Chapter 8 Bank
If Toranaga-san, who works for a Japanese trading company that operates in Japanese yen, wanted to purchase Spanish castanets from a company in Barcelona and needed euros to complete the transaction, he would use the ________ to gain access to spot euros.
foreign-exchange market
If a foreign currency is quoted in American terms (the direct quote) and the forward rate for a foreign currency is less than the spot rate, the foreign currency is selling at a ________.
forward discount
The pound-dollar forward rate for pounds is $1.9068, and the spot rate is $1.9100. Pounds are selling at a ________.
forward discount
If a foreign currency is quoted in American terms (the direct quote) and the forward rate is greater than the spot rate, the foreign currency is selling at a ________.
forward premium
The pound-dollar forward rate for pounds is $1.9068, and the spot rate is $1.9059. Pounds are selling at a ________.
forward premium
Outright forward transactions involve the exchange of currency on a future date beyond two business days at a fixed exchange rate, known as the ________.
forward rate
A foreign exchange contract that is an agreement between two parties to buy or sell a particular currency at a particular price at a particular date in the future as specified in a standardized contract to all participants in the specified market is known as a(n) ________.
futures contract
As a trading currency, the euro is ________.
gaining ground against the U.S. dollar in Eastern European countries
Which of the following best explains the increase in trading activity in recent years?
growing emphasis on hedge funds
Which of the following is an example of interest arbitrage?
investing in debt instruments in different currencies or different countries
What is a futures contract? What institutions handle futures contracts?
A foreign currency futures contract resembles a forward contract insofar as it specifies an exchange rate some time in advance of the actual exchange of currency. However, a future is traded on an exchange, not OTC. Instead of working with a bank or other financial institution, companies work with exchange brokers when purchasing futures contracts.
How does arbitrage differ from speculation?
A speculator buys or sells foreign currency with the hope that that currency will either weaken or strengthen in the future, resulting in a profit.
Which of the following is most likely true regarding options?
An option is a right to sell foreign currency
Why would companies become involved in arbitrage? What is the difference between arbitrage and interest arbitrage?
As with most types of foreign exchange activities, companies attempt to earn money through arbitrage and interest arbitrage. One type of profit-seeking activity is arbitrage, which is the purchase of foreign currency on one market for immediate resale on another market (in a different country) to profit from a price discrepancy. Interest arbitrage is the investing in debt instruments, such as bonds, in different countries.
A major challenge faced by Western Union in transferring money between the United States and Mexico is that Mexican citizens trust the banks but do not trust Western Union due to its reliance on global banks.
FALSE
A tariff is the price of a currency
FALSE
According to 2010 surveys, the most frequently traded currency pair is the U.S. dollar and Japanese yen.
FALSE
An American investing in a London-based company is an example of interest arbitrage.
FALSE
An irrevocable letter of credit is the basis for multilateral netting.
FALSE
An offer is the right but not the obligation to buy or sell foreign currency.
FALSE
Commercial banks look at foreign-exchange trading as a service extended primarily to important customers, not as a major business activity of its own.
FALSE
Hong Kong is one of the top four largest markets in the world in foreign exchange trades and the largest in Asia.
FALSE
If the forward rate for a foreign currency is less than the spot rate, the foreign currency is selling at a forward premium.
FALSE
Most foreign exchange is handled through voice brokers
FALSE
One reason that companies use the foreign exchange market is to diversify their expenses from other sources.
FALSE
Outright forward transactions involve the exchange of currency the second day after the date on which the two foreign exchange traders agree to the transaction.
FALSE
The Chicago Mercantile Exchange and NASDAQ are part of the OTC market.
FALSE
The U.S. dollar is so widely traded partially because the New York Stock Exchange is the biggest foreign exchange center in the world.
FALSE
The bid is the price at which the trader is willing to sell foreign currency.
FALSE
The largest market in foreign exchange is in London
FALSE
In which of the following transactions is one currency swapped for another on one date and then swapped back on a future date?
FX swap
How is foreign exchange traded? What methods are available?
