Chapter 4

Approximately how many different currencies are used to make international payments for goods and services?

150

For many countries, adopting the euro has provided many benefits EXCEPT which of the following?

A reduction in GDP

Forex Market

Abbreviation of foreign exchange markets.

What is the practice of buying goods in a lower priced market and selling them in a higher priced market to make a profit called?

Arbitrage

If you were a global distributor and purchased products in a lower priced market and then sold those products in a higher priced market, what would this practice be called?

Arbritrage

How would a purchase of foreign goods from the United States that required importing be recorded in the balance of payment (BOP)?

As a debit in the current account

To fully appreciate the strengths and weaknesses of a country (such as Greece) against the rest of the world, and to ascertain its budget constraint, it is important to have a basic understanding of which of its statistics?

Balance of Payments

What is the statement of account that shows all transactions between the residents of one country and the rest of the world for a given period of time called?

Balance of payments

The four subaccountrs of the current account of the BOP

Balance of trade in goods Balance of trade in services Balance of primary income Balance of secondary income

The forward market is run by _____.

Banks

why do govts intervene in markets

Because of the perceived benefits to society, the need for goods and services that will not be protected or provided by the market, or the failure or inability of the market in distributing income, producing desired goods, or achieving other politically/socially desirable outcomes.

The ____ rate will always be lower that the ____ rate

Bid; ask

Over time, various international monetary systems have developed to facilitate international business. Which 1944 agreement established the International Monetary Fund (IMF), a financial authority that helps to ensure the stability of the international monetary and financial system?

Bretton Woods Agreement

What is a hedge?

Buying currency futures to expand markets.

Which is the least significant item in a country's balance of payment?

Capital account balance

Money leaving the country is what type of transaction?

Debit

In 1979, the European community established the European Exchange Rate Mechanism (ERM). Under the ERM, a weighted basket of European currencies known as the ECU (European Currency Unit) was defined with varying exchange rates. The EMU introduced the euro as a new currency to replace the currencies of the member countries in the Eurozone, which has since grown to 19 members. The euro is currently a monetary system with varying degrees of government intervention to maintain a range of acceptable values against other currencies. This is best described by which concept?

Dirty float currency

What type of monetary system utilizes varying degrees of government intervention to maintain a range of acceptable values against other currencies?

Dirty float currency

What does the financial account do?

Documents the net acquisition and disposal of financial assets and liabilities

Which country practices dollarization?

El Salvador

How many major accounts comprise the balance of payments (BOP)?

Five

What is the net of investment income from abroad and investment payments to foreigners called?

Income balance

The three largest foreign exchange markets are in

London New York Tokyo

Country A is an emerging economy and Country B is a developed economy with a hard currency. Country A's currency is less stable in value than Country B's currency and is pegged to Country B's currency value. How would you describe Country A's currency?

Soft

Purchasing power parity (PPP)

The amount of money needed in one country to purchase the same goods and services in another country

Net errors and omissions can be derived from

The balance of financial account minus the balance of current and capital accounts

What is the second major subaccount of a country's BOP?

The financial account

What concept best describes a country that imports more than it exports?

Trade deficit

In the 60 day forward market the dollar is selling at

a discount

BOP

balance of payments

spot market

market in which a transaction is made immediately at the prevailing price

The four subaccounts of the financial account of the BOP

-Foreign direct investment -Portfolio investment -Financial derivatives -Other investment assets

China has the world's largest folding of foreign exchange reaching approximately _________.

3.4 trillion in 2020

What do the subaccounts of the financial account balance measure?

Changes in financial transactions

The largest forex traders are

Citibank & JP Morgan Chase of US Barclays of the UK BNP of France Deutsche Bank of Germany

What would occur if country A's inflation rate exceeded that of countries B, C, and D?

Country A's currency would depreciate relative to countries B, C, and D

Money moving into a country is what type of transaction?

Credit

What does the capital account show?

Credit and debit entries for non-produced nonfinancial asset and capital transfers between residents and nonresidents

What are the activities of consumers and businesses in the economy with respect to the trade balance, services balance, income balance, and net transfers collectively referred to as?

Current account

Data consistency isn't required to perform cross-country data comparisons, track growth rates across time, and produce regional and global data aggregates. True/False

False

What is a global network of international banks and currency traders that trade different countries' currencies called?

Foreign exchange market

How many subaccounts does the current account have?

Four

How many subaccounts does the financial account of the balance of payments (BOP) have?

Four

Large banks normally carry an inventory of what?

Frequently used currencies in international transactions

Other investments includes

Hot money Currency seeking safe haven Trade credit & advances Other accounts receivable/payable

A country's BOP is an objective standard that shows what?

How well the country's economy and government policies are performing.

Imagine you were evaluating a system that sets the values of major currencies based on their demand and supply in world currency markets. What type of system is this?

Independent floating exchange rate system

Which country uses a managed floating exchange rate system?

