Chapter 10: The Foreign Exchange Market

True / False Questions

 

1. What happens in the foreign exchange market does not directly impact the sales, profits, and
strategy of a multinational enterprise. 
 
True    False
 
2. The foreign exchange market is a market for converting the currency of one country into that
of another country. 
 
True    False
 
3. The currency of Argonia falls sharply in value against the currency of Palladia. This
exchange rate movement will boost Palladia's exports to Argonia. 
 
True    False
 
4. The foreign exchange market offers complete insurance against foreign exchange risk. 
 
True    False
 
5. Foreign exchange risk refers to the risk of not getting paid for a product that is exported from
one country to another. 
 
True    False
 
6. The euro/dollar exchange rate is €1 = $1.20. If it costs $36 to buy a European product, the
stated price of the product would be €36. 
 
True    False
 
7. The short-term movement of funds from one currency to another in the hopes of profiting
from shifts in exchange rates is known as countertrade. 
 
True    False
 
8. Companies engage in currency speculation to get minimal but assured returns from idle
cash. 
 
True    False
 
9. Carry trade is a kind of speculation whose success is based upon a belief that there will be no
adverse movement in exchange rates. 
 
True    False
 
10. The forward exchange rate refers to the rate at which a foreign exchange dealer converts one
currency into another currency on a particular day. 
 
True    False
 
11. For most major currencies, forward exchange rates are quoted for 30 days, 90 days, and 180
days into the future. 
 
True    False
 
12. Spot exchange rates and the 30-day forward rates are the same. 
 
True    False
 
13. Assume that current dollar/yen spot exchange rate is $1 = ¥110. If the 30-day forward
exchange is $1 = ¥105, we say the dollar is selling at a premium on the 30-day forward
market. 
 
True    False
 
14. When a firm enters into a spot exchange contract, it is taking out insurance against adverse
future exchange rate movements. 
 
True    False
 
15. Currency swaps are transacted between international businesses and their banks, between
banks, and between governments when it is desirable to move out of one currency into
another for a limited period without incurring foreign exchange risk. 
 
True    False
 
16. A common kind of currency swap is spot against forward. 
 
True    False
 
17. When companies wish to convert currencies, they typically enter the foreign exchange
market directly. 
 
True    False
 
18. The integration of financial centers implies there can be no significant difference in exchange
rates quoted in the foreign exchange trading centers. 
 
True    False
 
19. Although a foreign exchange transaction can involve any two currencies, most transactions
involve dollars on one side. 
 
True    False
 
20. London has lost its leading position in the global foreign exchange market due to the
diminishing importance of the British pound. 
 
True    False
 
21. If the law of one price were true for all goods and services, the purchasing power parity
(PPP) exchange rate could be found from any individual set of prices. 
 
True    False
 
22. In the context of The Economist's "Big Mac Index," assume that the average price of a Big
Mac in South Korea is $2.98 at the prevailing won/dollar exchange rate. The average price of
a Big Mac in the United States is $3.58. This suggests that the Korean won is overvalued
against the U.S. dollar. 
 
True    False
 
23. Theoretically, a country in which price inflation is very high should expect to see its currency
depreciate against that of countries in which inflation rates are lower. 
 
True    False
 
24. Inflation occurs when the money supply in a country increases faster than output increases. 
 
True    False
 
25. For price discrimination to work, arbitrage opportunities must be unlimited. 
 
True    False
 
26. In countries where inflation is expected to be high, interest rates also will be high. 
 
True    False
 
27. Unlike the purchasing power parity theory, the international Fisher effect is a good predictor
of short-run changes in spot exchange rates. 
 
True    False
 
28. Relative monetary growth, relative inflation rates, and nominal interest rate differentials are
all moderately good predictors of long-run changes in exchange rates. 
 
True    False
 
29. In terms of exchange rate forecasting, the efficient market school argues that companies
should spend additional money trying to forecast short-run exchange rate movements. 
 
True    False
 
30. Technical analysis, an approach to foreign exchange forecasting, does not rely on a
consideration of economic fundamentals. 
 
True    False
 
31. When residents and nonresidents rush to convert their holdings of domestic currency into a
foreign currency, the phenomenon is generally referred to as capital flight. 
 
True    False
 
32. Transaction exposure, a category of foreign exchange risk, refers to the impact of currency
exchange rate changes on the reported financial statements of a company. 
 
True    False
 
33. Since translation exposure, a category of foreign exchange risk, is concerned with the present
measurement of past events, the resulting accounting gains or losses are said to be
unrealized, and therefore unimportant. 
 
True    False
 
34. Economic exposure, a category of foreign exchange risk, is distinct from transaction
exposure, which is concerned with the effect of exchange rate changes on individual
transactions, most of which are short-term affairs that will be executed within a few weeks or
months. 
 
True    False
 
35. Leading and lagging strategies involve accelerating payments from weak-currency to strong-
currency countries and delaying inflows from strong-currency to weak-currency countries. 
 
