Chapter 2 Foreign Exchange Market International Economics

If the exchange rate for the Australian dollar is US$/A$=.7833 and the exchange rate for the Hong Kong dollar is US$/HK$=.1280, then the Kong Kong-Australian dollar exchange rate (or how many HK$s does it take to buy one A$), HK$/A$ equals

a. 1.2767
b. 7.8133
c. 6.1195
d. 9.9738

c. 6.1195

At the last BIS survey, the average daily volume of foreign exchange trading was approximately equal to

a. $5,100 billion.
b. $100 billion.
c. $15 billion.
d. $2,000 billion

a. $5,100 billion

A gain can be made by the holder of a call option when the current exchange rate

a. exceeds the exercise price.
b. exceeds the forward price.
c. is less than the futures price.
d. falls to zero.

a. exceeds the exercise price

The largest volume of foreign exchange trading occurs in

a. the U.K.
b. the U.S.
c. Japan.
d. Germany.

a. the U.K.

Central banks intervene in the foreign exchange market

a. to smooth out currency fluctuations.
b. to facilitate the transfer of goods and services internationally.
c. to conduct foreign exchange operations for central governments.
d. All of the above.

d. All of the above

A ________ is a transaction in which both a spot transaction and a forward transaction are agreed upon simultaneously.

a. arbitrage
b. call
c. swap
d. put

c. swap

Suppose an investor has 100 euros, and has a choice of: 1) buying a bond in Germany that pays 5% interest in euros; 2) buying a similar bond in the US that pays 5% interest in dollars. If the exchange rate today is 0.87 euros per dollar, what the exchange rate have to be at the maturity of the bonds for the investor to earn the same return from either bond?

a. 1 euro per dollar
b. 0.87 euro per dollar
c. 0.87 dollar per euro
d. 1.3 dollar per euro
e. none of the above

b. 0.87 euro per dollar

Foreign exchange activity is dominated by the spot and swaps markets.

True or False

True

An increase in the exchange rate from $2.00 per euro to $2.20 per euro is a

a. 10% depreciation of the euro with respect to the dollar.
b. 10% depreciation of the dollar with respect to the euro.
c. 10% appreciation of the dollar with respect to the euro.
d. None of the above.

b. 10% depreciation of the dollar with respect to the euro

The essential feature of a ________ is that it immediately fixes the rate at which a specified amount of one currency is to be delivered in exchange for a specific amount of another at a future date.

a. forward contract
b. spot contract
c. money contract
d. bid contract

a. forward contract

The euro is now the official currency of all of the following countries except

a. France.
b. Germany.
c. Great Britain.
d. Spain.
e. Montenegro
f. Slovenia

c. Great Britian

Riskless transactions to take advantage of profit opportunities due to a price differential or a yield differential in excess of transaction costs are called

a. differential actions.
b. cash transactions.
c. arbitrage.
d. forward transactions.

c. arbitrage

If an investor can open a bank deposit in Japanese yen and earn 2% or she could open a bank deposit in U.S. dollars and earn 6% in US dollars, clearly the U.S. dollar deposit is preferred.

True or False

False

The price in the foreign exchange market is called:

a. the trade surplus.
b. the money price.
c. the exchange rate.
d. the currency rate.

c. the exchange rate

In the case of an appreciating domestic currency, central banks often sell foreign currencies in exchange for domestic currency to stop the appreciation.

True or False

False

A central bank can influence foreign exchange rates by

a. announcing it will support its currency at a given exchange rate.
b. announcing a non-interventionist policy.
c. buying its currency on the market.
d. selling its stock of foreign exchange on the market.
e. all of the above.

e. all of the above

The reduction or covering of a foreign exchange risk is called

a. hedging.
b. speculation.
c. intervention.
d. arbitrage.

a. hedging

Suppose that in the free market, where the supply of the foreign currency is equal to demand for that currency, the peso-dollar exchange rate is 4 pesos = $1. Assume the central bank sets an official exchange rate at 3 pesos = $1, we can say that in the official market the dollar is

a. overvalued.
b. undervalued.
c. appreciated.
d. None of the above.

b. undervalued

Suppose:
1 £ = 2.435 $ in New York
1 $ = 1.07 € in Paris
1 € =0 .4 £ in London
How much could you profit per pound initially traded?

a. 0.04218 £
b. 0.1042 £
c. 0.6055 £
d. 1.6055 £

a. 0.04218 euro

Suppose:
1 £ = 2.435 $ in New York
1 $ = 1.07 € in Paris
1 € =0 .4 £ in London

Suppose New York was considering adding a transaction cost for every trade of pounds to dollars. What is the lowest transaction cost that would remove the arbitrage opportunity? Hint: a transaction cost of x means that for every 1 £ traded you receive back (2.435 - x)$ in New York.

a. 0.097 $
b. 0.098 $
c. 0.099 $
d. 0.1 $

c. $0.099