FIN 450 Exam 1

Explain why a public forecast by a respected economist about future interest rates could affect the value of the dollar today. Why do some forecasts by well‑respected economists have no impact on today's value of the dollar? (Ch. 4)

Interest rate movements affect exchange rates. Speculators can use anticipated interest rate movements to forecast exchange rate movements. They may decide to purchase securities in particular countries because of their expectations about currency movements, since their yield will be affected by changes in a currency's value. These purchases of securities require an exchange of currencies, which can immediately affect the equilibrium value of exchange rates. If a forecast of interest rates by a respected economist was already anticipated by market participants or is not different from investors' original expectations, an announced forecast does not provide new information. Thus, there would be no reaction by investors to such an announcement, and exchange rates would not be affected.

Why do you think international trade volume has increased over time? In general, how are inefficient firms affected by the reduction in trade restrictions among countries and the continuous increase in international trade? (Ch. 2)

International trade volume has increased because of the reduction in trade restrictions over time. It may have also increased for many other reasons, such as increased information flow (via Internet etc.) between firms in different countries. Inefficient firms are adversely affected if they have to face tougher competition from foreign firms as a result of a reduction in trade restrictions.

Cross FX Rates: Assume Poland's currency (the zloty) is worth $.17 and the Japanese yen is worth $.008. What is the cross rate of the zloty with respect to yen? That is, how many yen equal a zloty? (Ch. 3)

$.17/$.008 = 21.25 1 zloty = 21.25 yen

Utah Bank's bid price for Canadian dollars is $.7938 and its ask price is $.81. What is the bid/ask percentage spread? (Ch. 3)

($.81 - $.7938)/$.81 = .02 or 2%

Percentage Depreciation: Assume the spot rate of the British pound is $1.73. The expected spot rate one year from now is assumed to be $1.66. What percentage depreciation does this reflect? (Ch. 4)

($1.66 - $1.73)/$1.73 = -4.05% Expected depreciation of 4.05% percent

Indirect FX Rates: If the direct exchange rate of the euro is worth $1.25, what is the indirect rate of the euro? That is, what is the value of a dollar in euros? (Ch. 3)

1/1.25 = .8 euros

Why would a central bank's indirect intervention have a stronger impact than its direct intervention? (Ch. 6)

A central bank's indirect intervention can affect the factors that influence exchange rates and therefore affect the natural equilibrium exchange rate. Conversely, direct intervention is a superficial method of affecting the demand and supply conditions for a currency, and could be overwhelmed by market forces.

Should the governments of Asian countries allow their currencies to float freely? What would be the advantages of letting their currencies float freely? What would be the disadvantages? (Ch. 6)

A freely floating currency may allow the exchange rate to adjust to market conditions, which can stabilize flows of funds between countries. If there is a larger amount of funds going out versus coming in, the exchange rate will weaken due to the forces and the flows may change because the currency has become cheaper; this discourages further outflows. Yet, a disadvantage is that speculators may take positions that force a freely floating currency to deviate far from what is perceived to be a desirable exchange rate.

What are some advantages and disadvantages of a freely floating exchange rate system versus a fixed exchange rate system? (Ch. 6)

A freely floating system may help correct balance-of-trade deficits since the currency will adjust according to market forces. Also, countries are more insulated from problems of foreign countries under a freely floating exchange rate system. However, a disadvantage of freely floating exchange rates is that firms have to manage their exposure to exchange rate risk. Also, floating rates still can often have a significant adverse impact on a country's unemployment or inflation.

How would a relatively high home inflation rate affect the home country's current account, other things being equal? (Ch. 2)

A high inflation rate tends to increase imports and decrease exports, thereby increasing the current account deficit, other things equal.

Explain how syndicated loans are used in international markets. (Ch. 3)

A large MNC may want to obtain a large loan that no single bank wants to accommodate by itself. Thus, a bank may create a syndicate whereby several other banks also participate in the loan.

