NEU-CEPM-FFL

Specific Topics of Banking and Finance - Instructor: Nguyễn Thị Hồng Hạnh
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Full Name: ..................................... Class: .................................. Student Code: .................... .........
UNIT 5: THE FOREIGN EXCHANGE MARKET
TASK 1: Match the terms with suitable explanations.
Terms Explanations
1. Mortgage a. A bond-like security that is backed by a pool of mortgage loans.
2. Mortgage-backed security
b. The risk that a borrower will pay off a loan before its scheduled maturity date.
(MBS)
3. Securitization c. The global market for the trading of national currencies against one another.
4. Prepayment risk d. The exchange rate for future delivery of currencies.
5. Foreclosure e. An increase in the value of one currency relative to another currency.
6. Subprime mortgage f. A decrease in the value of one currency relative to another currency.
7. Foreign exchange market g. A loan used to finance the purchase of real estate, with the real estate serving
(Forex or FX) as collateral for the loan.
h. The process by which a lender takes possession of the property used as
8. Exchange rate
collateral for a loan because the borrower has defaulted on the loan.
i. The risk that the domestic currency value of a foreign currency-denominated
9. Spot exchange rate
asset or liability will change due to changes in the exchange rate.
j. The demand for foreign exchange by investors who are attempting to profit
10. Forward exchange rate
from expected changes in exchange rates.
11. Foreign exchange risk k. The price of one currency in terms of another currency.
l. The act of entering into a financial transaction to reduce or eliminate the risk
12. Currency appreciation
of adverse price movements in an asset.
m. Actions taken by a government or central bank to influence the value of its
13. Currency depreciation
currency in the foreign exchange market.
14. Purchasing power parity n. The process of converting relatively illiquid assets, such as mortgage loans, into
(PPP) marketable securities.
o. A mortgage loan made to a borrower with a poor credit history or other high-
15. Arbitrage
risk characteristics.
16. Speculative demand for p. The simultaneous purchase and sale of an asset to profit from a difference in
foreign exchange the asset's price.
q. The exchange rate between two currencies that are both quoted against a third
17. Hedging
currency.
r. A system of exchange rate determination where a currency's value is allowed to
18. Cross-rate fluctuate, but the government or central bank intervenes to moderate the
degree of fluctuation.
s. A theory that the exchange rate between two currencies should adjust to
19. Intervention
equalize the currencies' purchasing power in their respective countries.
20. Managed float t. The exchange rate for immediate delivery of currencies.
TASK 2: Choose the best answers for the questions below.
1. What is the main function of the foreign exchange market?
A. To facilitate the exchange of one currency for another B. To buy and sell stocks and bonds
C. To lend and borrow money D. To trade commodities
2. What is the most widely traded currency in the world?

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Specific Topics of Banking and Finance - Instructor: Nguyễn Thị Hồng Hạnh
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A. US dollar B. Euro C. Japanese yen D. British pound
3. What is the term used to describe the exchange rate between two currencies?
A. Interest rate B. Inflation rate C. Spot rate D. Forward rate
4. What is the difference between the bid price and the ask price in the foreign exchange market?
A. The spread B. The premium C. The discount D. The volatility
5. What is the main reason why individuals and businesses participate in the foreign exchange market?
A. To make a profit B. To diversify their investments C. To hedge against currency risk D. All of the above
6. What is the primary function of the spot market in the foreign exchange market?
A. To facilitate the immediate exchange of currencies C. To provide forward contracts for currencies
B. To allow traders to speculate on future exchange rate movements
D. To allow central banks to intervene in the market
7. What is the main difference between the spot market and the forward market in the foreign exchange market?
A. The spot market deals with immediate exchange, while the forward market deals with future exchange
B. The spot market is more liquid than the forward market
C. The spot market is more volatile than the forward market
D. The spot market is more regulated than the forward market
8. What is the primary reason why central banks participate in the foreign exchange market?
A. To make a profit B. To stabilize the value of their domestic currency
C. To diversify their foreign exchange reserves D. To speculate on currency movements
9. What is the relationship between interest rates and exchange rates, according to the theory of interest rate parity?
A. Higher interest rates lead to a stronger domestic currency
B. Higher interest rates lead to a weaker domestic currency
C. There is no relationship between interest rates and exchange rates
D. The relationship depends on other factors, such as inflation
10. What is the purpose of a forward contract in the foreign exchange market?
A. To buy or sell a currency at a predetermined price and future date C. To hedge against currency risk
B. To speculate on future currency movements D. All of the above
11. What is the main difference between a fixed exchange rate and a floating exchange rate system?
A. In a fixed exchange rate system, the government sets the exchange rate, while in a floating system, the market
determines the exchange rate.