True    False
 
 

Multiple Choice Questions

 

36. A(n) _____ refers to the rate at which one currency is converted into another.  
 

A. economic exposure

B. arbitrage

C. exchange rate

D. tariff rate

E. currency swap
 
37. Which of the following enables organizations to conduct international trade without having
to resort to barter?  
 

A. Foreign exchange market

B. Caribbean Single Market and Economy

C. Auction market

D. Countertrade

E. Balance-of-Trade Equilibrium
 
38. The currency of Venadia, a country, falls sharply in value against the currency of Lutetia, a
neighboring country. Which of the following is a consequence of this exchange rate
movement?  
 

A. Lutetia's products will achieve a competitive pricing in Venadia.

B. Venadia's exports to Lutetia will increase because Venadian goods will become cheaper in
Lutetia.

C. Venadia's products will cost more in Lutetia.

D. There will be no difference in the volume or direction of trade.

E. Lutetia's exports to Venadia will increase because Lutetian goods will become cheaper in
Venadia.
 
39. Which of the following is a function of the foreign exchange market?  
 

A. To provide some insurance against foreign exchange risk

B. To protect short-term cash flow from adverse changes in exchange rates

C. To eliminate volatile changes in exchange rates

D. To reduce the economic exposure of a firm

E. To enable companies to engage in capital flight when countertrade is not possible
 
40. _____ refers to the adverse consequences of unpredictable changes in exchange rates.  
 

A. Countertrade

B. Foreign exchange risk

C. Currency speculation

D. Forward exchange

E. Floating exchange rate

 
41. Steven converted $1,000 to ¥105,000 for a trip to Japan. However, he spent only ¥50,000.
During this period, the value of the dollar weakened against the yen. Considering a current
exchange rate of $1=¥100, how many dollars did Steven spend on the trip?  
 

A. $550

B. $523

C. $450

D. $600

E. $500
 
42. A French company wants to invest 20 million euros for three months. The company found
that investing in a Thai money market account will give it a higher interest rate than domestic
investments. Which of the following is true about this investment?  
 

A. The investment is risk-free because money market investments are considered to be

equivalent to bank deposits.

B. The investment is not risk-free because foreign currency movements in the intervening
period can affect the profitability of the firm.

C. The investment is risk-free because such investments also lock foreign exchange rates for
the duration of the investment.

D. The investment is not risk-free because money market instruments are considered to be
the most speculative of all investments.

E. The investment is risk-free because the Thai money market is considered to be more stable
and secure than other markets.
 
43. Which of the following refers to currency speculation?  
 

A. The short-term movement of funds from one currency to another in the hopes of profiting
from shifts in exchange rates

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

C. Simultaneous purchase and sale of a given amount of foreign exchange for two different
value dates

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

E. The growth in a country’s money supply exceeding the growth in its output, leading to
price inflation
 
44. Robben Inc. converts $1,000,000 into euros when the exchange rate is $1 = €0.75. After
three months, the company converts this back into dollars when the exchange rate is $1 =
€0.80. Which of the following is the outcome of this transaction?  
 

A. A loss of $62,500

B. A loss of $66,667

C. A gain of $50,000

D. A gain of $62,500

E. A loss of $50,000

 
45. Which of the following refers to carry trade?  
 

A. Providing insurance or hedging against the risks that arise from volatile changes in
exchange rates

B. A transaction between two parties that involves exchanging currency and executing a deal
at some specific date in the future

C. Simultaneous purchase and sale of a given amount of foreign exchange for two different
value dates

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

E. Borrowing in one currency where interest rates are low and then using the proceeds to
invest in another currency where interest rates are high
 
46. The interest rate on borrowings in Rhodia is 2 percent and the interest rate on bank deposits
in Maritia is 7.5 percent. In this scenario, a carry trade would be to:  
 

A. borrow money in Maritian currency, convert it into Rhodian currency, and deposit it in a
Rhodian bank.

B. borrow money in Rhodian currency and invest in stocks with good growth potential in
Rhodia.

C. borrow money in Rhodian currency, convert it into Maritian currency, and deposit it in a
Maritian bank.

D. invest in bank deposits of Maritia and reinvest the earnings in Rhodia.

E. invest in bank deposits of Rhodia and reinvest the earnings in Maritia.

 
47. Carry trade, a kind of speculation, takes advantage of the:  
 

A. temporary undervaluation of one currency vis-à-vis another.

B. disparity between spot exchange rates and forward exchange rates.

C. the collapse of the gold standard.

D. differences in interest rates between countries.

E. the rise of the fixed exchange rate system.

 
48. The speculative element of the carry trade is that its success is based upon a belief that:  
 

A. there will be no adverse movement in exchange rates or interest rates.

B. liquidity is the key factor in determining interest rates.

C. increasing money supply will not drive inflation.

D. spot exchange rates are more favorable than forward exchange rates.

E. hedging insures a company against foreign exchange risks.

 
49. Which of the following caused a decline in the dollar-yen carry trade during 2008-09?  
 

A. Increase in risk appetite making the carry trade less attractive

B. Decrease in interest rate differentials as the U.S. rates came down

C. Increase in interest rate differentials as Japanese interest rates came down

D. Decrease in interest rate differentials as the U.S. interest rates went up

E. Decrease in interest rate differentials as the Japanese rates went up

 
50. When a firm insures itself against foreign exchange risk, it is said to be engaging in _____.  
 

A. currency speculation

B. carry trade

C. hedging

D. currency swap

E. arbitrage
 
51. When two parties agree to exchange currency and execute the deal immediately, the
transaction is referred to as _____.  
 