If Asian countries experience a decline in economic growth (and experience a decline in inflation and interest rates as a result), how will their currency values (relative to the U.S. dollar) be affected? (Ch. 4)

A relative decline in Asian economic growth will reduce Asian demand for U.S. products, which places upward pressure on Asian currencies. However, given the change in interest rates, Asian corporations with excess cash may now invest in the U.S. or other countries, thereby increasing the demand for U.S. dollars. Thus, a decline in Asian interest rates will place downward pressure on the value of the Asian currencies. The overall impact depends on the magnitude of the forces just described.

What is the impact of a strong home currency on the home economy, other things being equal? (Ch. 6)

A strong home currency can keep inflation in the home country low, since it encourages consumers to buy abroad. Local producers must maintain low prices to remain competitive. Also, foreign supplies can be obtained cheaply. This also helps to maintain low inflation. However, a strong home currency can increase unemployment in the home country. This is due to the increase in imports and decrease in exports often associated with a strong home currency (imports become cheaper to that country but the country's exports become more expensive to foreign customers).

Explain the potential feedback effects of a currency's changing value on inflation. (Ch. 6)

A weak home currency can cause inflation since it tends to reduce foreign competition within any given industry. Higher inflation can weaken the currency further since it encourages consumers to purchase goods abroad (where prices are not inflated). A strong home currency can reduce inflation since it reduces the prices of foreign goods and forces home producers to offer competitive prices. Low inflation, in turn, places upward pressure on the home currency.

What is the impact of a weak home currency on the home economy, other things being equal? (Ch. 6)

A weak home currency tends to increase a country's exports and decrease its imports, thereby lowering its unemployment. However, it also can cause higher inflation since there is a reduction in foreign competition (because a weak home currency is not worth much in foreign countries). Thus, local producers can more easily increase prices without concern about pricing themselves out of the market.

Assume that the U.S. income level rises at a much higher rate than does the Canadian income level. Other things being equal, how should this affect the (a) U.S. demand for Canadian dollars, (b) supply of Canadian dollars for sale, and (c) equilibrium value of the Canadian dollar? (Ch. 4)

Assuming no effect on U.S. interest rates, demand for dollars should increase, supply of dollars for sale may not be affected, and the dollar's value should increase.

Explain the process used by banks in the Eurocredit market to determine the rate to charge on loans. (Ch. 3)

Banks set the loan rate based on the prevailing LIBOR, and allow the loan rate to float (change every 6 months) in accordance with changes in LIBOR.

Why do you think most crises in countries (such as the Asian crisis) cause the local currency to weaken abruptly? Is it because of trade or capital flows? (Ch. 4)

Capital flows have a larger influence. In general, crises tend to cause investors to expect that there will be less investment in the country in the future and also cause concern that any existing investments will generate poor returns (because of defaults on loans or reduced valuations of stocks). Thus, as investors liquidate their investments and convert the local currency into other currencies to invest elsewhere, downward pressure is placed on the local currency.

How can a central bank use direct intervention to change the value of a currency? Explain why a central bank may desire to smooth exchange rate movements of its currency. (Ch. 6)

Central banks can use their currency reserves to buy up a specific currency in the foreign exchange market in order to place upward pressure on that currency. Central banks can also attempt to force currency depreciation by flooding the market with that specific currency (selling that currency in the foreign exchange market in exchange for other currencies). Abrupt movements in a currency's value may cause more volatile business cycles, and may cause more concern in financial markets (and therefore more volatility in these markets). Central bank intervention used to smooth exchange rate movements may stabilize the economy and financial markets.

Chapman Co. is a privately owned MNC in the U.S. that plans to engage in an initial public offering (IPO) of stock, so that it can finance its international expansion. At the present time, world stock market conditions are very weak but are expected to improve. The U.S. market tends to be weak in periods when the other stock markets around the world are weak. A financial manager of Chapman Co. recommends that it wait until the world stock markets recover before it issues stock. Another manager believes that Chapman Co. could issue its stock now even if the price would be low, since its stock price should rise later once world stock markets recover. Who is correct? (Ch. 3)

Chapman Co. should wait until the world stock markets recover, and the U.S. stock market conditions have improved. If it issues stock now when the price is low, it would receive a lower dollar amount of proceeds to use for its expansion. If its stock price rises later, it would not benefit because it already sold the shares (only its shareholders who originally purchased the shares would benefit if the stock price increased).

