Chapter 10: The Foreign Exchange Market

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. This is called the law of ____________________.

one price

Jen knows that it is not possible to accurately predict how exchange rates might fluctuate and result in a loss of finances for her company. In other words, Jen understands the reality of foreign exchange ____.

risk

The adverse consequences of unpredictable changes in exchange rates is called foreign exchange ______.

risk

The impact of psychological factors and investor expectations make it difficult for exchange rate theories to predict ______ changes in exchange rates.

short-term

Brittany is traveling in Germany and went to a bank to convert $200 into euros. She was concerned when she received fewer euros than she had last week when she converted the same amount of money. The teller explained that the money had been converted based on the rate that was available today for currency exchange and this rate fluctuates. What type of rate is being used in this transaction?

spot exchange

The _____ rate is the exchange rate of currency at a particular time on a particular day.

spot exchange

It would be possible to determine the PPP exchange rate that would exist if markets were efficient by comparing _____.

the prices of identical products in different currencies

Capital flight is a possibility when _____.

the value of a country's currency is experiencing rapid depreciation

An efficient market lacks _____.

trade barriers

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 to the adverse movement in exchange rates between the time of the deal and the time when payment is due is called ______ exposure.

transaction

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?

$4.50

If the exchange rate is 1 British pound to $1.35, an American in London will need $______ (rounded to closest whole number) to purchase a purse priced at 20 pounds.

27

For most major currencies, forward exchange rates are commonly quoted for which three periods of time?

30 days 180 days 90 days

What is hyperinflation?

An explosive and seemingly uncontrollable price inflation in which money loses value very rapidly

Which type of control of exposure is MOST effective at protecting resources efficiently and ensuring that each subunit adopts the correct mix of tactics and strategies?

Centralized

______ agreements are barter-like agreements used by countries whose currency is NOT convertible.

Countertrade

The PPP, according to research, seems to predict exchange rate movements best for countries exhibiting which two characteristics?

Countries with high inflation rates Countries with underdeveloped capital markets

True or false: Short-term exchange rate movements are simple to predict.

False

Fit-Right Shoe Company is a shoe distribution center. The company agrees to buy 1,000 pairs of shoes from a factory in China. Fit-Right enters into a 30-day forward exchange transaction with the factory. What is the result of this type of agreement?

Fit-Right will be guaranteed that they will have to pay no more than the 30-day forward exchange rate, insuring a profit.

The _____________ market school believes that forward exchange rates are NOT the best predictors of future spot exchange rates.

Inefficient

The most important foreign exchange trading center (with more than 37% of the market) is ______.

London

The five most important foreign exchange trading centers are

London, New York, Zurich, Tokyo and Singapore.

Brittany is traveling in Germany and went to a bank to convert $200 into euros. She was concerned when she received fewer euros than she had last week when she converted the same amount of money. The teller explained that the money had been converted based on the rate that was available today for currency exchange and this rate fluctuates. What type of rate is being used in this transaction?

Spot exchange

Kenneth wants to buy a new winter coat for his trip to London. He found the coat for $80 at Nordstrom in New York but he thinks he would prefer to buy it at Harrod's when he gets to London. He knows that based on the law of one price, the coat should cost _____ in London.

The same.

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 suggests that the International Fisher effect does NOT explain short-term exchange rate movements well.

True

Identify two ways international businesses use the foreign exchange market.

When income from foreign investments is received in a foreign currency When a business must pay a foreign company in its country's currency

If the demand for dollars is greater than the supply of them and the supply of Indian rupee is greater than the demand for them, then the dollar will _____ against the rupee.

appreciate

When the citizens of the small country realized that the value of their currency was decreasing because of recent government sanctions, they all rushed to exchange their money for a foreign currency. This demonstrates the idea of ______.

capital flight

It would be _____ for an international business to use the services of the foreign exchange market.

common

The foreign exchange market is used to _____.

convert currency

When a country trades goods and services for other goods and services it is called _____.

countertrade

What determines the value of a spot exchange rate?

demand and supply

Exchange rates are based on the ______.

