Chapter 11 – The Foreign Exchange Market and Exchange Rates
Multiple Choice
Individuals, firms, and banks buy and sell foreign currencies in the:
A)foreign exchange market
B)currency market
C)Eurocurrency market
D)Export-Import Bank
Answer: A pg. 281
The foreign exchange market is:
A)where American consumers purchase goods imported from other countries
B)where domestic commercial bank deposits are denominated in a currency other than the home nation’s
C)the framework for the exchange of one national currency for another
D)where bank deposits are denominated in a currency other than that of the nation in which the deposit is held
Answer: C pg. 281
What is the principal function of the foreign exchange market?
A)To transfer purchasing power from one nation to another in exchange for currency
B)To maintain fixed exchange rates that remain unaffected by market forces
C)To facilitate foreign direct investment
D)None of the above
Answer: A pg. 281
Which of the following activities generates an increase in a nation’s demand for foreign currency?
A)American tourists visit Japan
B)a US firm imports goods from Europe
C)An individual in the US buys bonds from France
D)all of the above
Answer: D pg. 281
Which of the following generates an increase in a nation’s supply of foreign currencies?
A)American tourists visit Japan
B)An American firm exports goods to Canada
C)An individual in the US buys bonds from France
D)a US firm imports goods from Europe
Answer: B pg. 281
A nation’s commercial bank operates as a(n) ____________ for the foreign exchange demanded and supplied as the nation’s residents engage in foreign transactions.
A)barter trader
B)exporter
C)clearinghouse
D)all of the above
Answer: D pg. 282
How many levels of agents or participants can be identified in the foreign exchange market?
A)One
B)Five
C)Four
D)Seven
Answer: C pg. 282
The Bank of International Settlements (BIS) in Switzerland estimated that foreign exchange market transaction total __________ per day.
A)$1.3 billion
B)$1.3 trillion
C)$350 million
D)$5 trillion
Answer: B pg. 283
Which city is home to the largest foreign exchange market in the world?
A)New York
B)London
C)Frankfurt
D)Tokyo
Answer: B pg. 283
A television costs 600 Canadian dollars (CAD) in Canada and 500 US dollars (USD) in the US. The exchange rate between the Canadian dollar and the US dollar is:
A)1.2 CAD per 1 USD
B)1.2 USD per 1 CAD
C).833 CAD per 1 USD
D)Cannot determine
Answer: A pg. 287
An exchange rate is defined as:
A)the interest rate at which currencies can borrowed
B)the domestic currency price of the foreign currency
C)the ratio of export prices to import prices
D)The domestic currency price of a market basket of the most traded currencies in the world
Answer: B pg. 283
________ was the common currency adopted a majority of the member nations in the EU.
A)The pound sterling
B)The euro
C)The dollar
D)The franc
Answer: B pg. 285
If the US dollar price of the Japanese yen changes from $1 per 100 yen to $1.50 per 100 yen, the dollar is said to have _____________ and the yen has ______________.
A)appreciated, depreciated
B)depreciated, appreciated
C)appreciated, appreciated
D)depreciated, depreciated
Answer: B pg. 286
A foreign currency is said to have appreciated against the dollar when:
A)the dollar price of the currency has increased
B)the foreign currency price of the dollar has increased
C)the exchange rate of both currencies with respect to the euro has increased
D)the exchange rate for both currencies with respect to a third currency has decreased
Answer: A pg. 287
A foreign currency is said to have depreciated against the dollar when:
A)the dollar price of the currency has increased
B)the foreign currency price of the dollar has increased
C)the exchange rate of both currencies with respect to the euro has decreased
D)the exchange rate for both currencies with respect to a third currency has increased
Answer: B pg. 287
Which of these would not cause the US demand curve for foreign currency to shift to the left?
