Answer:: ch07: Dealing With Foreign Exchange
Answer:: ch07: Dealing With Foreign Exchange
Answer:: ch07: Dealing With Foreign Exchange
2. Purchasing power parity (PPP) is usually used to capture the differences in cost of living between countries.
a. True
b. False
ANSWER: True
3. In managed float exchange rate policy, a main objective for government intervention in deciding the exchange rate is to
prevent erratic fluctuations that may trigger macroeconomic turbulence.
a. True
b. False
ANSWER: True
5. In the short term, variations in interest rates have an insignificant effect on exchange rates and foreign funds.
a. True
b. False
ANSWER: False
6. Today we live in a post-Bretton Woods system which has no official common denominator and is characterized by a
diversity of exchange rate systems.
a. True
b. False
ANSWER: True
7. Treevia is a country that has just received a loan from the IMF. Because the IMF operates in a no-strings-attached
manner, Treevia is free to enact its own policy reforms to enable repayment of the loan.
a. True
b. False
ANSWER: False
8. The gold standard was essentially a global peg system with little volatility and a great deal of predictability and
stability.
a. True
b. False
ANSWER: True
9. Under the gold standard, every central bank needed to maintain gold reserves in order to be able to redeem its currency
in gold at a fixed price.
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a. True
b. False
ANSWER: True
10. The International Monetary Fund (IMF) offers grants to member countries.
a. True
b. False
ANSWER: False
11. Forward discount is a condition under which the forward rate of one currency relative to another currency is higher
than the spot rate.
a. True
b. False
ANSWER: True
12. The most basic way for a nonfinancial company to cope with potential currency risks is to invoice customers in their
own currency.
a. True
b. False
ANSWER: True
13. The nature of the electronically linked global foreign exchange market is leading to firms taking more time on
decisions about buying and selling on the foreign exchange market.
a. True
b. False
ANSWER: False
14. In the context of currency management, a country with high currency risk must be totally avoided to prevent currency
risk.
a. True
b. False
ANSWER: False
15. In the context of currency risk management, many large, internationally experienced firms choose currency hedging
since it is highly predictable.
a. True
b. False
ANSWER: False
16. In the context of foreign exchange rate, a(n) _____ is an increase in the value of a currency.
a. ask rate
b. capital increase
c. appreciation
d. forecast
ANSWER: c
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17. According to the economic theory, which of the following factors determines a commodity’s price?
a. Spot transaction
b. Currency hedging
c. Forward rates
d. Supply and demand
ANSWER: d
18. Which of the following statements is true of the relationship between a commodity’s supply and demand?
a. If the supply of a commodity decreases, the price of the commodity decreases.
b. Strong demand of a commodity will lead to price drops.
c. Oversupply of a commodity will result in price drops.
d. If the demand for a commodity decreases, the price of the commodity increases.
ANSWER: c
19. The demand for dollars is much stronger than any other currency because:
a. the dollar is the common transaction currency involving both US. imports and US. exports.
b. supply of the US. dollar is significantly higher than other currencies.
c. the price of the dollar is much lower compared to the currencies of other countries.
d. the US dollar is nonconvertible in other countries.
ANSWER: a
20. Which of the following is also known as the "law of one price"?
a. Common denominator
b. dirty float
c. Purchasing power parity
d. Flexible exchange rate policy
ANSWER: c
21. Which of the following scenarios exemplifies the purchasing power parity (PPP) theory?
a. A cell phone manufactured in Russia costs lesser in UK than in Egypt.
b. A cell phone manufactured in Russia costs more in UK than in Egypt.
c. A cell phone manufactured in Russia costs lesser in UK and Egypt than other countries.
d. A cell phone manufactured in Russia costs the same in UK and Egypt.
ANSWER: d
22. Grenasia is a developed country. The exchange rate of Grenasia’s currency is higher than other currencies in the
world. In this case, which of the following is the effect of such a high exchange rate?
a. Grenasia’s exchange value will decrease.
b. Demand for Grenasia’s home currency will decrease.
c. Grenasia will attract foreign funds.
d. Outflow of capital will be more than inflow of capital.
ANSWER: c
24. In the context of interest rates and money supply, quantitative easing:
a. leads to appreciation in the value of a country’s currency.
b. tends to stimulate inflation with more currency.
c. decreases the per unit value of a currency.
d. attracts foreign funds.
