Test One
1.Multiple choices: (Questions 1-25 carry two points each)
(1)A high home inflation rate relative to other countries would________the home country’s current account balance, other things equal.A high growth in the home income level relative to other countries would________the home country’s current account balance,other things equal.
a.increase; increase
b.increase; decrease
c.decrease; decrease
d.decrease; increase
(2)An increase in the current account deficit will place________pressure on the home currency value, other things equal.
a.upward
b.downward
c.no
d.upward or downward (depending on the size of the deficit)
(3)In capital budgeting analysis, the use of cumulative NPV is useful for________.
a.determining the probability distribution of NPVs
b.determining the time required to achieve a positive NPV
c.determining how the required rate of return changes over time
d.determining how the cost of capital changes over time
e.a and b
(4)The “J curve” effect describes________.
a.the continuous long-term inverse relationship between a country’s current account balance and the country’s growth in gross national product
b.the short run tendency for a country’s balance of trade to deteriorate even while its currency is depreciating
c.the tendency for exporters to initially reduce the price of goods when their own currency appreciates
d.the reaction of a country’s currency to initially depreciate after the country’s inflation rate declines
(5)Assume that a bank’s bid rate on Swiss francs is $0.45 and its ask rate is $0.47.Its bid-ask percentage spread is________.
a.about 4.44％
b.about 4.26％
c.about 4.03％
d.about 4.17％
(6)Assume the spot rate of a currency is $0.37 and the 90-day forward rate is $0.36.The forward rate of this currency exhibits a________of________on an annualized basis.
a.discount; 11.11％
b.premium; 11.11％
c.premium; 10.81％
d.discount; 10.81％
(7)If a US firm desires to avoid the risk from exchange rate fluctuations, and it is receiving 100,000 marks in 90 days, it could________.
a.obtain a 90-day forward purchase contract on marks
b.obtain a 90-day forward sale contract on marks
c.purchase marks 90 days from now at the spot rate
d.sell marks 90 days from now at the spot rate
(8)From 1944 to 1971, the exchange rate between any two currencies was typically________.
a.fixed within narrow boundaries
b.floating, but subject to central bank intervention
c.floating, and not subject to central bank intervention
d.nonexistent, that is, currencies were not exchanged, but gold was used to pay for all foreign transactions
(9)A large increase in the income level in France along with no growth in the US income level is normally expected to cause (assuming no change in interest rates or other factors)a(n)________in French demand for US goods, and the French franc should________.
a.increase; appreciate
b.increase; depreciate
c.decrease; depreciate
d.decrease; appreciate
(10)If US inflation suddenly increased while German inflation stayed the same, there would be________.
a.an increased US demand for marks and an increased supply of marks for sale
b.a decreased US demand for marks and an increased supply of marks for sale
c.a decreased US demand for marks and a decreased supply of marks for sale
d.an increased US demand for marks and a decreased supply of marks for sale
(11)The premium on a pound put option is $0.03 per unit.The exercise price is $1.60.The break-even point is________for the buyer of the put, and________for the seller of the put.(Assume that transactions costs are zero and that the buyer and seller of the put option are speculators.)
a.$1.63; $1.63
b.$1.63; $1.60
c.$1.63; $1.57
d.$1.57; $1.63
e.None of the above.
(12)You are a speculator who sells a call option on Swiss francs for a premium of $0.06, with an exercise price of $0.64.The option will not be exercised until the expiration date, if at all.If the spot rate of the Swiss franc is $0.69 on the expiration date, your net profit per unit is________.
a.-$0.02
b.-$0.01
e.$0.01
d.$0.02
e.None of the above.
(13)A primary result of the Bretton Woods agreement was________.
a.the establishment of the European Monetary System (EMS)
b.establishing specific rules for when tariffs and quotas could be imposed by governments
c.establishing that exchange rates of most major currencies were to be allowed to fluctuate 1％ above or below their initially set values
d.establishing that exchange rates of most major currencies were to be allowed to fluctuate freely without boundaries (although the central banks did have the right to intervene when necessary)
(14)Under a managed float exchange rate system, the Fed may attempt to stimulate the US economy by________the dollar.Such an adjustment in the dollar’s value should________the US demand for products produced by major foreign countries.
a.weakening; increase
b.weakening; decrease
c.strengthening; increase
d.strengthening; decrease
(15)________is an example of direct intervention in foreign exchange markets.