B. In a fixed exchange rate system, the exchange rate is more volatile than in a floating system.
C. In a fixed exchange rate system, central banks do not participate in the market, while in a floating system, they do.
D. In a fixed exchange rate system, there is no currency risk, while in a floating system, there is.
12. What is the role of speculation in the foreign exchange market?
A. Speculation helps to stabilize exchange rates B. Speculation helps to increase market liquidity
C. Speculation helps to increase the efficiency of the marketD. Speculation can contribute to exchange rate volatility
13.What is the relationship between exchange rates and trade balances, according to the theory of purchasing power
parity?
A. A stronger domestic currency leads to a trade surplus B. A weaker domestic currency leads to a trade surplus
C. There is no relationship between exchange rates and trade balances
D. The relationship depends on other factors, such as productivity and inflation
14. What is the main reason why businesses participate in the foreign exchange market?
A. To make a profit from currency speculation B. To diversify their investment portfolios
C. To hedge against currency risk D. To facilitate international trade and investment
15. What is the role of technology in the foreign exchange market?
A. Technology has made the market more efficient and liquid.B. Technology has increased the speed of transactions
C. Technology has increased the ability to access real-time information D. All of the above
16. What are the main types of exchange rate regimes?
A. Fixed and floating B. Managed and unmanaged C. Both A and B D. None of the above
17. What is the primary reason central banks participate in the foreign exchange market?
A. To make a profit B. To stabilize exchange rates C. To influence monetary policy D. All of the above
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Specific Topics of Banking and Finance - Instructor: Nguyễn Thị Hồng Hạnh
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18.According to the theory of interest rate parity, what is the relationship between interest rates and exchange rates?
A. Higher interest rates lead to a stronger domestic currency
B. Higher interest rates lead to a weaker domestic currency
C. There is no relationship between interest rates and exchange rates
D. The relationship depends on other factors, such as inflation
19. What is the primary impact of speculation on the foreign exchange market?
A. It increases market efficiency and liquidity B. It stabilizes exchange rates
C. It contributes to exchange rate volatility D. It has no significant impact on the market
20. What is the key insight of the purchasing power parity theory regarding the relationship between exchange rates
and trade balances?
A. A stronger domestic currency leads to a trade surplus B. A weaker domestic currency leads to a trade surplus
C. There is no relationship between exchange rates and trade balances
D. The relationship depends on other factors, such as productivity and inflation
TASK 3: Fill in the gaps in the text below using the correct terms from the given table. Each term can only be
used once, and five terms will not be used.
3.1 Foreign exchange rates, which denote the price of one country's (1) ____ in terms of another's, play a (2) ____
role in the global economy. They (3) ____ the cost of domestically produced goods sold abroad and the (4) ____
of foreign goods purchased domestically. This makes them vital for both (5) ____ trade and (6) ____ stability.
The theory of purchasing power (7) ____ (PPP) posits that in the long run, exchange rate movements between two
countries' currencies are driven by (8) ____ in the relative price levels of those countries. Essentially, if one country
experiences higher inflation than another, its currency should (9) ____ relative to the other country's currency to
maintain parity in the purchasing power of both currencies. Other (10) ____ -term (11) ____ influencing exchange
rates include tariffs and quotas, import and export demands, and differences in productivity levels.
In the short term, however, exchange rates are more influenced by changes in the relative expected returns on
domestic (12) ____. These changes cause shifts in the (13) ____ curve for currencies. Factors that can alter the
expected returns on domestic assets include variations in domestic and foreign interest rates and any changes in the
factors that affect the long-term exchange rate, such as economic policies or market expectations about future
economic (14) ____.
The asset market (15) ____ to exchange rate determination provides insights into the volatility of exchange rates. This
approach can explain significant movements, such as the rise of the U.S. dollar during the 1980-1984 period and its
subsequent decline. The approach considers exchange rates as prices that (16) ____ the supply and demand for
financial assets denominated in different currencies, making it a useful tool for understanding market dynamics.
For (17) ____ institution managers, (18) ____ forecasts of foreign exchange rates are invaluable. These rates impact
decisions on which foreign-denominated assets to hold and inform trading strategies in the foreign exchange market.
Accurate predictions help in managing risks and optimizing returns, as (19) ____ in exchange rates can significantly
affect the value of international (20) ____ and trade activities.
accurate approach assets balance changes
long-term foreign fluctuations currency conditions
market influence economic demand cost
parity international factors depreciate country
price investments financial domestic crucial
3.2. Foreign exchange rates, which represent the value of one country's currency in terms of another's, play a crucial
role in the global economy. They (1) ____ the cost of domestically produced goods sold abroad and the price of
foreign goods purchased domestically. For instance, a strong domestic currency makes imports cheaper but can make
exports more expensive for (2) ____, potentially affecting a country’s (3) ____.
