SOM 354 Chapter 10

The most important foreign exchange trading center is ______ with 43 percent of the activity. - New York - Singapore - London - Tokyo

- London

Forward exchange rates are exchange rates that govern _____ transactions. - future - current - supply - spot

- future

When the growth in a country's money supply is faster than the growth in its output of goods, ______ tends to increase. - the exchange rate - trade exports - direct investment - price inflation

- price inflation

The impact of psychological factors and investor expectations makes it difficult for exchange rate theories to predict ______ changes in exchange rates. - short-term - inefficient - stabilized - long-term

- short-term

The impact of psychological factors and investor expectations makes it difficult for exchange rate theories to predict ______ changes in exchange rates. - short-term - long-term - inefficient - stabilized

- short-term (day-to-day fluctuations are difficult to predict)

Currency ______ involves buying, selling, and holding currencies in order to make a profit from favorable fluctuations in exchange rates. - speculation - arbitrage - spotting - rating

- specultation

Foreign Exchange Market

a market for converting the currency of one country into that of another country

Capital Flight

converting domestic currency into a foreign currency

Inefficient Market

one in which prices do not reflect all available information

Spot exchange rate

the exchange rate at which a foreign exchange dealer will convert one currency into another that particular day

Foreign Exchange Risk

the risk that changes in exchange rates will hurt the profitability of a business deal

If a basket of goods costs $400 in the United States and 40,000 yen in Japan, PPP theory predicts that the dollar/yen exchange rate should be - $10 per Japanese yen. - $1.00 per Japanese yen. - $.01 per Japanese yen. - $.10 per Japanese yen.

- $.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. - $3.50 - $13.50 - $27 - $35

- $27

Assume that the exchange rate between the euro and the dollar is €1.00 = $1.50. Jenna is an American tourist in Italy buying a leather wallet whose price is €60. How much in U.S. dollars will Jenna have to pay to buy the product? - $90 - $30 - $60 - $150 - $75

- $90

PPP theory, according to research, seems to predict exchange rate movements best for countries in which two situations? (Select all that apply.) - Countries with underdeveloped capital markets - Countries with low inflation rates - Countries with developed capital markets - Countries with high inflation rates

- Countries with underdeveloped capital markets - Countries with high inflation rates

According to the __________, there is a strong relationship between inflation rates and interest rates. - theory of demand - efficient market hypothesis - purchasing power parity theory - law of one price - Fisher effect

- Fisher effect

What causes inflation to occur in a country? - Inflation occurs when the money supply in a country outpaces the level of production of goods and services. - Inflation occurs when there is an excess supply of goods and services in a country. - Inflation occurs when the government sets the prices of goods and services to stabilize the economy. - Inflation occurs when incomes are reduced and people have less money to purchase goods and services.

- Inflation occurs when the money supply in a country outpaces the level of production of goods and services.

The five most important foreign exchange trading centers in terms of level of activity are - Dublin, Chicago, Moscow, Tokyo, and Sydney. - London, New York, Zurich, Tokyo, and Hong Kong. - London, New York, Paris, Hong Kong, and Beijing. - Paris, Berlin, New York, Shanghai, and Mumbai.

- London, New York, Zurich, Tokyo, and Hong Kong.

What are the two main functions of the foreign exchange market? (Select all that apply) - Provide insurance against foreign exchange risk - Currency conversion - Advance mass customization - Eliminate double taxation

- Provide insurance against foreign exchange risk - Currency conversion

What are three moderately decent predictors of long-term changes in exchange rates? (Select all that apply.) - Real unemployment rate - Relative inflation rates - Predictive birth rate - Relative monetary growth - Nominal interest rate differentials

- Relative inflation rates - Relative monetary growth - Nominal interest rate differentials

__________ occurs when two parties agree to exchange currency and execute the deal at some specific date in the future. - a spot exchange - carry trade - currency speculation - a currency swap - a forward exchange

- a forward exchange

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 - forward exchange - arbitrage - carry trade - currency swap - countertrade

- arbitrage

Freeman Fabricators International 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 equipment for the company. This company engaged in - an option - a carry trade - a currency swap - arbitrage - countertrade

- arbitrage

Residents of the hypothetical nation of Jarna feared that the country's economy was failing. They rushed to convert their domestic currency into U.S. dollars and investors in businesses in Jarna also converted their financial holdings. This mass conversion of currency is known as _____. - arbitration - countertrade - translation exposure - capital flight

- capital flight

Assume that the interest rate on borrowings in Chile is 4 percent, but the interest rate on deposits in British banks is 8 percent. A trader borrows 1 million Chilean pesos, then converts the money into British pounds and deposits it in a British bank. What is the trader involved in? - arbitration - countertrade - purchasing power parity - carry trade - forward exchange

- carry trade

Jameson Electric Corp. would use the foreign exchange market when it needs to - convert currency. - translate written materials. - customize products. - advertise internationally.