demand and supply of one currency against another

A lead strategy occurs when a firm attempts to collect foreign currency receivables early when a currency is expected to ______ and pay foreign currency payables before they are due when a currency is expected to ______.

depreciate; appreciate

A country in which inflation is on the rise will have a currency that ____ compared to a country in which inflation is low.

depreciates

When a dominant enterprise is able to set different prices in different markets to reflect varying demand conditions, it is practicing price ______.

discrimination

A key to reducing economic exposure involves _____ so the firm is not severely affected by adverse changes in exchange rates.

distributing a firm's productive assets to various locations

A fundamental analysis approach to forecasting relies on _____ theory.

economic

One way to reduce _____ exposure involves distributing a firm's productive assets to various locations.

economic

A market in which prices reflect all available public information is considered to be _________________(efficient or inefficient?).

efficient

PPP theory shows a direct relationship between a change in relative prices and a change in _____.

exchange rates

The failure to find a link between which two conditions has been referred to as the purchasing power parity puzzle?

exchange rates and inflation rates

Transaction _____ refers to the extent that income from individual transactions is affected by changes in foreign exchange values.

exposure

Hillary's country only lets nonresidents convert money into a foreign currency without any restrictions. This country has a(n) _____ convertible currency.

externally

When only nonresidents can convert a currency into a foreign currency with no limitations, the currency is considered

externally convertible

True or false: Most companies focus on reducing their economic exposure while ignoring strategies to reduce their transaction and translation exposure.

false

Converting the currency of one country into the currency of another country is done through the _____.

foreign exchange market

An exchange rate that is used to take care of business in the future is called a _______________ exchange rate.

forward

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

forward

Scott's company is planning a major purchase from a Japanese company and doesn't want to take the risk that the dollar will depreciate in value against the yen. He sets up an agreement with the Japanese company to exchange currency now and execute the sale in six months. This is an example of _____.

forward exchange

The efficient market school suggests that ______ exchange rates are optimal at forecasting future ______ exchange rates.

forward; spot

Marcy is happy to live in a country where she is allowed to purchase unlimited amounts of foreign currency. Her country demonstrates a currency that is _____ convertible.

freely

When a country allows both residents and nonresidents to purchase unlimited amounts of a foreign currency, the country's currency is

freely convertible.

The approach to forecasting that draws on economic theory to develop models that predict exchange rate movements is the _____ approach.

fundamental

The link between price changes and changes in exchange rates is further weakened by ______ intervention in foreign exchange markets in their attempt to affect the value of their currencies.

government

A(n) ______ market is one in which prices do not reflect all available information, and forward exchange rates will not be the best predictors of future spot exchange rates.

inefficient

According to the ____ market school of thought, companies can improve the foreign exchange market's estimate of future exchange rates by investing in forecasting services.

inefficient

If the citizens of a country all had enough money to purchase anything they wanted, the demand for products across the country would increase. In response, the companies that supply products would raise the price. This demonstrates the idea of (inflation or deflation?) in an economy.

inflation

Interest rates reflect expectations about future ____ rates, which has been shown to lead to a depreciation in exchange rates.

inflation

When a country's money supply grows faster than goods and services can be produced, it results in _____.

inflation

What are the three fundamental determinants of exchange rates?

inflation rates interest rates monetary growth

Increases in interest rates reflect likely increases in ______, which is connected to depreciating ______ rates.

inflation; exchange

One main reason why the International Fisher Effect is NOT good at explaining short-term exchange rate movements is the impact of ______ on those movements.

investor psychology

A(n) ___________ strategy is when a firm attempts to collect foreign currency receivables early when a currency is expected to depreciate and pay foreign currency payables before they are due when a currency is expected to appreciate.

lead

According to research, the PPP is a relatively good predictor of ______ exchange rate movements, but is not as good a predictor of ______ movements.

long-run; short-run

When a country experiences hyperinflation, money _______ value very rapidly. (Choose gains or loses.)

loses

A(n) _____ currency is when neither residents nor nonresidents are allowed to exchange money into a foreign currency.

nonconvertible

No one in Trevor's country is allowed to convert currency into any foreign currency. This is an example of ____ currency.

nonconvertible