ANSWER: b
25. Lumberne, a country, reviews its international transaction statement to assess its performance in international trade.
This transaction statement contains accurate details on merchandise trade, service trade, and capital movement. Such a
transaction statement is called the _____.
a. purchasing power parity (PPP)
b. common denominator
c. balance of payments (BOP)
d. capital flight
ANSWER: c
26. The _____ consists of exports minus imports of merchandise and services, plus income on a country’s assets abroad
minus payments on foreign assets in the focal country, plus unilateral government transfers and private remittances.
a. current account balance
b. statement of retained earnings
c. cash flow statement
d. statement of changes in equity
ANSWER: a
27. In the context of balance of payments (BOP), a country experiencing a current account surplus:
a. will see its currency appreciate.
b. has to be financed by purchase and sales of assets.
c. will see a decrease in exchange rates.
d. will experience a decrease in demand for its currency.
ANSWER: a
ANSWER: d
29. In the context of exchange rate policies, _____ is a pure market solution to determine exchange rates.
a. fixed exchange rate
b. managed float
c. free float
d. target exchange rate policy
ANSWER: c
30. In a fixed exchange rate policy, which of the following involves setting the exchange rate of the domestic currency in
terms of another currency?
a. Currency swap
b. Pegging
c. Crawling bands
d. Spread
ANSWER: b
31. Investors-currency traders, foreign portfolio investors, and average citizens-may move in the same direction at the
same time, like a herd, resulting in the _____.
a. Matthew effect
b. bandwagon effect
c. snob effect
d. Veblen effect
ANSWER: b
32. Which of the following is true of the theory of purchasing power parity (PPP)?
a. It suggests that in the long run, exchange rates should move toward levels that would equalize the prices of an
identical basket of goods in any two countries.
b. It encourages traders to buy low and sell high, eventually driving different prices for identical products to the
same level around the world.
c. It suggests that the price for identical products sold in different countries should be controlled purely by the
supply and demand of those goods.
d. It increases the disparity of prices for identical products from different countries.
ANSWER: a
33. What is the difference between a clean float and a dirty float?
a. Most countries adopt a clean float policy while the dirty float policy is rare in practice
b. A clean float involves upper management policy interventions
c. A dirty float uses selective government interventions to determine exchange rates
d. A dirty float relies solely on the market to determine exchange rate
ANSWER: c
34. Mexico recently printed more currency, causing the supply of the peso to increase while demand stayed the same.
Which of the following is NOT a likely outcome of this scenario?
a. the value of the peso will decrease
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37. Which of the following is true of the gold standard used from 1870 to 1914?
a. It was highly volatile global peg system.
b. Banks were free from the need of maintaining gold reserves.
c. It propelled the dollar to the commanding heights of the global economy.
d. Gold was used as the common denominator for all currencies.
ANSWER: d
38. The Bretton Woods system was centered on _____ as the common denominator.
a. diamond
b. the US dollar
c. gold
d. the British pound
ANSWER: b
39. According to the Bretton Woods system, which of the following statements is true?
a. All currencies were required to be gold convertible.
b. Gold was used as the common denominator for all currencies.
c. The exchange rate of the dollar was allowed to unilaterally change.
d. Only the US dollar was convertible to gold.
ANSWER: d
41. The _____ refers to a system of flexible exchange rate regimes with no official common denominator.
a. Bretton Woods system
b. post-Bretton Woods system
c. gold standard
d. International Monetary Fund
ANSWER: b
42. The International Monetary Fund receives its funds from _____.
a. subsidiary investing
b. member countries’ quota
c. foreign direct investment
d. currency hedging
ANSWER: b
43. In the context of foreign exchange, _____ are the classic single-shot exchange of one currency for another.
a. currency swaps
b. spot transactions
c. forward discounts
d. forward transactions
ANSWER: b
44. An Indian tourist visits the US and exchanges rupees for dollars at a foreign exchange counter at the airport. In this
case, which of the following type of foreign exchange transaction has the tourist used?
a. Spot transaction
b. Forward transaction
c. Currency hedging
d. Currency swap
ANSWER: a
45. Chang Lee deals with foreign exchange. He exchanged 800 Chinese yuan for US dollars. He sold the US dollars 180
days after his initial transaction. In this scenario, which of the following types of foreign exchange transaction has Chang
Lee used?