Briefly describe the historical developments that led to floating exchange rates as of 1973. (Ch. 3)

Country governments had difficulty in maintaining fixed exchange rates. In 1971, the bands were widened. Yet, the difficulty of controlling exchange rates even within these wider bands continued. As of 1973, the bands were eliminated so that rates could respond to market forces without limits (although governments still did intervene periodically).

Assume that the U.S. inflation rate becomes high relative to Canadian inflation. Other things being equal, how should this affect the (a) U.S. demand for Canadian dollars, (b) supply of Canadian dollars for sale, and (c) equilibrium value of the Canadian dollar? (Ch. 4)

Demand for Canadian dollars should increase, supply of Canadian dollars for sale should decrease, and the Canadian dollar's value should increase.

Assume U.S. interest rates fall relative to British interest rates. Other things being equal, how should this affect the (a) U.S. demand for British pounds, (b) supply of pounds for sale, and (c) equilibrium value of the pound? (Ch. 4)

Demand for pounds should increase, supply of pounds for sale should decrease, and the pound's value should increase.

Assume that the Japanese government relaxes its controls on imports by Japanese companies. Other things being equal, how should this affect the (a) U.S. demand for Japanese yen, (b) supply of yen for sale, and (c) equilibrium value of the yen? (Ch. 4)

Demand for yen should not be affected, supply of yen for sale should increase, and the value of yen should decrease.

Suppose that the government of Chile reduces one of its key interest rates. The values of several other Latin American currencies are expected to change substantially against the Chilean peso in response to the news. Explain why other Latin American currencies could be affected by a cut in Chile's interest rates. (Ch. 6)

Exchange rates are partially driven by relative interest rates of the countries of concern. When Chile's interest rates decline, there is a smaller flow of funds to be exchanged into Chilean pesos because the Chile interest rate is not as attractive to investors. There may be a shift of investment into the other Latin American countries where interest rates have not declined. However, if these Latin American countries are expected to reduce their rates as well, they will not attract more capital and may even attract less capital flows in the future, which could reduce their values.

You just came back from Canada, where the Canadian dollar was worth $.70. You still have C$200 from your trip and could exchange them for dollars at the airport, but the airport foreign exchange desk will only buy them for $.60. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for $.10 per peso. You met a tourist at the airport who is from Mexico and is on his way to Canada. He is willing to buy your C$200 for 1,300 pesos. Should you accept the offer or cash the Canadian dollars in at the airport? (Ch. 3)

Exchange with the tourist. If you exchange the C$ for pesos at the foreign exchange desk, the cross-rate is $.60/$10 = 6. Thus, the C$200 would be exchanged for 1,200 pesos (computed as 200 × 6). If you exchange Canadian dollars for pesos with the tourist, you will receive 1,300 pesos.

U.S. bond prices are normally inversely related to U.S. inflation. If the Fed planned to use intervention to weaken the dollar, how might bond prices be affected? (Ch. 6)

Expectations of a weak dollar can cause expectations of higher inflation, because a weak dollar places upward pressure on U.S. prices for reasons mentioned in the chapter. Higher inflation tends to place upward pressure on interest rates. Because there is an inverse relationship between interest rates and bond prices, bond prices would be expected to decline. Such an expectation causes bond portfolio managers to liquidate some of their bond holdings, thereby causing bond prices to decline immediately.

Explain why some financial institutions prefer to provide credit in financial markets outside their own country. (Ch. 3)

Financial institutions may believe that they can earn a higher return by providing credit in foreign financial markets if interest rate levels are higher and if the economic conditions are strong so that the risk of default on credit provided is low. The institutions may also want to diversity their credit so that they are not too exposed to the economic conditions in any single country.