Indonesia

An individual wants to invest in the currency of their own country and then convert it into the currency of another country with the intent of making a profit. Which theory states that is not possible?

Interest rate parity

The annual interest rate in Country A is 8%, while in Country B it is 6%. Which theory suggests that the currency in Country A will fall two percent against the currency of Country B until the two are equal?

Interest rate parity (IRP)

What is foreign direct investment?

Investment made by a foreign company in the economy of another country.

Firms use the forward market to do what

Lock in future exchange rates and ensure against uncertain future currency movements

If Greece resumed the drachma and you wanted to forecast future exchange rates of the euro in Germany (or elsewhere in the EU) against it, which theory suggests that forecasts of relative inflation rates in the two countries can be used to estimate the future exchange rate of the drachma to the euro?

Purchasing Power parity

Assume that a candy bar in Germany is priced at EUR 1 and in the United States it is USD 1.50. The exchange rate between the EUR/USD would be 1.50 (the USD/EUR). What theory does this example illustrate?

Purchasing power parity

Which theory suggests that forecasts of relative inflation rates in two countries can be used to estimate the future exchange rate of a certain amount of domestic currency relative to foreign currencies?

Purchasing power parity

What theory states that a basket of goods should have approximately the same prices across different countries?

Purchasing power party

Balance of Payments

Refers to a statement of account that summarizes all transactions between the residents of one country and the rest of the world for a given period of time

An investor requires the added return for risk associated with a security or asset. What would this added return be called?

Risk premium

What happens if a country's BOP is not managed properly?

The country could diminish its holding of foreign exchange reserves, which is used to support its currency, and eventually face a currency crisis.

Which account balance is the most important subaccount of a country's BOP

The current acount

What information would the balance of payments (BOP) provide to a manager of an international firm?

The demand for a country's currency and potential changes in its economic environment

Which three currencies make up roughly 60% of the world's currency transactions in global business?

The dollar, euro, and yen

Exchange rate

The measure of how much one currency is worth in relation to another.

What is the balance of trade in goods made of

The net of merchandise exports and merchandise imports

What is sometimes referred to as the overall balance of payments

The total of the current account, capital account, and financial account

The Big Mac index

Tool for calculating purchasing power parity that compares prices of a Big Mac throughout the world.

Banks earn a transaction fee for forex services. True/False

True

The five most widely traded currencies in the world are

US Dollar Eurozone Euro British Pound Chinese Yuan Japanese Yen

The balance of FDI in the US consists of what two components?

US acquired assets abroad and foreign investor acquisition of assets in the US

fixed exchange rate system

a currency system in which governments try to keep the values of their currencies constant against one another

A direct quote gives the price of

a foreign currency in dollars or the number of dollars per one fixed unit of foreign currency

When a country imports more than it exports it has what?

a goods trade deficit

ABC Limited, a U.S.-based company, has a liability to deliver 2 million euros in nine months. To minimize the risk of significant currency fluctuations, it decides to enter into a contract to purchase 2 million euros on the same date to ensure it can buy and sell in the same currency on the same date. What is this an example of?

a hedge

If the dollar was expected to appreciate in the 60-day forward market against the Japanese yen, it would be selling at

a premium

Which of the following theories can be used to forecast exchange rates?

a purchasing power parity and interest rate parity

Maastricht Treaty

a treaty created in 1991 that set strict financial criteria for joining the proposed monetary union, with it single currency and set 1999 as the start date for its establishment.

Smithsonian Agreement

agreement (1971) among IMF members to restructure and strengthen the international monetary system created at Bretton Woods

Reserve assets are part of a country's international liquidity that ___________.

are readily available to and controlled by monetary authorities for meeting balance of payments financing needs, for intervention in exchange markets to affect the currency exchange rate, and for other related purposes.

forward market

exchange that enables purchases and sales of currencies in the future with prices (or the forward rate) established at a previous time

The exchange of currencies takes place in what?

foreign exchange markets

clean float currency

monetary system with minimal government intervention; largely market determined

Net financial derivatives

risk transfer rather than supply of BOP funds

independent floating exchange rate system

system that sets the values of major currencies based on their demand and supply in world currency markets

Jamaica Agreement

the 1976 international monetary order that allowed countries to adopt different exchange rate systems including floating their currencies in world markets

Which country is the world's second largest goods exporter after China?

the United States

bid-ask spread

the difference between the bid price and the asked price

Internal Rate of Return (IRR)

the discount rate that makes the NPV of an investment zero

Net Present Value (NPV)

the sum of the present values of expected future cash flows from an investment, minus the cost of that investment

Errors and omissions reflect two issues

timing and illegal trade

A country that conducts international transactions with only one major country may find it more beneficial to do what?

to use dollarization

Dollarization

when a poorer country ties the value of its currency to that of a wealthier country, or when it abandons its currency and adopts the wealthier country's currency as its own