- convert currency

An American company sold construction equipment to the government of Singapore. Instead of receiving payment in U.S. dollars, the company agreed to take payment in the form of goods. This is an example of: - a carry trade - countertrade - short selling - capital flight - arbitrage

- countertrade

An investment made to profit from future currency movements is called: - currency speculation. - currency conversion. - exchange risk. - currency weighting.

- currency speculation

A(n) __________ refers to the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. - carry trade - option trade - currency swap - hedge - forward exchange

- currency swap

The value of a currency is determined by the ______ of that currency relative to other currencies. - FDI - transaction costs - demand and supply - future value

- demand and supply

Theoretically, a country in which price inflation is running wild should expect to see its currency Blank______ against that of countries in which inflation rates are lower. - remain neutral - stay the same - appreciate - depreciate

- depreciate

What is the key way a company can reduce economic exposure? - Distribute production facilities and assets to various locations - Maintain several production facilities in one country - Request government intervention in trade barriers - Limit FDI to licensing and franchising agreements

- distribute production facilities and assets to various locations

Company A is based in Europe and does a large amount of business in the United States. 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. - translation - political - transaction - economic

- economic

The extent to which a firm's future international earning power will be affected by exchange rate changes is called ______ exposure. - transaction - economic - translation - political

- economic

A(n) __________ market is one in which prices reflect all available public information. - forward - facilitating - convertible - free - efficient

- efficient

A tactic that reduces translation and economic exposure is - investing in government bonds. - entering into forward exchange rate contracts. - using nonconvertible currencies. - creating enough supply to meet demand.

- entering into forward rate contracts

A(n) ______ convertible currency allows only nonresidents to convert it into a foreign currency without any limitations. - capital - forward - freely - externally

- externally

When only nonresidents can convert a currency into a foreign currency with no limitations, the currency is considered - nonconvertible. - externally convertible. - partially convertible. - freely convertible.

- externally convertible

In terms of the approaches to exchange rate forecasting, __________ draws on economic theory to construct sophisticated econometric models that are used to predict exchange rate movements. - technical analysis - behavioral equilibrium model - fundamental analysis - portfolio balance model - chart analysis

- fundamental analysis

Shreya is the chief financial officer for Home Safe Security Inc. Her company is interested in investing in a facility in Indonesia, but she is worried about unpredictable fluctuations in future exchange rates, which could cost her company millions of dollars. One way to ensure against this exchange risk is for Shreya to use: - countertrade - forecasting - hedging - arbitrage - currency speculation

- hedging

Translation exposure refers to the - impact of currency exchange rate changes on the reported financial statements of a company. - extent to which a firm's future international earning power is affected by changes in exchange rates. - extent to which income from individual transactions is affected by fluctuations in foreign exchange values. - extent to which the government allows residents and nonresidents to convert a currency into a foreign currency. - extent to which the money supply increases faster than output increases.

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

The Fisher effect predicts that there is a strong relationship between ______ and interest rates. - inflation rates - government intervention - greenfield ventures - supply and demand

- inflation rates

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. - environmental conditions - investor psychology - regulations - personal income

- inventor psychology

Alejandro is the manager of Polar Plastics, 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 Alejandro using to minimize the company's foreign exchange exposure? - forecast strategy - spot exchange rate - lag strategy - lead strategy - buying swaps

- lag strategy

According to research, PPP theory is a relatively good predictor of ______ exchange rate movements, but is not as good a predictor of ______ movements. - short-run; long-run - short-run; intermediate - long-run; intermediate - long-run; short-run

- long-run; short-run

Hudson Oil and Gas Inc., based in Houston, has a plant in Norway that builds cargo ships used to transport the company's products around the world. Each year this plant has been profitable, but Hudson Inc. is not able to convert the profits into U.S. dollars and take them out of the country. What type of convertibility does this represent? - freely convertible - nonconvertible - proconvertible - carry convertible - externally convertible

- nonconvertible

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 - rate differences - competitive markets - dual prices

- one price

The rate at which a foreign exchange dealer converts one currency into another currency on a particular day is the - forward exchange rate - future exchange rate - spot exchange rate - fixed exchange rate - floating exchange rate.