The theory of (4) ____ (PPP) posits that in the long run, changes in the exchange rate between two countries are
influenced by the relative (5) ____ in those countries. If one country experiences higher (6) ____ than another, its
currency should depreciate to maintain (7) ____. Beyond price levels, several other factors can influence long-term
(8) ____. These include tariffs and quotas, which can alter trade flows; import demand, which affects how much
foreign currency is needed; export demand, which influences how much (9) ____ is sought by foreign buyers; and
(10) ____, which impacts a country's (11) ____ and economic health.
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Specific Topics of Banking and Finance - Instructor: Nguyễn Thị Hồng Hạnh
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In the (12) ____, exchange rates are primarily driven by changes in the relative expected return on domestic (13)
____, which shift the demand curve for these assets. When investors expect (14) ____ on assets in one country
compared to another, they will demand more of that country's currency, driving up its value. Factors that influence
these (15) ____ include (16) ____ changes on domestic and foreign assets, as well as any variables affecting long-term
exchange rates, like anticipated shifts in inflation or (17) ____.
The asset market approach to exchange rate determination highlights the role of (18) ____ in explaining both the
volatility of exchange rates and significant movements, such as the rise of the US dollar from 1980 to 1984 and its
subsequent decline. This approach emphasizes that exchange rates are influenced by the (19) ____ for financial assets,
making them susceptible to market speculation and investor sentiment.
Accurate forecasts of foreign exchange rates are invaluable for financial institutions. These rates guide decisions on
which foreign-denominated assets to hold and inform trading (20) ____ in the foreign exchange market. Effective
exchange rate management can significantly impact an institution's profitability and risk management, making
currency forecasting a critical skill for financial managers.
economic policies impact interest rates productivity foreign exchange rates
exchange rates demand higher returns competitiveness supply and demand
financial markets inflation short run price levels purchasing power parity
expectations assets foreign buyers strategies exchange rate management
domestic currency parity trade balance profitability financial institutions
TASK 4: Decide if the statements are True or False. If false, correct them.
1. The spot market involves the immediate exchange of currencies.
2. Currency appreciation occurs when a currency increases in value relative to another currency.
3. The law of one price underlies the concept of purchasing power parity.
4. The foreign exchange market is centralized and operates through a single exchange.
5. A currency depreciates when its value rises compared to another currency.
6. Purchasing power parity (PPP) theory suggests that exchange rates are determined by interest rates.
7. The foreign exchange market operates continuously around the clock.
8. Speculators in the foreign exchange market seek to profit from currency price movements.
9. Exchange rate volatility represents the degree of variation in currency prices over time.
10. Fixed exchange rate systems allow currencies to fluctuate freely based on market forces.
11. The International Monetary Fund (IMF) does not play a role in stabilizing exchange rates.
12. Foreign exchange risk does not affect multinational corporations.
13. Devaluation refers to a deliberate reduction in a currency’s value by a government.
14. Spot exchange rates are current exchange rates for immediate currency exchange.
15. Foreign exchange reserves are held by central banks to influence exchange rates and ensure stability.
16. The foreign exchange market operates independently of other financial markets.
17. The nominal exchange rate adjusts for differences in price levels between countries.
18. The Forex market only operates during regular business hours.
19. An appreciation of the domestic currency can hurt exporters.
20. Exchange rate expectations can influence current exchange rates.
21. Exchange rates are determined by the supply and demand for different currencies.
22. Fixed exchange rates are determined solely by market forces.
23. Forex transactions are always settled immediately.
24. There is a single global regulatory body for the Forex market.
25. Forex trading typically involves currency pairs, such as EUR/USD.
26. The Forex market facilitates international trade and investment by enabling currency conversion.
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Specific Topics of Banking and Finance - Instructor: Nguyễn Thị Hồng Hạnh
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27. Currency risk, or exchange rate risk, is a major concern for Forex market participants.
28. When a country’s currency appreciates, the country’s goods abroad become cheaper and foreign goods in
that country become more expensive.
29. If a factor increases the demand for domestic goods relative to foreign goods, the
domestic currency will depreciate.
30. In the long run, a rise in a country’s price level (relative to the foreign price level) causes its currency to
appreciate, and a fall in the country’s relative price level causes its currency to depreciate.
31. Spot transactions involve the immediate (two-day) exchange of bank deposits.
32. Forward transactions involve the exchange of bank deposits at some specified future date.
33. Exchange rates are important because they affect the relative price of domestic
and foreign goods.