Explain why firms may issue stock in foreign markets. Why might U.S. firms issue more stock in Europe since the conversion to the euro in 1999? (Ch. 3)

Firms may issue stock in foreign markets when they are concerned that their home market may be unable to absorb the entire issue. In addition, these firms may have foreign currency inflows in the foreign country that can be used to pay dividends on foreign‑issued stock. They may also desire to enhance their global image. Since the euro can be used in several countries, firms may need a large amount of euros if they are expanding across Europe.

How can government restrictions affect international payments among countries? (Ch. 2)

Governments can place tariffs or quotas on imports to restrict imports. They can also place taxes on income from foreign securities, thereby discouraging investors from purchasing foreign securities. If they loosen restrictions, they can encourage international payments among countries.

The Hong Kong dollar's value is tied to the U.S. dollar. Explain how the following trade patterns would be affected by the appreciation of the Japanese yen against the dollar: Hong Kong exports to Japan (Ch. 6)

Hong Kong exports to Japan should increase because the yen will have appreciated against the Hong Kong dollar. Therefore, Hong Kong goods will be less expensive to Japanese importers.

Hong Kong exports to the United States. (Ch. 6)

Hong Kong exports to the U.S. should increase because Japanese goods become more expensive to U.S. importers as a result of yen appreciation. Therefore, some U.S. importers may find that even though the exchange rate between the U.S. dollar and Hong Kong dollar is unchanged, the Hong Kong prices are now lower than Japanese prices (from a U.S. perspective). This answer assumes that Japanese exporters did not reduce their prices to compensate U.S. importers for the weaker dollar. If Japanese exporters do reduce their prices to fully offset the effect of the stronger yen, there would be less of a shift to Hong Kong goods.

Assume that there are substantial capital flows among Canada, the U.S., and Japan. If interest rates in Canada decline to a level below the U.S. interest rate, and inflationary expectations remain unchanged, how could this affect the value of the Canadian dollar against the U.S. dollar? How might this decline in Canada's interest rates possibly affect the value of the Canadian dollar against the Japanese yen? (Ch. 4)

If interest rates in Canada decline, there may be an increase in capital flows from Canada to the U.S. In addition, U.S. investors may attempt to capitalize on higher U.S. interest rates, while U.S. investors reduce their investments in Canada's securities. This places downward pressure on the Canadian dollar's value. Japanese investors that previously invested in Canada may shift to the U.S. Thus, the reduced flow of funds from Japan would place downward pressure on the Canadian dollar against the Japanese yen.

Explain how the appreciation of the Australian dollar against the U.S. dollar would affect the return to a U.S. firm that invested in an Australian money market security. (Ch. 3)

If the Australian dollar appreciates over the investment period, this implies that the U.S. firm purchased the Australian dollars to make its investment at a lower exchange rate than the rate at which it will convert A$ to U.S. dollars when the investment period is over. Thus, it benefits from the appreciation. Its return will be higher as a result of this appreciation.

Explain how the appreciation of the Japanese yen against the U.S. dollar would affect the return to a U.S. firm that borrowed Japanese yen and used the proceeds for a U.S. project. (Ch. 3)

If the Japanese yen appreciates over the borrowing period, this implies that the U.S. firm converted yen to U.S. dollars at a lower exchange rate than the rate at which it paid for yen at the time it would repay the loan. Thus, it is adversely affected by the appreciation. Its cost of borrowing will be higher as a result of this appreciation.

Would the U.S. balance of trade deficit be larger or smaller if the dollar depreciates against all currencies, versus depreciating against some currencies but appreciated against others? (Ch. 2)

If the dollar weakens against all currencies, the U.S. balance of trade deficit will likely be smaller. Some U.S. importers would have more seriously considered purchasing their goods in the U.S. if most or all currencies simultaneously strengthened against the dollar. Conversely, if some currencies weaken against the dollar, the U.S. importers may have simply shifted their importing from one foreign country to another.

In some periods, foreign exchange traders do not respond to a trade deficit announcement, even when the announced deficit is very large. Offer an explanation for such a lack of response. (Ch. 4)

If the market correctly anticipated the trade deficit figure, then any news contained in the announcement has already been accounted for in the market. The market should only respond to an announcement about the trade deficit if the announcement contains new information.