A)Americans wanting to consume fewer foreign goods
B)Decreasing interest rates in the US relative to other countries
C)Decreasing incomes in the US
D)A depreciation of the US dollar against foreign currencies
Answer: D pg. 286
A weighted average of the exchange rates between the domestic currency and the nation’s most important trade partners is called:
A)the effective exchange rate
B)the cross exchange rate
C)arbitrage exchange rate
D)speculative exchange rate
Answer: A pg. 287
The exchange rate between any two currencies is kept the same in different monetary centers by ____________.
A)the effective exchange rate
B)speculation
C)arbitrage
D)hedging
Answer: C pg. 289
The act of purchasing currency in one market at a lower price for immediate resale in another market at a higher price in order to make a profit is called:
A)arbitrage
B)hedging
C)speculation
D)interest arbitrage
Answer: A pg. 289
A depreciation of the dollar refers to a(n):
A)Increase in the dollar price of foreign currency
B)Decrease in the interest rate one must pay to borrow currency
C)Decrease in the dollar price of foreign currency
D)Decrease in US demand for dollars
Answer: A pg. 286
A transaction that calls for the payment and receipt of the foreign exchange within two business days from the transaction date is a:
A)forward transaction
B)spot transaction
C)arbitrage transaction
D)foreign discount with respect to the domestic currency
Answer: B pg. 292
A ______________ involves an agreement today to buy or sell a specified amount of a foreign currency, for delivery at a specified future date, at a rate agreed upon today.
A)forward transaction
B)spot transaction
C)arbitrage transaction
D)foreign discount with respect to the domestic currency
Answer: A pg. 292
The most common forward rate is ____________.
A)one month
B)six months
C)three months
D)nine months
Answer: C pg. 292
A currency that is selling at a forward rate greater than the spot rate is said to be trading at a(n):
A)forward increase
B)forward discount
C)forward transaction
D)forward premium
Answer: D pg. 292
The percentage per year by which the forward rate on the foreign currency is below its spot rate is the:
A)forward increase
B)forward discount
C)forward transaction
D)forward premium
Answer: B pg. 292
____________ are traded in a forward contract for standardized currency amounts and traded only on selected calendar dates.
A)foreign exchange futures
B)spot rate transactions
C)forward premium currencies
D)forward discount currencies
Answer: A pg. 293
Which currencies are traded in the futures market?
A)the Japanese Yen and the British pound
B)the Japanese Yen, the British pound, the Australian dollar, the Canadian dollar, the Mexican peso, the Swiss franc and the euro
C)all foreign currencies and the US dollar
D)the British pound, the U.S. dollar, and the Japanese yen
Answer: B pg. 293
A _______________ is a contract giving the purchaser the right, but not the obligation, to buy or to sell a standard amount of a traded currency on a stated date or at any time before a stated date and at a stated price.
A)foreign exchange option
B)futures transaction
C)spot transaction
D)forward transaction
Answer: A pg. 297
Assume there is an increase in the American demand for Japanese cameras. This results in:
A)An increase in the demand for yen
B)An decrease in the demand for yen
C)An increase in the supply of yen to the US
D)An decrease in the supply of yen to the US
Answer: A pg. 283
________________ refers to the covering of an open position by eliminating some level of risk.
A)Arbitrage
B)Hedging
C)Foreign exchange risk
D)Speculation
Answer: B pg. 298
What is the primary difference between speculation and arbitrage in the foreign exchange market?
A)They are fundamentally the same transaction
B)Arbitrage involves transactions separated by time, while speculative transactions take place in concurrent markets
C)Speculation is risk free, arbitrage is not
D)Speculative transactions are separated by time, while arbitrage occurs in concurrent markets
Answer: D pg. 300
__________________ refers to the purchase of a foreign currency when the domestic price of the foreign currency falls or is low, in the expectation that it will soon rise, thus leading to a profit.
A)Destabilizing speculation
B)Stabilizing speculation
C)Hedging
D)Arbitrage
Answer: B pg. 301
________________ is the sale of a foreign currency when the exchange rate falls or is lower, in the expectation that it will fall even lower in the future.
