies focus on reducing transaction and translation exposure when managing foreign exchange risk, very few companies pay attention to Blank 1Blank 1 transaction , Incorrect Unavailable exposure.

economic

What is meant by economic exposure?

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

The efficient market school believes that the foreign exchange market is efficient at setting ______ exchange rates.

forward

According to the efficient market school, ________ do the best job at predicting future spot exchange rates.

forward exchange rates

Jacob is the chief financial officer for RinseAll Detergent products. His company is interested in investing in a facility in Indonesia, but he is worried about unpredictable fluctuations in future exchange rates, which could cost his company millions of dollars. One way to ensure against this exchange risk is for Jacob to use

hedging.

A company's translation exposure is based on the

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

One reason for the failure of purchasing power parity theory and international Fisher effect in predicting short-term movements in exchange rates is due to the

impact of investor psychology on short-run exchange rate movements.

The law of one price states that

in competitive markets free of transportation costs and trade barriers, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.

The ________ is a variable used in exchange rate forecasting models based on fundamental analysis.

inflation rate

A(n) Blank 1Blank 1 lead , Incorrect Unavailable(lead or lag?) strategy is when a firm attempts to delay the collection of foreign currency receivables when a currency is expected to appreciate and delay foreign currency payables when a currency is expected to depreciate.

lag

Carlos is the manager of an American company. He expects the value of the British pound to appreciate in the near future and so delays the collection of payments from British customers until the next month. Which tactic is Carlos using to minimize the foreign exchange exposure?

lag strategy

Assume that the exchange rate between the U.S. dollar and the Japanese yen is $1 = ¥150. A book that retails for $10 in New York should sell for ¥1,500 in Tokyo, if there are no trade barriers and transportation costs, according to the

law of one price.

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

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

nonconvertible

When $1 buys more lira with a forward exchange than with a spot exchange, it is said that the dollar is selling at a _____ on the 30-day forward market.

premium

When Lila was planning her visit to Japan, she learned that the 30-day forward exchange rate was $1 = ¥130, which meant that $1 would buy more yen with a forward exchange than a spot exchange. In other words, the dollar was selling at a ________ on the 30-day forward market.

premium

Gold Brands is the industry leader in golf equipment and not only has a degree of pricing power amongst its competition but also sets different prices in different markets based on demand conditions. Gold Brands is practicing

price leadership.

One function of the foreign exchange market is to

provide some insurance against foreign exchange risk.

The purchasing power parity puzzle is the name given to the failure to find a strong link between exchange rate movements and

relative inflation rates.

Foreign exchange markets can provide some insurance against volatile changes in exchange rates, which is called foreign exchange_________________________________

risk

A country that relies on technical analysis for forecasting exchange rate movements would know that

since forward exchange rates are the best predictors of future spot rates, it makes no sense to invest in forecasting.

In terms of the approaches to exchange rate forecasting, _____ is based on the premise that there are analyzable market trends and waves and that previous trends and waves can be used to predict future trends and waves.

technical analysis

A currency is considered freely convertible when

the country's government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency with it.

The phenomenon of capital flight is most likely to occur when

the value of the domestic currency depreciates rapidly because of hyperinflation.

Currency speculation takes place when

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

Why do governments limit convertibility of their currency?

to preserve their foreign exchange reserves

Suppose a US company agrees to buy products worth 1 million euros. At the time of the agreement, the dollar/euro exchange rate was $1 = €1.10, but at the time of payment, the exchange rate is $1 = €0.80. The additional money owed by the US company due the adverse movement in exchange rates between the time of the deal and the time when payment is due is called ______ exposure.

transaction

The purchasing power parity (PPP) theory best predicts exchange rate changes for countries with

underdeveloped capital markets.

If a basket of goods costs $100 in the United States and €120 in Europe, what would the purchasing power parity theory's prediction of the dollar/euro exchange rate be?

$1 = €1.20

Assume that the exchange rate between the euro and the dollar is €1.00 = $1.50. An American tourist in Germany is buying a product whose price is €80. How much in U.S. dollars would the tourist have to pay to buy the product?

$120

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