A. forward exchange

B. countertrade

C. arbitrage

D. spot exchange

E. currency swap
 
52. How are spot exchange rates determined?  
 

A. By using historical average prices of different currencies

B. By the interaction between demand and supply of a currency relative to other currencies

C. By taking the average of a basket of currencies

D. By government decree

E. By predicting future currency movements

 
53. An American company imports laptop computers from Japan. The company knows that after
a shipment arrives, it must pay in yen to the Japanese supplier within 30 days. In a particular
exchange, the American company must pay the Japanese supplier ¥150,000 for each
computer at the current dollar/yen spot exchange rate of $1 = ¥110. The company intends
to resell the computers the day they arrive for $1,600 each but it does not have the funds to
pay the Japanese supplier until the computers have been sold. Which of the following will
happen if the exchange rate after 30 days is $1 = ¥90?  
 

A. The importer will earn a profit of approximately $236 per computer.

B. The importer will earn a profit of approximately $67 per computer.

C. The importer will incur a loss of approximately $236 per computer.

D. The importer will incur a loss of approximately $67 per computer.

E. The importer will incur a loss of approximately $90 per computer.

 
54. A U.S. company that imports laptop computers from Japan knows that in 30 days it must pay
in yen to a Japanese supplier when a shipment arrives. The company will pay the Japanese
supplier ¥150,000 for each computer, and the current dollar/yen spot exchange rate is $1 =
¥110. The importer can sell the computers the day they arrive for $1,600 each. However, the
importer will not have the funds to pay the Japanese supplier until the computers have been
sold. The importer enters into a 30-day forward exchange transaction with a foreign
exchange dealer at $1 = ¥105. Which of the following will happen if the exchange rate after
30 days is $1 = ¥90?  
 

A. The importer will earn a profit of approximately $236 per computer.

B. The importer will earn a profit of approximately $171 per computer.

C. The importer will earn a profit of approximately $65 per computer.

D. The importer will incur a loss of approximately $67 per computer.

E. The importer will incur a loss of approximately $105 per computer.

 
55. A(n) _____ occurs when two parties agree to exchange currency and execute the deal at
some specific date in the future.  
 

A. forward exchange

B. spot exchange

C. carry trade

D. currency swap

E. arbitrage
 
56. Which of the following indicates that the dollar is selling at a discount on the 30-day forward
market?  
 

A. When the spot exchange rate is $1 = ¥120 currently and $1 = ¥130 after 30 days

B. When the spot exchange rate is $1 = ¥120 currently and $1 = ¥100 after 30 days

C. When the current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 =
¥110 after 30 days

D. When the current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 =
¥130 after 30 days

E. When the current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 =
¥120 after 30 days
 
57. Which of the following instances indicates that the dollar is selling at a premium on the 30-
day forward market?  
 

A. When the spot exchange rate is currently $1 = ¥120  and changes to $1 = ¥130 after 30
days

B. When the spot exchange rate is currently $1 = ¥120 and changes to $1 = ¥110 after 30
days

C. When the current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 =
¥110 after 30 days

D. When the current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 =
¥130 after 30 days

E. When the current spot exchange rate is $1 = ¥120 and the 30-day forward rate is $1 =
¥120
 
58. Assume that the dollar is selling at a premium on the 30-day dollar/euro forward market.
Which of the following is true of the foreign exchange dealers' market's expectations about
the dollar over the next 30 days?  
 

A. The dollar will depreciate against the euro.

B. The market is undecided about the direction of currency movement.

C. The dollar will appreciate against the euro.

D. The dollar/euro exchange rate will be steady.

E. The dollar will buy more euros with a spot exchange than with a 30-day forward
exchange.
 
59. _____ refers to the simultaneous purchase and sale of a given amount of foreign exchange
for two different value dates.  
 

A. Carry trade

B. Forward exchange

C. Spot exchange

D. Currency swap

E. Arbitrage
 
60. Which of the following transactions is used to move out of one currency into another for a
limited period without incurring foreign exchange risk?  
 