a. Spot exchange
b. Spot transaction
c. Currency swap
d. Forward transaction
ANSWER: d
47. The Greyon Bank in Australia has an excess balance of euros but is in need of dollars. Similarly, Huran Bank in the
US has an excess of dollars and is currently in need of euros. The two banks agree to exchange euros for dollars now and
dollars for euros at a later date. This type of foreign exchange transaction is an example of _____.
a. currency hedging
b. spot transaction
c. currency swap
d. forward transaction
ANSWER: c
48. _____ means spreading out activities in a number of countries in different currency zones in order to offset any
currency losses in one region through gains in other regions.
a. Strategic hedging
b. Currency hedging
c. Forward transaction
d. Spot transaction
ANSWER: a
49. Which of the following is a difference between currency hedging and strategic hedging?
a. Currency hedging offsets any currency losses in one region through gains in other regions, while strategic
hedging focuses on one region.
b. Currency hedging is effective in predicting currency movements, whereas strategic hedging has significant
currency risks.
c. Currency hedging deals in multiple currency zones, whereas strategic hedging deals in a single currency zone.
d. Currency hedging is done through in-house financial specialists, whereas strategic hedging is done through
sourcing or foreign direct investment.
ANSWER: d
50. Explain how supply and demand determines the price of a commodity. Reason out with an example why the US dollar
is the most sought after currency.
ANSWER: Basic economic theory suggests that a commodity’s price is fundamentally determined by its supply and
demand. Strong demand will lead to price hikes, and oversupply will result in price drops.
When the United States sells products to China, US exporters often demand that they be paid in US dollars
because the Chinese yuan is useless in the United States. Chinese importers of US products must somehow
generate US dollars in order to pay for US imports. The easiest way to generate US dollars is to export to the
United States, whose buyers pay in US dollars. In this example, the dollar is the common transaction
currency involving both US imports and US exports. As a result, the demand for dollars is much stronger
than the demand for yuan. A wide variety of users, such as Chinese exporters, Colombian drug dealers, and
Swiss bankers, prefer to hold and transact in US dollars, thus fueling the demand for dollars. Such a strong
demand explains why the US dollar is the most sought after currency in the postwar decades.
53. Explain the Bretton Woods system and the reasons for its demise.
ANSWER: The Bretton Woods system was centered on the US dollar as the new common denominator. All currencies
were pegged at a fixed rate to the dollar. Only the dollar was convertible to gold at $35 per ounce. Other
currencies were not required to be gold convertible. By the late 1960s and early 1970s, a combination of
rising productivity elsewhere and US inflationary policies led to the demise of Bretton Woods. First, in the
1960s, President Lyndon Johnson increased government spending in order to finance both the Vietnam War
and Great Society welfare programs. He did this not by additional taxation but by increasing money supply.
These actions led to rising inflation levels and strong pressures for the dollar to depreciate. Second, the
United States ran its first post-1945 trade deficit in 1971 as Germany and other countries caught up to the
United States in productivity and increased their exports. This pushed the German mark to appreciate and the
dollar to depreciate, a situation very similar to the yen-dollar relationship in the 1980s and the yuan-dollar
relationship in the 2000s.
The Bretton Woods system also became a pain in the neck for the United States because the exchange rate of
the dollar was not allowed to unilaterally change. Per Bretton Woods agreements, the US Treasury was
obligated to dispense one ounce of gold for every $35 brought to it by a foreign central bank such as the
Bundesbank. Consequently, the United States was hemorrhaging gold into the coffers of foreign central
banks. In order to stop the flow of gold out of the Treasury, President Richard Nixon unilaterally announced
in 1971 that the dollar was no longer convertible into gold. After tense negotiations, the major countries
collectively agreed in 1973 to allow their currencies to float, thus ending the Bretton Woods system.
54. From an institution-based view and a resource-based view, explain the factors that determine the success and failure of
currency management around the globe.
ANSWER: The answer boils down to two components. First, from an institution-based standpoint, the changing rules of
the game-economic, political, and psychological-enable or constrain firms. For example, Swiss exporters’
frustration with the appreciation of the Swiss franc relative to the euro stems from the centuries-old policy of
Switzerland to maintain its political and economic independence. While all of Switzerland’s neighbors have
joined the EU and adopted the euro, Switzerland will not. Second, from a resource-based perspective, how
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firms develop valuable, unique, and hard-to-imitate capabilities in currency management may make or break
them.