A)Destabilizing speculation
B)Stabilizing speculation
C)Hedging
D)Arbitrage
Answer: A pg. 301
_______________ involves the transfer of short-term liquid funds abroad to earn a higher return.
A)Destabilizing speculation
B)Stabilizing speculation
C)Hedging
D)Interest arbitrage
Answer: D pg. 301
If you have a commitment to pay a friend in Britain 1,000 pounds in 30 days, and you are holding US dollars, you could remove the risk of loss due to the appreciation of the pound by:
A)Buying dollars in the 30-day forward market
B)Selling dollars in the 30-day forward market
C)Buying pounds in the 30-day forward market
D)Selling pounds in the 30-day forward market
Answer: C pg. 302
Suppose the exchange rate of the British pound is $1.75 per pound while the exchange value of the Swiss franc is $0.667 cents per franc. The cross exchange rate between the pound and the franc is:
A).381 franc per pound
B)1.167 francs per pound
C)Cannot determine
D)2.624 francs per pound
Answer: D pg. 287
_____________ are commercial bank deposits in one nation denominated in the currency of another nation.
A)Eurobonds
B)Eurocurrencies
C)Euronotes
D)Offshore deposits
Answer: B pg. 305
Eurobonds are defined as:
A)long-term debt securities sold outside the borrower’s country to raise long-term capital in a currency other than the currency of the nation where the securities are sold.
B)bank deposits denominated in a currency other than that of the nation in which the deposit is held.
C)commercial bank deposits in one nation denominated in the currency of another nation.
D)Bonds purchased from any nation that is a member of the European Union.
Answer: A pg. 305
_______________ are bank deposits denominated in a currency other than that of the nation in which the deposit is held.
A)Eurobonds
B)Eurocurrencies
C)Euronotes
D)Offshore deposits
Answer: D pg. 305
True/False
True or False? The foreign exchange market for any currency is composed of all the locations where the currency is bought and sold for other currencies
Answer: True pg. 281
True or False? The principal function of the foreign exchange market is the transfer of funds, thus purchasing power, from one nation and currency to another.
Answer: True pg. 281
True or False? The total demand for foreign currencies is not changed when individuals travel abroad.
Answer: False pg. 281
True or False? Without a nation’s commercial banking system exchanging demanded and supplied transactions, the process of exchanging transactions from one currency to another would be inefficient.
Answer: True pg. 282
True or False? If the exchange rate is $0.012 per yen in New York and $0.019 per yen in Tokyo, an arbitrage trade could profit by buying yen in Tokyo and simultaneously selling them in New York.
Answer: False pg. 289
True or False? If it takes 116.57 yen to buy one dollar, it takes $.0085785 to buy one yen.
Answer: True pg. 287
True or False? If the exchange rate is equal to $/€ = 2, then two dollars are required to purchase one Euro.
Answer: True pg. 283
True or False? Exchange rates are not free to fluctuate in response to market forces.
Answer: False pg. 284
True or False? A currency is said to have depreciated against the dollar if the dollar price of the currency has increased.
Answer: False pg. 286
True or False? As arbitrage is being conducted, the exchange rate between the two countries tends to equalize in the two monetary centers.
Answer: True pg. 290
Essay
Name and briefly describe the four levels of agents or participants in the foreign exchange market.
The first level is the traditional user such as tourists, importers, exporters, investors, etc. These are the immediate users and suppliers of foreign currencies. The second level is the commercial banks, acting as a clearinghouse between the users and earners of foreign exchange. The third level is foreign exchange brokers, where the nation’s commercial banks even out their foreign exchange position. Lastly is the nation’s central bank, acting as the seller or buyer of last resort when the nation’s total foreign exchange earnings and expenditures are unequal. The last resort occurs when the central bank wants to either draw down its foreign exchange reserves or add to them.