A. Currency swap

B. Currency speculation

C. Carry trade

D. Spot exchange

E. Arbitrage
 
61. Which of the following foreign exchange trading centers has the highest percentage of
activity?  
 

A. Frankfurt

B. London

C. Paris

D. Hong Kong

E. Sydney
 
62. Which of the following is a reason for London's dominance in the foreign exchange market?  
 

A. Great Britain's decision to retain the British pound instead of using the euro

B. The preeminence of Financial Times Stock Exchange (FTSE) index as an economic health
indicator

C. London's location making it the link between the East Asian and New York markets

D. London being the preferred headquarters destination for major multinational corporations

E. London's trading centers opening soon after Tokyo's and New York's trading
centers closing for the night
 
63. Which of the following is a key feature of the foreign exchange market?  
 

A. The foreign exchange market never sleeps.

B. The foreign exchange market is located in London.

C. The foreign exchange market is characterized by high transaction costs.

D. The foreign exchange market is shut for two hours every day.

E. The foreign exchange market is poorly interconnected giving rise to ample arbitrage
opportunities.
 
64. What is meant by arbitrage?  
 

A. To provide insurance or hedge against the risks that arise from volatile changes in
exchange rates

B. A transaction between two parties that involves exchanging currency and executing a deal
at some specific date in the future

C. Simultaneous purchase and sale of a given amount of foreign exchange for two different
value dates

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

E. To borrow in one currency where interest rates are low and use the proceeds to invest in
another currency where interest rates are high
 
65. Assume that the yen/dollar exchange rate quoted in London at 3 p.m. is ¥120 = $1, and the
New York yen/dollar exchange rate at the same time (10 a.m. New York time) is ¥123 = $1.
Which of the following transactions would yield immediate profit?  
 

A. Forward exchange

B. Carry trade

C. Currency swap

D. Arbitrage

E. Currency speculation
 
66. The yen/dollar exchange rate is ¥120 = $1 in London and ¥123 = $1 in New York at the
same time. What is the net profit if a dealer takes $1,000,000 to purchase ¥1,23,000,000 in
New York and engages in arbitrage by selling it in London?  
 

A. $34,000

B. $20,390

C. $25,000

D. $46,666

E. $39,454
 
67. Which of the following is true of arbitrage opportunities in foreign exchange markets?  
 

A. They cause long-term bandwagon effects.

B. They tend to be small and they disappear in minutes.

C. They tend to occur very frequently.

D. They are only valid for dollar transactions.

E. They provide insurance against foreign exchange risk.

 
68. A dealer wishes to sell Thai baht for Argentine peso. Which of the following currencies is
most likely to act as a vehicle currency in this transaction?  
 

A. Malaysian ringgit

B. Japanese yen

C. British pound

D. U.S. dollar

E. South African rand

 
69. Which of the following is a vehicle currency due to its central role in foreign exchange
deals?  
 

A. South African rand

B. U.S. dollar

C. British pound

D. Japanese yen

E. Chinese renminbi
 
70. In terms of foreign exchange transactions, the _____ has replaced the German mark as the
world’s second most important vehicle currency.  
 

A. euro

B. yen

C. pound

D. riyal

E. mark
 
71. Which of the following is true of the determination of exchange rates?  
 

A. Differences in relative demand and supply do not explain the determination of exchange
rates.

B. Differences in relative demand and supply explain the factors underlying the
phenomenon behind the demand for and supply of a currency.

C. The differences in relative demand and supply alone provide a high level understanding of
behind determination of exchange rates.

D. While the differences in relative demand and supply they provide an accurate explanation
for appreciation of currencies, they fail to explain depreciation.

E. The differences in relative demand and supply cannot explain or predict the conditions
under which a particular currency will be in demand or not.
 
72. Which of the following is true of the differences in relative demand and supply of
currencies?  
 

A. They cannot be used to explain the determination of exchange rates.

B. While they provide an understanding of the major factors underlying exchange rates, they
exclude minor factors.

C. They provide a high level understanding of exchange rates.

D. While they provide an accurate explanation for appreciation of currencies, they fail to
explain depreciation.

E. They cannot explain or predict when the demand of a particular currency would exceed its
supply and vice versa.
 
73. The law of one price states that:  
 

A. by comparing the prices of identical products in different currencies, it would be possible
to determine the “real” or PPP exchange rate that would exist if markets were efficient.

B. a country’s “nominal” interest rate (i) is the sum of the required “real” rate of interest (r)
and the expected rate of inflation over the period for which the funds are to be lent (I).

C. a country in which price inflation is running wild should expect to see its currency
depreciate against that of countries in which inflation rates are lower.

D. when the growth in a country’s money supply is faster than the growth in its output, price
inflation is fueled.

E. in competitive markets free of transportation costs and trade barriers, identical products
sold in different countries must sell for the same price when their price is expressed in
terms of in the same currency.
 
74. The euro/dollar exchange rate is €1 = $1.20. According to the law of one price, a camera that
retails for $300 in New York should sell for _____ in Germany.  
 

A. €320

B. €300

C. €250

D. €360

E. €150
 
75. The euro/dollar exchange rate is €1 = $1.20. If a trader buys a camera that retails for $300 in
New York and sells it for €200 in Berlin (ignoring transaction costs, transportation costs, or
trade barriers), this represents a potential profit (arbitrage) of _____.  
 