Foreign exchange is traded using electronic methods, customer direct, interbank direct, or voice broker. There are different kinds of electronic methods. One is an electronic broking system where trades are matched up for foreign exchange dealers using electronic systems such as EBS, Reuters, and Bloomberg. Another is an electronic trading system that is executed on a single-bank proprietary system or a multibank dealing system. Customer direct refers to trades between a reporting dealer and either a non-reporting dealer or customer, without a third party being involved. Usually trades are executed by telephone or direct electronic trading. Interbank direct refers to trades between dealer banks via telephone or direct electronic trading. Voice broker is a trade via telephone communication with a foreign exchange voice broker.
Which of the following is NOT one of the top four locations for trading foreign exchange?
Hong Kong
In 2010, what was the top remittance-receiving country in the world?
India
The top location for trading foreign exchange is ________.
London
Why is London most likely the top market for trading foreign exchange?
London is uniquely positioned geographically in terms of time zones
What are the characteristics of the spot market? What institutions handle spot exchanges?
Most foreign currency transactions take place between foreign exchange traders, so the traders, who work for foreign exchange brokerage houses or commercial banks, quote the rates. The traders always quote a bid and offer rate. The bid is the price at which the trader is willing to sell foreign currency. In the spot market, the spread is the difference between the bid and offer rates and is the trader's profit margin. The method of quoting exchange rates is called the direct quote, also known in the foreign exchange industry as "American terms." It represents a quote from the point of view of someone in the United States. The other convention for quoting foreign exchange is "European terms," which means a direct quote from the perspective of someone in Europe. From a U.S. point of view, this means the number of units of the foreign currency per U.S. dollar. This is also sometimes called the indirect quote in the United States, although American terms and European terms are the most accurate way to describe the quotes.
Which of the following best explains why migrant workers in Dubai send money back home?
Non-citizens cannot purchase property
Why are options most likely so attractive to companies?
Options provide companies with more flexibility than a forward contract
What is remittance income? What institutions in Mexico can handle remittance accounts? Why are some institutions used more frequently than others?
Remittance income refers to money that an individual makes in one country and sends back to friends and family members in another country in a different currency. Wells Fargo and other U.S. banks, including Citi and Bank of America, have established alliances with Mexican banks to offer remittance accounts to the immigrant workers in the United States. Although immigrant workers complain about the high transfer fees and exchange-rate spread associated with Western Union, many continue to use this service instead of the lower-cost method of remitting money through banks. Mexico has a history of unstable currencies and widespread inflation, resulting in a traditional mistrust of banks. Other immigrants base their choice on word of mouth or convenience and location. Many are simply unaware of the variety of choices available for sending money and do not know how to get the best deal. Others need the convenience offered by Western Union.
An example of an electronic brokerage system used to trade foreign exchange is ________.
Reuters
What is currency speculation? Why is it risky?
Speculation is the buying or selling of a commodity that has both an element of risk and the chance of great profit. For example, an investor could buy euros in anticipation of the euro's strengthening against other currencies. If it strengthens, the investor earns a profit; if it weakens, the investor incurs a loss. Speculators are important in the foreign exchange market because they spot trends and try to take advantage of them. They create demand for a currency by purchasing it in the market, or they can create a supply of the currency by selling it in the market. Speculation is a very risky business. In recent years, the advent of e-trading has attracted a lot of day traders in foreign exchange. The problem is that day traders rarely make money speculating in exchange rates because forecasting currency movements is a risky business.
________ involve the exchange of currency the second day after the date on which the two foreign exchange traders agree to the transaction.
Spot transactions
A confirmed letter of credit may obligate the exporter's bank to honor a draft presented to it.
TRUE
A currency sells at a forward premium when the forward rate is greater than the spot rate.
TRUE
Although most foreign exchange activity takes place through big money center banks, the use of electronic trading has allowed even regional banks to deal directly in foreign exchange markets.
TRUE
An exchange rate is the number of units that buys one unit of another currency.
TRUE
Arbitrage is the purchase of foreign currency on one market for immediate resale on a foreign market in order to profit from a price discrepancy.
TRUE
Companies use the foreign exchange market to convert money for use in financial transactions.
TRUE
EBS and Reuters provide customers with electronic foreign exchange services as well as current market data.
TRUE
In an FX swap, one currency is swapped for another on one date and then swapped back on a future date.
TRUE
In foreign exchange markets, reporting dealers trade more foreign exchange with other reporting dealers than with any other category of users.
TRUE
In the spot market, the spread is the difference between the bid and offer rates and is the trader's profit margin.
TRUE
Options are more flexible than forward contracts.