Analysts commonly attribute the appreciation of a currency to expectations that economic conditions will strengthen. Yet, this chapter suggests that when other factors are held constant, increased national income could increase imports and cause the local currency to weaken. In reality, other factors are not constant. What other factor is likely to be affected by increased economic growth and could place upward pressure on the value of the local currency? (Ch. 4)

Interest rates tend to rise in response to a stronger economy, and higher interest rates can place upward pressure on the local currency (as long as there is not offsetting pressure by higher expected inflation).

Why would the Fed's indirect intervention have a stronger impact on some currencies than others? (Ch. 6)

Intervention may have a more pronounced impact when the market for a given currency is less active, such that the intervention can jolt the supply and demand conditions more.

Assume that Belgium, one of the European countries that uses the euro as its currency, would prefer that its currency depreciate against the dollar. Can it apply central bank intervention to achieve this objective? (Ch. 6)

It can not apply intervention on its own because the European Central Bank (ECB) controls the money supply of euros. Belgium is subject to the intervention decisions of the ECB.

What is LIBOR and how is it used in the Eurocredit market? (Ch. 3)

LIBOR (London interbank offer rate) is the rate of interest at which banks in Europe lend to each other. It is used as a base from which loan rates on other loans are determined in the Eurocredit market.

With regard to Eurocredit loans, who are the borrowers? (Ch. 3)

Large corporations and some government agencies commonly request Eurocredit loans.

What are some of the major objectives of the IMF? (Ch. 2)

Major IMF objectives are to (1) promote cooperation among countries on international monetary issues, (2) promote stability in exchange rates, (3) provide temporary funds to member countries attempting to correct imbalances of international payments, (4) promote free mobility of capital funds across countries, and (5) promote free trade.

When South Korea's export growth stalled, some South Korean firms suggested that South Korea's primary export problem was the weakness in the Japanese yen. How would you interpret this statement? (Ch. 2)

One of South Korea's primary competitors in exporting is Japan, which produces and exports many of the same types of products to the same countries. When the Japanese yen is weak, some importers switch to Japanese products in place of South Korean products. For this reason, it is often suggested that South Korea's primary export problem is weakness in the Japanese yen.

Explain the difference between sterilized and nonsterilized intervention. (Ch. 6)

Sterilized intervention is conducted to ensure no change in the money supply while nonsterilized intervention is conducted without concern about maintaining the same money supply.

If most countries in Europe experience a recession, how might the European Central Bank use direct intervention to stimulate economic growth? (Ch. 6)

The ECB could sell euros in the foreign exchange market, which may cause the euro to depreciate against other currencies, and therefore cause an increase in the demand for European imports.

Assume there is concern that the United States may experience a recession. How should the Federal Reserve influence the dollar to prevent a recession? How might U.S. exporters react to this policy (favorably or unfavorably)? What about U.S. importing firms? (Ch. 6)

The Federal Reserve would normally consider a loose money policy to stimulate the economy. However, to the extent that the policy puts upward pressure on economic growth and inflation, it could weaken the dollar. A weak dollar is expected to favorably affect U.S. exporting firms and adversely affect U.S. importing firms. If the U.S. interest rates rise in response to the possible increase in economic growth and inflation in the U.S., this could offset the downward pressure on the U.S. dollar. In this case, U.S. exporting and importing firms would not be affected as much.

How is the IMF involved in international trade? (Ch. 2)

The IMF in involved in international trade because it attempts to stabilize international payments, and trade represents a significant portion of the international payments.

Explain why an MNC may invest funds in a financial market outside its own country. (Ch. 3)

The MNC may be able to earn a higher interest rate on funds invested in a financial market outside of its own country. In addition, the exchange rate of the currency involved may be expected to appreciate.