34. Increasing trade barriers causes a country’s currency to depreciate in the long run.
35. Increased demand for a country’s exports causes its currency to depreciate in the long run; conversely,
increased demand for imports causes the domestic currency to appreciate.
36. In the long run, as a country becomes more productive relative to other countries, its currency depreciates.
37. When a country’s currency appreciates (rises in value relative to other currencies), the country’s goods
abroad become more expensive and foreign goods in that country become cheaper (holding domestic prices
constant in the two countries).
38. When a country’s currency depreciates, its goods abroad become cheaper
and foreign goods in that country become more expensive.
39. The law of one price states that if two countries produce an identical good, and
transportation costs and trade barriers are very low, the price of the good should
be the same throughout the world no matter which country produces it.
40. Theory of purchasing power parity (PPP) states that exchange rates between any two currencies will adjust
to reflect changes in the price levels of the two countries.
41. The theory of PPP is simply an application of the law of one price to national price levels.
42. The theory of PPP suggests that if one country’s price level rises relative
to another’s, its currency should depreciate (the other country’s currency should appreciate).
43. If a factor increases the demand for domestic goods relative to foreign goods, the
domestic currency will appreciate; if a factor decreases the relative demand for domestic goods, the domestic
currency will depreciate.
44. In the long run, a rise in a country’s price level (relative to the foreign price level) causes its currency to
depreciate, and a fall in the country’s relative price level causes its currency to appreciate.
45. Increasing trade barriers causes a country’s currency to appreciate in the long run.
46. Increased demand for a country’s exports causes its currency to appreciate in the long run; conversely,
increased demand for imports causes the domestic currency to depreciate.
47. In the long run, as a country becomes more productive relative to other countries, its currency appreciates.
48. When domestic real interest rates rise, the domestic currency appreciates.
49. When domestic interest rates rise due to an expected increase in inflation, the domestic currency
depreciates.
TASK 5: Answer the following questions
1. How do central banks intervene in the foreign exchange market to influence their currency’s value?

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Specific Topics of Banking and Finance - Instructor: Nguyễn Thị Hồng Hạnh
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2. How might a central bank’s decision to change interest rates affect the foreign exchange market and influence
a company’s currency strategy?
3. "A country is always worse off when its currency is weak (falls in value)." Is this statement true, false, or
uncertain? Explain your answer.
4. A U.S.-based company, TechExports Inc., sells products to European customers and receives payments in
euros. Recently, the euro has depreciated against the U.S. dollar. How does this affect TechExports, and
what can the company do to mitigate the impact?
5. Alice, a currency trader, believes that the Japanese yen will appreciate against the U.S. dollar over the next
month due to anticipated economic policies in Japan. How can she profit from her expectation?
6. The central bank of Japan increases its interest rates, while Vietnam’s rates remain unchanged. How might
this interest rate differential affect the exchange rate between Yen and VND?
7. Vietnam is experiencing high inflation compared to its trading partners. How does this affect the value of
VND in the foreign exchange market?
8. The central bank of Vietnam intervenes in the foreign exchange market by selling its own currency and
buying U.S. dollars. What is the likely goal of this intervention, and what effect does it have on VND?
9. If the Japanese price level rises by 5% relative to the price level in the United States, what does the theory of
purchasing power parity predict will happen to the value of the Japanese yen in terms of dollars?
10. The president of the United States announces that he will reduce inflation with a new anti-inflation program.
If the public believes him, predict what will happen to the exchange rate for the U.S. dollar.
11. If the British central bank prints money to reduce unemployment, what will happen to the value of the pound
in the short run and the long run?
12. If the Indian government unexpectedly announces that it will be imposing higher tariffs on foreign goods one
year from now, what will happen to the value of the Indian rupee today?
13. If nominal interest rates in America rise but real interest rates fall, predict what will happen to the U.S.
exchange rate.
14. If American auto companies make a breakthrough in automobile technology and are able to produce a car
that gets 60 miles to the gallon, what will happen to the U.S. exchange rate?
15. If Mexicans go on a spending spree and buy twice as much French perfume, Japanese TVs, English sweaters,
Swiss watches, and Italian wine, what will happen to the value of the Mexican peso?
16. If expected inflation drops in Europe so that interest rates fall there, predict what will happen to the exchange
rate for the U.S. dollar.
17. If the European central bank decides to contract the money supply to fight inflation, what will happen to the
value of the U.S. dollar?
18. If there is a strike in France, making it harder to buy French goods, what will happen to the value of the
euro?
19. When the euro appreciates, are you more likely to drink California wine or French wine?
20. When the U.S. dollar depreciates, what happens to exports and imports in the United States?