A. $60

B. $80

C. $20

D. $100

E. $40
 
76. Which of the following has no impediments to the free flow of goods and services, such as
trade barriers?  
 

A. Economic Union

B. Currency Board

C. Efficient market

D. Carry trade

E. European Monetary System

 
77. To express the PPP theory in symbols, let P$ be the U.S. dollar price of a basket of particular
goods and P¥ be the price of the same basket of goods in Japanese yen. The (purchasing
power parity) PPP theory predicts that the dollar/yen exchange rate, E$/¥, should be
equivalent to _____.  
 

A. E$/¥= (1+P¥)/P$

B. E$/¥= (1 + P$)/P¥

C. E$/¥= P¥/P$

D. E$/¥= P$/P¥

E. E$/¥= (1+P$)/(1+P¥)
 
78. If a basket of goods costs $100 in the United States and €120 in Europe, purchasing power
parity theory predicts that the dollar/euro exchange rate should be _____.  
 

A. $1 = €1.20

B. $1 = €1

C. $1 = €0.80

D. $1 = €0.90

E. $1 = €1.10
 
79. Which of the following is true of the purchasing power parity (PPP) theory?  
 

A. A country’s “nominal” interest rate (i) is the sum of the required “real” rate of interest (r)
and the expected rate of inflation over the period for which the funds are to be lent (I).

B. The exchange rate will not change if relative prices change.

C. The price of a "basket of goods" should be roughly equivalent in each country in

relatively efficient markets.

D. In competitive markets free of transportation costs and trade barriers, identical products
sold in different countries must sell for the same price.

E. If the law of one price were true for all goods and services, the PPP exchange rate could
not be found from any individual set of prices.
 
80. Which of the following is illustrated by the Big Mac Index published by The Economist?  
 

A. The law of one price

B. The purchasing power parity theory

C. The Fisher effect

D. Flow of FDI

E. The bandwagon effect

 
81. The average price of a Big Mac in the United States is $3.58. Which of the following
currencies is the most overvalued according to the Big Mac Index?  
 

A. Japanese yen; average price of a Big Mac equals $3.50

B. South African rand; average price of a Big Mac equals $2.46

C. Norwegian krone; average price of a Big Mac equals $7.02

D. Chinese yuan; average price of a Big Mac equals $1.83

E. Swiss franc; average price of a Big Mac equals $6.80

 
82. Which of the following is true of inflation?  
 

A. It occurs when the demand for a particular currency is more than the supply

B. It occurs when securities are purchased in one market for immediate resale in another

C. It occurs when two parties agree to exchange currency and execute a deal at a specific
date in the future

D. It occurs when the quantity of money in circulation rises faster than the stock of goods
and services

E. It occurs when output increases faster than the money supply
 
83. Which of the following results from the output of goods and services not matching the
increase in money supply?  
 

A. Inflation

B. Deflation

C. Arbitrage

D. Bandwagon effect

E. Carry trade
 
84. Which of the following occurs when a government increases money supply?  
 

A. It results in an overall decrease in credit.

B. It makes it difficult for individuals and companies to borrow from banks.

C. It makes it easier for banks to borrow from the government.

D. It causes a decrease in demand for goods and services.

E. It causes price deflation as the money supply exceeds goods and services output.
 
85. The purchasing power parity (PPP) theory tells us that a country with a high inflation rate
will see:  
 

A. appreciation in its currency exchange rate.

B. decrease in interest rates.

C. the collapse of the gold standard.

D. depreciation in its currency exchange rate.

E. a decrease in its money supply.

 
86. During inflation, an increase in the amount of currency available leads to:  
 

A. overheating of the economy thereby reducing the production levels in the economy.

B. changes in the relative demand and supply conditions in the foreign exchange market.

C. a reduction in the rate of inflation thus leading to an appreciation of the currency.

D. decreased lending by banks thereby resulting in more savings.

E. a decrease in the demand of goods and services which drives currency value higher.
 
87. Which of the following is true when a government is strongly committed to controlling the
rate of growth in money?  
 

A. The country's future inflation rate may be low.

B. The country's currency will steadily depreciate significantly and instantly in the foreign
exchange market.

C. The country's economy will be marked by an abundance of liquidity.

D. The country will see a good number of populist measures not funded by taxation.

E. The country will struggle to match money supply with adequate supply of goods and
services.
 
88. If a country's government does not control the rate of growth in money supply:  
 

A. its future inflation rate will be low.

B. its taxes will decrease in the future.

C. it will see reduced spending on public infrastructure projects.

D. its currency could depreciate in the future.

E. its output of goods and services will exceed money supply, thereby fueling deflation.
 
89. Which of the following is a drawback of the purchasing power parity theory?     
 

A. It does not appear to be a strong predictor of short-run movements in exchange rates
covering time spans of five years.

B. It does not explain change in exchange rates in terms of change in relative prices.

C. It cannot explain when the demand of a particular currency would exceed its supply and
vice versa.

D. It does not address inflation in situations where governments control the rate of growth
in money supply.

E. It cannot predict exchange rate changes for countries with high rates of inflation and
underdeveloped capital markets.
 