Assume a simple world in which the U.S. exports soft drinks and beer to France and imports wine from France. If the U.S. imposes large tariffs on the French wine, explain the likely impact on the values of the U.S. beverage firms, U.S. wine producers, the French beverage firms, and the French wine producers. (Ch. 2)

The U.S. wine producers benefit from the U.S. tariffs, while the French wine producers are adversely affected. The French government would likely retaliate by imposing tariffs on the U.S. beverage firms, which would adversely affect their value. The French beverage firms would benefit.

How would the central banks of other Latin American countries be likely to adjust their interest rates? How would the currencies of these countries respond to the central bank intervention? (Ch. 6)

The central banks would likely attempt to lower interest rates, which causes the currency to weaken. A weaker currency and lower interest rates can stimulate the economy.

Explain how the existence of the euro may affect U.S. international trade. (Ch. 2)

The euro allowed for a single currency among many European countries. It could encourage firms in those countries to trade among each other since there is no exchange rate risk. This would possibly cause them to trade less with the U.S. The euro can increase trade within Europe because it eliminates the need for several European countries to exchange currencies when trading with each other.

Explain why the value of the British pound against the dollar will not always move in tandem with the value of the euro against the dollar. (Ch. 4)

The euro's value changes in response to the flow of funds between the U.S. and the countries using the euro or their currency. The pound's value changes in response to the flow of funds between the U.S. and the U.K. [Answer is based on intuition, is not directly from the text.]

What factors affect the future movements in the value of the euro against the dollar? (Ch. 4)

The euro's value could change because of the balance of trade, which reflects more U.S. demand for European goods than the European demand for U.S. goods. The capital flows between the U.S. and Europe will also affect the U.S. demand for euros and the supply of euros for sale (to be exchanged for dollars).

How would a U.S. firm that exports products to Latin American countries be affected by the central bank intervention? (Assume the exports are denominated in the corresponding Latin American currency for each country.) (Ch. 6)

The exporter is adversely affected if the Chilean peso and other currencies depreciate. It is favorably affected by the appreciation of any Latin American currencies.

The Wolfpack Corporation is a U.S. exporter that invoices its exports to the United Kingdom in British pounds. If it expects that the pound will appreciate against the dollar in the future, should it hedge its exports with a forward contract? (Ch. 3)

The forward contract can hedge future receivables or payables in foreign currencies to insulate the firm against exchange rate risk. Yet, in this case, the Wolfpack Corporation should not hedge because it would benefit from appreciation of the pound when it converts the pounds to dollars.

What is the function of the international money market? Briefly describe the reasons for the development and growth of the European money market. Explain how the international money, credit, and bond markets differ from one another. (Ch. 3)

The function of the international money market is to efficiently facilitate the flow of international funds from firms or governments with excess funds to those in need of funds. Growth of the European money market was largely due to (1) regulations in the U.S. that limited foreign lending by U.S. banks; and (2) regulated ceilings placed on interest rates of dollar deposits in the U.S. that encouraged deposits to be placed in the Eurocurrency market where ceilings were nonexistent. The international money market focuses on short‑term deposits and loans, while the international credit market is used to tap medium‑term loans, and the international bond market is used to obtain long‑term funds (by issuing long‑term bonds).

During the Asian crisis, some Asian central banks raised their interest rates to prevent their currencies from weakening. Yet, the currencies weakened anyway. Offer your opinion as to why the central banks' efforts at indirect intervention did not work. (Ch. 6)

The higher interest rates did not attract sufficient funds to offset the outflow of funds, as investors had no confidence that the currencies would stabilize and were unwilling to invest in Asia.

What is the expected relationship between the relative real interest rates of two countries and the exchange rate of their currencies? (Ch. 4)

The higher the real interest rate of a country relative to another country, the stronger will be its home currency, other things equal.

List some of the important characteristics of bank foreign exchange services that MNCs should consider. (Ch. 3)

The important characteristics are (1) competitiveness of the quote, (2) the firm's relationship with the bank, (3) speed of execution, (4) advice about current market conditions, and (5) forecasting advice.