TRUE
The U.S. dollar is important as a vehicle for foreign exchange transactions between two countries other than the United States.
TRUE
The U.S. dollar is widely traded because it is a transaction currency in many international commodity markets.
TRUE
Trading activity has increased in recent years due to the growing importance of foreign exchange as an alternative asset and the expanded emphasis on hedge funds.
TRUE
What are the two major segments of the foreign exchange market? What types of foreign exchange instruments are traded within these markets?
The foreign exchange market has two major segments: the over-the-counter market (OTC) and the exchange-traded market. The OTC market is comprised of banks, both commercial banks and investment banks, as well as other financial institutions, and is where most of the foreign exchange activity takes place. The exchange-traded market is composed of securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Mercantile Exchange, where certain types of foreign exchange instruments, such as exchange-traded options and futures, are traded. Several different types of foreign exchange instruments are traded in these markets, but the traditional foreign exchange instruments that comprise the bulk of foreign exchange trading are spot transactions, outright forwards, and FX swaps. Spot transactions involve the exchange of currency the second day after the date on which the two foreign exchange traders agree to the transaction. The rate at which the transaction is settled is the spot rate. Outright forward transactions involve the exchange of currency three or more days after the date on which the traders agree to the transaction. It is the single purchase or sale of a currency for future delivery. The rate at which the transaction is settled is the forward rate and is a contract rate between the two parties. In an FX swap, one currency is swapped for another on one date and then swapped back on a future date. Although an FX swap is both a spot and a forward transaction, it is accounted for as a single transaction.
A letter of credit that provides an exporter with the guarantee of another bank in addition to the importer's bank is called ________.
a confirmed letter of credit
The U.S. dollar is most likely traded widely because it is ________.
a reserve currency held by many central banks
What is the Bank for International Settlements? What three categories does the BIS designate in the foreign exchange market? Briefly describe each category.
The foreign-exchange market is made up of many different players. The Bank for International Settlements (BIS), a central banking institution in Basel, Switzerland, owned and controlled by 56 member central banks, divides the market into three major categories: reporting dealers, other financial institutions, and nonfinancial institutions. Reporting dealers, also known as money center banks, are financial institutions that actively participate in local and global foreign exchange and derivative markets. They are mainly the large commercial and investment banks and are widely assumed to include the 10 largest banks and financial institutions in terms of overall market share in foreign-exchange trading: Deutsche Bank, Barclays Capital, UBS, Citi, JP Morgan, HSBC, RBS, Credit Suisse, Goldman Sachs, and Morgan Stanley. The other financial institutions are financial institutions not classified as reporting dealers. They include smaller commercial banks, investment banks and securities houses, hedge funds, pension funds, money market funds, currency funds, mutual funds, specialized foreign-exchange trading companies, and so forth. Nonfinancial customers are any counterparty other than those described above and include any non-financial end user, such governments and companies (MNEs as well as small- and medium-size corporations and firms).
What are the characteristics of the forward market? Why do companies participate in the forward market? Provide an example to illustrate your answer.
The spot market is for foreign exchange transactions that occur within two business days, but in some transactions a seller extends credit to the buyer for a period that is longer than two days. The forward rate is the rate quoted today for future delivery. The most widely traded currencies in the forward market are the British pound, Canadian dollar, Japanese yen, and Swiss franc. Many currencies do not have a forward market due to the small size and volume of transactions in that currency. The difference between the spot and forward rates is either the forward discount or the forward premium. If the forward rate for a foreign currency is less than the spot rate, the foreign currency is selling at a forward discount. If the forward rate is greater than the spot rate, the foreign currency is selling at a forward premium. For example, a Japanese exporter of consumer electronics might sell television sets to a U.S. importer with immediate delivery but payment due in 30 days. The U.S. importer is obligated to pay in yen in 30 days and may enter into a contract with a currency dealer to deliver the yen at a forward rate-the rate quoted today for future delivery.
In a short essay, discuss how companies use foreign exchange.
There are a number of reasons why companies use the foreign exchange market. The most obvious is for import and export transactions. Companies also use the foreign exchange market for financial transactions, such as those in FDI. Sometimes companies, but mostly traders and investors, deal in foreign exchange solely for profit. One type of profit-seeking activity is arbitrage, which is the purchase of foreign currency on one market for immediate resale on another market (in a different country) to profit from a price discrepancy.