90. The purchasing power parity (PPP) theory best predicts exchange rate changes for countries
with _____.  
 

A. appreciating currencies

B. stable currencies

C. underdeveloped capital markets

D. small differentials in inflation rates

E. industrialized economies
 
91. The failure to find a strong link between relative inflation rates and exchange rate
movements has been referred to as the _____.  
 

A. currency crisis

B. banking crisis

C. purchasing power parity puzzle

D. bandwagon effect

E. foreign exchange risk

 
92. Which of the following is a reason for the failure of the purchasing power parity (PPP)
theory to predict exchange rates accurately?  
 

A. It assumes away transportation costs and trade barriers.

B. It does not take into account the law of one price.

C. It does not take into account the practice of arbitrage.

D. It assumes that the markets are not efficient.

E. It does not consider government influence on a nation's money supply.

 
93. Which of the following weakens the link between relative price changes and changes in
exchange rates predicted by purchasing power parity (PPP) theory by violating the
assumption of efficient markets?  
 

A. Government intervention in cross-border trade

B. The relationship between money supply and price inflation

C. The impact of increase in currency on relative demand and supply conditions of

currencies

D. Excessive growth in money supply

E. The insignificant impact of transportation costs on international trade

 
94. When dominant enterprises in an industry exercise a degree of  pricing power, setting
different prices in different markets to reflect varying demand conditions, it is referred to as
_____.  
 

A. price discrimination

B. premium pricing

C. psychological pricing

D. price skimming

E. price leadership
 
95. Which of the following is a way in which enterprises with some market power limit arbitrage
so that their price discrimination policy works?  
 

A. Pricing its products identically despite huge differences in demand across different
markets

B. Differentiating otherwise identical products among nations along some line, such as
design or packaging

C. Adopting a pricing strategy that matches what competitors charge in each of the different
national markets

D. Limiting sales of its products to only a few nations

E. Selling its products at higher prices than normal to break even by selling fewer units
 
96. According to economic theory, interest rates reflect expectations about likely _____.  
 

A. spot exchange rates

B. unemployment rates

C. forward exchange rates

D. future inflation rates

E. GDP growth rates

 
97. In countries where inflation is expected to be high, interest rates also will be high, because
investors want compensation for the decline in the value of their money. This relationship is
referred to as the _____.  
 

A. PPP
theory puzzle

B. lead strategy

C. Fisher effect

D. bandwagon effect

E. international Fisher effect

 
98. The Fisher effect states that:  
 

A. a country's "nominal" interest rate (i) is the sum of the required "real" rate of interest (r)
and the expected rate of inflation over the period for which the funds are to be lent (I).

B. by comparing the prices of identical products in different currencies, it is possible to

determine the “real” or purchasing power parity exchange rate that would exist if markets
were efficient.

C. a country in which price inflation is running wild should expect to see its currency
depreciate against that of countries in which inflation rates are lower.

D. when the growth in a country’s money supply is faster than the growth in its output, price
inflation is fueled.

E. in competitive markets free of transportation costs and trade barriers, identical products
sold in different countries must sell for the same price.
 
99. According to the Fischer effect, if the "real" rate of interest in a country is 4 percent and
expected annual inflation is 9 percent, the "nominal" interest rate will be _____.  
 

A. 5 percent

B. 13 percent

C. 9 percent

D. 36 percent

E. 2.25 percent
 
100 The _____ states that 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
the two countries.  
 

A. bandwagon effect

B. law of one price

C. international Fisher effect

D. Helms-Burton Act

E. purchasing power parity (PPP) theory

 
101 The nominal interest rate is 9 percent in Brazil and 6 percent in Japan. Applying the
. international Fisher effect, the Brazilian real should:  
 

A. appreciate by 3 percent against the Japanese yen.

B. depreciate by 3 percent against the Japanese yen.

C. appreciate by 1.5 percent against the Japanese yen.

D. depreciate by 1.5 percent against the Japanese yen.

E. appreciate by 15 percent against the Japanese yen.

 
102 Which of the following refers to the bandwagon effect?  
.  

A. When securities are purchased in one market for immediate resale in another

B. When dominant enterprises exercise a degree of pricing power, setting different prices in
different markets to reflect varying demand conditions

C. When traders move like a herd, all in the same direction and at the same time, in response
to each others' perceived actions

D. When governments routinely intervene in international trade, creating tariff and nontariff
barriers to cross-border trade

E. When the output of goods and services grows at a lesser rate than that of the money
supply
 
103 Which of the following is the reason for the failure of purchasing power parity theory and
. international Fisher effect in predicting short-term movements in exchange rates?  
 

A. The impact of investor psychology on short-run exchange rate movements

B. The strong relationship between inflation rates and interest rates

C. The impact of interest rates and short-term exchange rate movements

D. The strong relationship between interest rate differentials and subsequent changes in spot
exchange rates

E. Government intervention in cross-border trade that violates the assumption of efficient

markets
 
104 Which of the following positions is adopted by the inefficient market school of thought
. toward exchange rate forecasting?  
 