- spot exchange rate

The Economist magazine version of the PPP uses ______ as a proxy for a "basket of goods." - rice - coffee - the Big Mac - a bunch of grapes

- the Big Mac

The movement of traders like a herd, all in the same direction and at the same time, in response to each other's perceived actions, is called - the Fisher effect - the bandwagon effect - the Sullivan principle - capital flight - the spot effect.

- the bandwagon effect

According to _____, 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. - spot exchange rates - antidumping policies - purchasing power parity - the law of one price

- the law of one price

At the simplest of levels, exchange rates are determined by _____. - gross national income levels in the United States - the supply and demand of currencies - interest rate levels in participating countries - the leverage of the dollar

- the supply and demand of currencies

Capital flight is most likely to occur when - outside investors replace local workers with expatriates. - residents are unable to freely convert their currency. - the value of domestic currency is rapidly depreciating. - a country trades goods and services for other goods and services.

- the value of domestic currency is rapidly declining

The effect of currency exchange rate changes on the reported financial statements of companies is referred to as ______ exposure. - transaction - translation

- 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. - maintains - strengthens - weakens

- weakens

(T/F): 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)

(T/F): Spot against forward is a common type of currency swap.

True

Efficient Market

a market where prices reflect all available information

To protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies, firms should aim for (centralized/decentralized) control of exposure.

centralized

Lead strategy

collecting foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate

Lag Strategy

delaying the collection of foreign currency receivables if that currency is expected to appreciate, and delaying payables if that currency is expected to depreciate

International Fisher Effect

for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between countries

Law of One Price

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

Currency Speculation

involves short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates

Externally Convertible Currency

limitations on the ability of residents to convert domestic currency, though nonresidents can convert their holdings of domestic currency into foreign currency

The adverse consequences of unpredictable changes in exchange rates are called foreign exchange __________.

risk

Currency Swap

simultaneous purchase and sale of a given amount of foreign exchange for two different value dates

Exchange Rate

the rate at which one currency is converted into another

Countertrade

the trade of goods and services for other goods and services

Nonconvertible currency

when both residents and nonresidents are prohibited from converting their holdings of that currency into another currency

Freely convertible currency

when the governmentvof that country allows both residents and nonresidents to purchase unlimited amounts of foreign currency with the domestic currency

Forward Exchange

when two parties agree to change currency and execute a deal at some specific date in the future

Forward Exchange Rate

the exchange rates governing a forward exchange transaction

Translation Exposure

the extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange values

Arbitrage

the purchase of securities in one market for immediate resale in another to profit from a price discrepancy

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. - $45.00 - $3.00 - $14.50 - $4.50

- $4.50

Which school of thought on exchange rate forecasting does NOT believe that forward exchange rates are the best predictors of future spot exchange rates? - Efficient - Inefficient

- Inefficient

PPP theory predicts that changes in relative prices will result in: - decreased interest rates. - a recession. - a change in exchange rates. - decreased GNI.

- a change in exchange rates

Buying a currency low and immediately selling it high to make a profit from the price discrepancy is called _____. - unionizing - phishing - bartering - arbitrage

- arbitrage

The extent to which a firm's future international earning power is affected by changes in exchange rates is known as: - carry trade - translation exposure - countertrade - transaction exposure - economic exposure

- economic exposure

When a country's money supply grows faster than the output of goods and services, this causes - arbitration. - recession. - inflation. - depression.

- inflation

Two strategies that can be used to reduce translation and transaction exposure are: (Select all that apply.) - labor strategy. - lag strategy. - legal strategy. - lead strategy.

- lag strategy - lead strategy

Assume that the exchange rate between the U.S. dollar and the Japanese yen is $1 = ¥150. A pair of shoes that retail for $100 in New York should sell for ¥15,000 in Tokyo, if there are no trade barriers and transportation costs, according to the: - international Fisher Effect - inefficient market theory - Sullivan principle - law of one price - bandwagon effect

- law of one price

Carry trade

a kind of speculation that involves borrowing in one currency where interest rates are low, and then using the proceeds to invest in another currency where interest rates are high

Bandwagon Effect

movement of traders like a herd, all in the same direction and at the same time, in response to each other's perceived actions

Fisher Effect

Nominal interest rates (i) in each country equal the required real rate of interest (r) and the expected rate of inflation over the period of time for which the funds are to be lent (pi). That is, i = r + pi

Economic exposure is concerned with the (short/long)- term effect of changes in exchange rates on future prices, sales, and costs.

long

Economic Exposure

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

Transaction Exposure

the extent to which income from individual transactions is affected by fluctuations in foreign exchange values