Exercises

Exercises

1.Single-choice questions

(1)Foreign exchange is________.

a.the act of trading different nations’ monies

b.the holdings of foreign currency

c.the act of importing foreign goods and services

d.Both a and b are correct

(2)If the price of British pounds in terms of US dollars is $1.80 per pound, then the price of US dollars in terms of British pounds is________.

a.1.80£ per dollar   b.0.555£ per dollar

c.0.90£ per dollar   d.3.60£ per dollar

(3)The________exchange rate is the price set now for an exchange that will take place sometime in the future.

a.current     b.forward   c.future spot    d.spot

(4)The foreign exchange market is________.

a.a single gathering place where traders shout buy and sell orders at each other

b.located in New York

c.a grouping, by electronic means, of banks and traders who work at banks that conduct foreign exchange trades

d.located in London

(5)Suppose that the exchange value of the British pound is $2 per pound while the exchange value of the Swiss franc is 50 cents per franc.From this we can conclude that the exchange rate between the pound and the franc is________.

a.1 franc per pound   b.2 francs per pound

c.3 francs per pound   d.4 francs per pound

(6)Under the managed float system of exchange rates, a fall in the market price of a currency is called________.

a.devaluation      b.depreciation

c.appreciation     d.both a and b

(7)A country’s demand for foreign currency is derived from________.

a.international transactions entering the debit column of its balance of payments accounts

b.international transactions entering the surplus column of its balance of payments accounts

c.the country’s demand for currency to finance exports and capital inflows

d.the country’s demand for currency to finance its government’s compensating transactions

(8)As the value of the yen falls relative to the US dollar________.

a.Japanese goods become more expensive to US consumers

b.The supply of dollars will fall

c.The demand for yen will rise

d.US goods become less expensive to Japanese consumers

(9)In a________exchange rate system the government or central bankers intervene to keep the exchange rate virtually steady.

a.fixed   b.market driven   c.floating   d.forward

(10)Exchange rates are equalized in different locations due to________.

a.arbitrage

b.government intervention in foreign exchange markets

c.free trade in goods and services

d.the actions of importers and exporters

(11)Suppose the exchange rate between the Japanese yen and the US dollar is 100 yen per dollar.A Japanese stereo with a price of 60,000 yen will cost________.

a.$1,667    b.$600      c.$6,000  d.$100

(12)The________exchange rate is the price for “immediate” currency exchange.

a.current    b.forward   c.future   d.spot

(13)The US dollar is called a________because it is often used as an intermediary to accomplish trading between two other currencies.

a.vehicle currency  b.main currency

c.common currency   d.primary currency

(14)Which of the following is NOT a function of the interbank operations of the foreign exchange market?

a.Provides a bank with a continuous stream of information on conditions in the foreign exchange market.

b.Provides a bank the means to readjust its own position quickly and at low cost.

c.Permits a bank to take on a position in a foreign currency quickly.

d.Provides a bank with technological resources for use in foreign exchange trading.

(15)US exports of goods and services will create a________foreign currency and a________US dollars.

a.demand for; supply of   b.supply of; demand for

c.shortage of; demand for   d.supply of; shortage of

(16)The demand curve for foreign currency slopes downward because as the exchange rate________the quantity demanded________.

a.increases; decreases   b.increases; increases

c.decreases; decreases   d.decreases; stays fixed

(17)How could you profit if the exchange rate in London was $2/£ while in New York the exchange rate was $1.95 per pound?

a.Buy dollars in New York and sell them in London.

b.Buy pounds in London and sell them in New York.

c.Buy pounds in New York and sell them in London.

d.Buy dollars in London and sell pounds in New York.

(18)Shifts in demand away from French products and toward US products (caused by forces other than changes in the exchange rate)would result in extra attempts to________euros and________dollars.

a.buy; buy   b.sell; sell   c.sell; buy   d.buy; sell

(19)US imports of goods and services will create a________foreign currency and a________US dollars.

a.demand for; supply of  b.supply of; demand for

c.shortage of; demand for  d.supply of; shortage of

(20)Interbank trading is conducted directly between________or through the use of________that provide anonymity until the trade is complete and reduce search costs.

a.traders; brokers

b.brokers; traders

c.individual consumers; the government

d.individual consumers; brokers

2.True/False questions

(1)Assuming the Japanese have a floating exchange rate, an increase in Japanese exports of goods and services will tend to cause the value of the yen to appreciate.

(2)The spot exchange rate is the price now for an exchange that will take place sometime in the future.

(3)French imports of goods and services will create a demand for foreign currency and a supply of euros.

(4)To maintain an undervalued currency, monetary authorities must intervene in the foreign exchange market to buy its currency.

(5)Triangular arbitrage will not cause the exchange rate between two foreign currencies to equalize.

3.Essay questions

(1)A retailer in Mexico wants to buy $100,000 worth of Apple computers from the United States.The Mexican retailer has pesos while the seller in the United States wants to be paid in US dollars.Explain how this transaction is completed with particular emphasis on the foreign exchange market and banks in the United States and Mexico.

(2)Suppose $1=0.85 euros in New York, 1 euro=150 yen in Paris, and 1 yen=$0.008 in Tokyo.

a.How could you profit from these exchange rates if you begin by holding $1? What is your arbitrage profit per dollar initially traded?

b.Identify the forces at work that will make the cross exchange rates consistent in currency arbitrage.That is, what forces will lead to a situation in which no profitable arbitrage is possible?

(3)For each case below, state whether the euro has appreciated or depreciated and give an example of an event that could cause the change in the exchange rate.

a.The spot rate goes from 450 euros/Mexican peso to 440 euros/Mexican peso.

b.The spot rate goes from 0.011 Mexican pesos/euro to 0.006 Mexican pesos/euro.

c.The spot rate goes from 1.48 euros/British pound to 1.51 euros/British pound.

4.Questions and calculations

(1)Assume the following information:

A Bank  B Bank

Bid price of Canadian dollar  $0.802  $0.796

Ask price of Canadian dollar  $0.808  $0.800

Given this information, is locational arbitrage possible? If so, explain the steps involved in locational arbitrage, and compute the profit from this arbitrage if you had $1,000,000 to use.(5%)

(2)What are the three levels of foreign exchange market?