a.Lowering interest rates
b.Increasing the discount rate
c.Exchanging dollars for foreign currency
d.Imposing barriers on international trade
(16)________is an example of foreign direct investment.
a.Exporting to a country
b.Establishing licensing arrangements in a country
c.Purchasing existing companies in a country
d.Investing directly (without brokers)in foreign stocks
(17)If interest rate parity exists, then________is not feasible.
a.forward realignment arbitrage
b.triangular arbitrage
c.covered interest arbitrage
d.locational arbitrage
(18)Assume that a US firm can invest funds for 1 year in the US at 12％ or invest funds in France at 14％.The spot rate of the French franc is $0.10 while the 1 year forward rate of the French franc is $0.10.If US firms attempt to use covered interest arbitrage, that________should occur.
a.spot rate of French franc increases and forward rate of French franc decreases
b.spot rate of French franc decreases and forward rate of French franc increases
c.spot rate of French franc decreases and forward rate of French franc decreases
d.spot rate of French franc increases and forward rate of French franc increases
(19)Assume that US and British investors require a real return of 2％.If the nominal US interest rate is 15％, and the nominal British rate is 13％, then according to the IFE, the British inflation is expected to be about________the US inflation, and the British pound is expected to________.
a.2 percentage points above; depreciate by about 2 percent
b.3 percentage points above; depreciate by about 3 percent
c.3 percentage points below; appreciate by about 3 percent
d.3 percentage points below; depreciate by about 3 percent
e.2 percentage points below; appreciate by about 2 percent
(20)According to the “law of one price”,________.
a.prices of similar products of two different countries should be equal when measured in a common currency
b.interest rates represent a price of money; interest rates of two different countries should be equal when measured in a common currency
c.inflation rates of two different countries should be equal when measured in a common currency
d.the price of one currency relative to another should be held constant by using central bank intervention
(21)________forecasting techniques would best represent the use of relationships between economic factors and exchange rate movements to forecast the future exchange rate.
a.Fundamental
b.Market-based
c.Technical
d.Mixed
(22)Assume that the forward rate is used to forecast the spot rate.The forward rate of the Canadian dollar contains a 6％ discount.Today’s spot rate of the Canadian dollar is $0.80.
The spot rate forecasted for one year ahead is________.
a.$0.860
b.$0.848
c.$0.740
d.$0.752
e.None of the above.
(23)Assume transaction costs are zero.If the 180-day forward rate is an accurate estimate of the spot rate 180 days from now, then the real cost of hedging receivables will be________.
a.positive
b.negative
c.positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount
d.zero
(24)________reflect(s)a hedge of net receivables in British pounds by a US firm.
a.Purchasing a currency put option in British pounds
b.Selling pounds forward
c.Borrowing US dollars, converting them to pounds, and investing them in a British pound deposit
d.a and b
(25)Whitewater Co.is a US company with sales to Canada amounting to C$8 million.Its cost of goods sold attributable to the purchase of Canadian goods is C$6 million.Its interest expense on Canadian loans is C$4 million.Given these exact figures above, the dollar value of Whitewater’s “earnings before interest and taxes” would________if the Canadian dollar appreciates; the dollar value of Whitewater’s “earnings before taxes”would________if the Canadian dollar appreciates.
a.increase; increase
b.decrease; increase
c.decrease; decrease
d.increase; decrease
e.increase; be unaffected
2.Essay questions: (Questions 26-28 carry ten points each)
(26)What is the J-curve effect?
(27)Describe the relationship between the balance of payments and the foreign exchange market.
(28)Given:
a.S(RMB/USD): 7.2000
b.Interest rate on three-month RMB: 5％
c.Interest rate on three-month dollars: 3％
Determine the quote for the three-month forward exchange rate.
(29)The price of a commodity in New Zealand is NZD10, whereas the price of the same commodity in Australia is AUD 6.The current exchange rate (NZD/AUD)is 1.15.
a.Is there a violation of the LOP?
b.If so, what will happen?
c.What is the Australian dollar price compatible with the LOP at the current exchange rate?
d.At the current Australian dollar price, what is the exchange rate compatible with the LOP?
(30)Distinguish among weak efficiency, semi-strong efficiency and strong efficiency.Why is strong efficiency more applicable to the stock market than to the foreign exchange market?