In the 1990s, Russia was attempting to import more goods but had little to offer other countries in terms of potential exports. In addition, Russia's inflation rate was high. Explain the type of pressure that these factors placed on the Russian currency. (Ch. 4)

The large amount of Russian imports and lack of Russian exports placed downward pressure on the Russian currency. The high inflation rate in Russia also placed downward pressure on the Russian currency.

Explain how the Asian crisis would have affected the returns to a U.S. firm investing in the Asian stock markets as a means of international diversification. (Ch. 3)

The returns to the U.S. firm would have been reduced substantially as a result of the Asian crisis because of both declines in the Asian stock markets and because of currency depreciation. For example, the Indonesian stock market declined by about 27% from June 1997 to June 1998. Furthermore, the Indonesian rupiah declined again the U.S. dollar by 84%.

A relatively small U.S. balance of trade deficit is commonly attributed to a strong demand for U.S. exports. What do you think is the underlying reason for the strong demand for U.S. exports? (Ch. 2)

The strong demand for U.S. exports is commonly attributed to strong foreign economies or to a weak dollar.

Every month, the U.S. trade deficit figures are announced. Foreign exchange traders often react to this announcement and even attempt to forecast the figures before they are announced. Why do you think the trade deficit announcement sometimes has such an impact on foreign exchange trading? (Ch. 4)

The trade deficit announcement may provide a reasonable forecast of future trade deficits and therefore has implications about supply and demand conditions in the foreign exchange market. For example, if the trade deficit was larger than anticipated, and is expected to continue, this implies that the U.S. demand for foreign currencies may be larger than initially anticipated. Thus, the dollar would be expected to weaken. Some speculators may take a position in foreign currencies immediately and could cause an immediate decline in the dollar.

The terrorist attacks on the U.S. on September 11, 2001 were expected to weaken U.S. economic conditions, and reduce U.S. interest rates. How do you think the weaker U.S. economic conditions would affect trade flows? How would this have affected the value of the dollar (holding other factors constant)? How do you think the lower U.S. interest rates would have affected the value of the U.S. dollar (holding other factors constant)? (Ch. 4)

The weak U.S. economy would result in a reduced demand for foreign products, which results in a decline in the demand for foreign currencies, and therefore places downward pressure on currencies relative to the dollar (upward pressure on the dollar's value). The lower U.S. interest rates should reduce the capital flows to the U.S., which place downward pressure on the value of the dollar.

Explain the foreign exchange situation for countries that use the euro when they engage in international trade among themselves. (Ch. 3)

There is no foreign exchange. Euros are used as the medium of exchange.

Is a negative current account harmful to a country? (Ch. 2)

This question is intended to encourage opinions and does not have a perfect solution. A negative current account is thought to reflect lost jobs in a country, which is unfavorable. Yet, the foreign importing reflects strong competition from foreign producers, which may keep prices (inflation) low.

How can a central bank use indirect intervention to change the value of a currency? (Ch. 6)

To increase the value of its home currency, a central bank could attempt to increase interest rates, thereby attracting a foreign demand for the home currency to buy high‑yield securities. To decrease the value of its home currency, a central bank could attempt to lower interest rates in order to reduce demand for the home currency by foreign investors.

Fixed Exchange Rate System (Ch. 6)

Under a fixed exchange rate system, the governments attempted to maintain exchange rates within 1% of the initially set value (slightly widening the bands in 1971).

Freely Floating Exchange Rate System (Ch. 6)

Under a freely floating system, government intervention would be non‑existent.

Managed Exchange Rate System (Ch. 6)

Under a managed float system, governments will allow exchange rates move according to market forces; however, they will intervene when they believe it is necessary.

Why would a bank desire to participate in syndicated Eurocredit loans? (Ch. 3)

With a Eurocredit loan, no single bank would be totally exposed to the risk that the borrower may fail to repay the loan. The risk is spread among all lending banks within the syndicate.

Compute the bid/ask percentage spread for Mexican peso retail transactions in which the ask rate is $.11 and the bid rate is $.10. (Ch. 3)

[($.11 - $.10)/$.11] = .091 or 9.1%