A. Forward exchange rates are the best possible predictors of future spot exchange rates.

B. Forward exchange rates represent market participants’ collective predictions of likely

spot exchange rates.

C. Companies cannot beat the markets because forward rates reflect all available information
about likely future changes in exchange rates.

D. Investing in forecasting services can improve the foreign exchange market's estimate of
future exchange rates.

E. The foreign exchange market is efficient at setting forward rates which are unbiased
predictors of future spot rates.
 
105 Which of the following is true of the efficient market school of thought toward exchange
. rate forecasting?  
 

A. Forward rates are not unbiased predictors of future spot rates.

B. Accurate predictions of future spot rates can be calculated from publicly available
information.

C. Prices do not reflect all available information about the market.

D. Inaccuracies in predictions will not be consistently above or below future spot rates; they
will be random.

E. Forecasts might provide better predictions of future spot rates than forward exchange
rates do.
 
106 In terms of exchange rate forecasting, a(n) _____ market is one in which prices do not
. reflect all available information.  
 

A. inefficient

B. spot

C. futures

D. efficient

E. forward
 
107 In terms of the approaches to exchange rate forecasting, _____ draw(s) on economic theory
. to construct sophisticated econometric models for predicting exchange rate movements.  
 

A. technical analysis

B. fractional integration models

C. Markov switching models

D. fundamental analysis

E. chart analysis
 
108 Which of the following is a variable used in exchange rate forecasting models based on
. fundamental analysis?  
 

A. Relative strength indicator

B. Moving average

C. Inflation rate

D. Business cycles

E. Regression
 
109 Which of the following is true of a country that is running a deficit on a balance-of-
. payments current account?  
 

A. It is importing fewer goods and services than it is exporting.

B. It may result in depreciation of the country's currency on the foreign exchange market.

C. It will lead to very low interest rates in the country.

D. It will lead to a shortage of the country's currency in the foreign exchange market.

E. It is engaging in neo-mercantilism.

 
110 Which of the following approaches to forecasting exchange rate movements uses price and
. volume data to determine past trends?  
 

A. Technical analysis

B. Behavioral equilibrium model

C. Interest rate parity equation model

D. Fundamental analysis

E. Portfolio balance model

 
111 Which of the following premises is technical analysis, an approach to exchange rate
. forecasting, based on?  
 

A. Price and volume data cannot be used to determine past trends.

B. Econometric models drawn from economic theory are best suited to predict exchange rate
movements.

C. The foreign exchange market is efficient and forward exchange rates are best predictors
of future spot exchange rates.

D. Previous market trends and waves can be used to predict future market trends and waves.

E. Since forward exchange rates are best predictors of future spot rates, it makes no sense to
invest in forecasting.
 
112 Which of the following observations is true of technical analysis, an approach to exchange
. rate forecasting?  
 

A. It draws on economic theory to construct models for predicting exchange rate
movements.

B. The variables contained in this model typically include relative money supply growth
rates, inflation rates, and interest rates.

C. There is a sound theoretical rationale for the assumption of predictability underlying this

approach.

D. Owing to its drawbacks, this approach has declined in importance over the last few years
giving way to fundamental analysis.

E. It does not rely on a consideration of economic fundamentals.

 
113 A country's currency is said to be _____ when the country's government allows both
. residents and nonresidents to purchase unlimited amounts of a foreign currency with it.  
 

A. externally convertible

B. nonconvertible

C. leading

D. freely convertible

E. lagging
 
114 A currency is said to be _____ when only nonresidents may convert it into a foreign
. currency without any limitations.  
 

A. externally convertible

B. nonconvertible

C. leading

D. freely convertible

E. lagging
 
115 The government of Beryllia tightly controls the ability of its residents to convert its currency
. into other currencies. However, all foreign businesses with deposits in banks of Beryllia
may, at any time, convert all their currency into foreign currency and take them out of the
country. Beryllia's currency is said to be _____.  
 

A. leading

B. nonconvertible

C. externally convertible

D. freely convertible

E. lagging
 
116 Which of the following is a reason why governments limit convertibility of their currency?  
.  

A. To encourage foreign investments

B. To control currency appreciation

C. To encourage capital flight

D. To preserve their foreign exchange reserves

E. To promote neo-mercantilism

 
117 The phenomenon of _____ occurs when residents and nonresidents of a country rush to
. convert their holdings of domestic currency into a foreign currency.  
 