The ________ is the most widely traded currency in the world.
U.S. dollar
Which of the following is NOT one of the top exchanges that trade in foreign currency futures and options?
UBS
Which of the following would have the LEAST influence on price setting in the foreign exchange market?
Western Union
Which term refers to money denominated in the currency of another nation or group of nations?
foreign exchange
As a center for foreign exchange trading, London ________.
actually trades more U.S. dollars than are traded in the United States
Ryan, a foreign exchange dealer, sold U.S. dollars for Swiss francs in the U.S., then sold Swiss francs for Japanese yen in Switzerland, and then sold the Japanese yen for U.S. dollars in the U.S. Ryan hopes that he will end up with more U.S. dollars than when he began. Which term best describes Ryan's actions?
arbitrage
The interbank market in foreign exchange is where ________.
banks trade currency with each other
Melissa, a foreign exchange trader, wants to buy euros from Stephanie. Which of the following is the price at which Melissa is willing to buy euros?
bid
An irrevocable letter of credit ________.
can be amended only if all parties involved agree
If a company from Country A decides to sell merchandise to a company from Country B, then the company from Country A ________.
can denominate the sale in either currency and use the foreign exchange market to convert currency
Which of the following is LEAST relevant to being designated by Euromoney magazine as a top foreign-exchange dealer?
capability of assessing cultural risk
An investor sells Japanese yen which is yielding a low interest rate and uses the proceeds to buy Swiss francs that yield a higher interest rate. Which term best describes the investor's actions?
carry trade
Which of the following handles the majority of all foreign exchange activities?
commercial banks
In a ________, one party directs another party to make payment.
commercial bill of exchange
Stella, who works and lives in San Diego, wants to send money to her mother who lives in a small village south of Puerto Vallarta, Mexico. Stella typically uses Western Union to handle the transaction. Which of the following is the most likely reason that Stella uses Western Union?
convenience
Companies most likely use the foreign exchange market to ________.
convert money for use in financial transactions
Albert, an employee at Morgan Stanley, has been given the task of handling the foreign exchange for a customer who is moving from Brazil to Switzerland in one week. Which of the following should Albert most likely use when exchanging the client's Brazilian real for Swiss francs?
cross rate
A(n) ________ is the price of a currency
exchange rate
The relationship between the value of the Brazilian and Chinese currencies is known as the ________.
exchange rate
Companies most likely use the foreign exchange market to ________.
facilitate regular business transactions
In foreign exchange markets, reporting dealers are ________.
financial institutions that actively participate in local and global foreign exchange markets
Compared with a forward contract, a futures contract ________.
is only traded on an exchange
A major challenge faced by Western Union in wiring money between the United States and Mexico is that ________.
it is facing competition from some commercial banks
When selecting a commercial and/or investment bank to deal in foreign exchange, corporations are most likely to use ________.
more than one bank to meet different needs
Which of the following is the price at which the trader is willing to sell foreign currency?
offer
A(n) ________ is the right but not the obligation to buy or sell a foreign currency within a certain time period or on a specific date at a specific exchange rate.
option
Which of the following best describes arbitrage?
purchasing foreign currency on one market for immediate resale on another market
Which of the following is the largest source of foreign-exchange income in Mexico?
remittance income
Gomez Enterprises, a firm based in Mexico City, exported 1,000 circuit boards to Taylor Industries, a firm based in Chicago. Taylor received a document from Gomez that requests immediate payment for the goods. Gomez has most likely sent a ________.
sight draft
Anita, an employee at ABX Partners, a hedge fund firm, has purchased euros because she believes that the euro will strengthen against other currencies. Which term best describes Anita's activities?
speculation
In the spot market, the ________ is the difference between the bid and offer rates and is the trader's profit margin.
spread
A speculator is someone who ________.
takes positions in foreign exchange markets to earn a profit
In the foreign exchange market, the bid is the rate at which ________.
the trader is willing to buy foreign exchange
A document requesting payment 30 days after delivery is known as a ________.
time draft
Which of the following is NOT a reason a company would deal in foreign exchange?
to import merchandise denominated in its currency rather than the currency of the exporter
In foreign-exchange markets, reporting dealers ________.
trade more foreign exchange with other financial institutions than with any other category of users
Western Union's role in foreign exchange trading is best described as ________.
transferring currency from one country to another