A. deflation

B. arbitrage

C. liquidity rush

D. capital flight

E. currency swap
 
118 When is the phenomenon of capital flight most likely to occur?  
.  

A. When the recovery phase post an economic depression nears its end

B. When the value of domestic currency depreciates rapidly because of hyperinflation

C. When a country's economic prospects are stable and indicate growth

D. When interest rates are low for a prolonged period of time

E. When governments lift convertibility restrictions on their currency

 
119 Companies can deal with the problem of nonconvertibility of currency by engaging in
. _____.  
 

A. price discrimination

B. countertrade

C. arbitrage

D. price skimming

E. currency speculation
 
120 Which of the following refers to countertrade?  
.  

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

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

C. Simultaneous purchase and sale of a given amount of foreign exchange for two different
value dates

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

E. A range of barter-like agreements by which goods and services can be exchanged for
other goods and services
 
121 Countertrade makes sense when a country's currency is _____.  
.  

A. lagging

B. nonconvertible

C. externally convertible

D. freely convertible

E. leading
 
122 Which of the following refers to the extent to which the income from individual transactions
. is affected by fluctuations in foreign exchange values?  
 

A. Translation exposure

B. Economic exposure

C. Purchasing power parity

D. Transaction exposure

E. Forward exchange rate

 
123 Which of the following is an example of transaction exposure?  
.  

A. Obligations for the purchase of goods at previously agreed prices

B. Borrowing of funds in domestic currency

C. Impact of currency exchange rate changes on the reported financial statements of a

company

D. Long-term effect of changes in exchange rates

E. The effect of changing exchange rates on future prices, sales, and costs
 
124 What is meant by translation exposure?  
.  

A. The long-run effect of changes in exchange rates on future prices, sales, and costs

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

C. The extent to which a firm’s future international earning power is affected by changes in
exchange rates

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

E. The obligations for the purchase or sale of goods and services at previously agreed prices
 
125 Which of the following is concerned with the present measurement of past events?  
.  

A. Economic exposure

B. Transaction exposure

C. Arbitrage

D. Translation exposure

E. Currency speculation
 
126 _____, a category of foreign exchange risk, refers to the extent to which the reported
. consolidated results and balance sheets of a corporation are affected by fluctuations in
foreign exchange values.  
 

A. Economic exposure

B. Transaction exposure

C. Translation exposure

D. Countertrade

E. Carry trade
 
127 What is meant by economic exposure?  
.  

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

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

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

D. The extent to which the quantity of money in circulation rises faster than the stock of
goods and services

E. The extent of disparity in prices, when expressed in the same currency, of similar
products in different countries
 
128 _____, a category of foreign exchange risk, is concerned with the long-run effect of changes
. in exchange rates on future prices, sales, and costs.  
 

A. Currency speculation

B. Transaction exposure

C. Economic exposure

D. Translation exposure

E. Countertrade
 
129 _____, a category of foreign exchange risk, is concerned with the effect of exchange rate
. changes on individual transactions, most of which are short-term affairs that will be
executed within a few weeks or months.  
 

A. Purchasing power parity

B. Transaction exposure

C. Economic exposure

D. Translation exposure

E. Currency speculation
 
130 A lead strategy involves:  
.  

A. delaying foreign currency payables when a currency is expected to appreciate.

B. delaying foreign currency payables when a currency is expected to depreciate.

C. attempting to collect foreign currency receivables early when a foreign currency is

expected to appreciate.

D. attempting to collect foreign currency receivables early when a foreign currency is

expected to depreciate.

E. delaying the collection of foreign currency receivables when a foreign currency is

expected to appreciate.
 
131 A lag strategy involves:  
.  

A. delaying the collection of foreign currency receivables when a foreign currency is

expected to appreciate.

B. delaying the collection of foreign currency receivables when a foreign currency is

expected to depreciate.

C. attempting to collect foreign currency receivables early when a foreign currency is

expected to appreciate.

D. paying foreign currency payables (to suppliers) before they are due when a currency is
expected to appreciate.

E. paying foreign currency payables (to suppliers) before they are due when a currency is
expected to depreciate.
 
132 In terms of foreign exchange, which of the following is true of leading and lagging
. strategies?  
 

A. They primarily protect long-term cash flows from adverse changes in exchange rates.

B. They are used to minimize economic exposure of companies.

C. They can help firms minimize their transaction and translation exposure.

D. The involve accelerating payments from strong-currency to weak-currency countries.

E. They are limited by governments because they create pressure on strong currencies.
 
133 In terms of foreign exchange, which of the following observations is true of leading and
. lagging strategies?  
 

A. They are easy to implement.

B. They primarily protect long-term cash flows from adverse changes in exchange rates.

C. Firms need minimal bargaining power to implement them.

D. They can put pressure on a weak currency.

E. They accelerate payments from strong-currency to weak-currency countries.

 
134 The key to reducing _____ is to distribute the firm’s productive assets to various locations so
. the firm’s long-term financial well-being is not severely affected by adverse changes in
exchange rates.  
 

A. transaction exposure

B. economic exposure

C. countertrade

D. arbitrage

E. translation exposure
 
135 Which of the following is a step taken to manage foreign exchange risk?  
.  

A. Firms should focus solely on managing transaction and translation exposures.

B. Forecasting future exchange rate movements should be avoided as it is speculative.

C. Firms need to develop strategies for dealing with economic exposure.

D. Firms should avoid central control of exposure.

E. Firms should not distinguish between transaction and translation exposure and economic
exposure.