Risk Management (1)

Question 1

If a company is exporting from, say, the UK to the US, and the US $ weakens from, say, $/£ 1.3 to $/£ 1.4?

Answer 1

Any exports from the UK will be more expensive when priced in $

Goods imported from the US will be cheaper in £

Question 2

What is the spot exchange rate?

Answer 2

The market exchange rate for buying/selling the currency for immediate delivery

Question 3

What is the forward exchange rate?

Answer 3

The exchange rate for buying or selling the currency at a specific date in the future

Question 4

Differences in interest rates => Expected differences in inflation rates

Answer 4

Fisher effect

Question 5

Differences in interest rates => Difference between spot and forward exchange rate

Answer 5

Expectations theory

Question 6

Expected difference in inflation rates => Expected change in spot exchange rate

Answer 6

Purchasing power parity

Question 7

Differences in interest rates => Expected change in spot exchange rate

Answer 7

International fisher effect

Question 8

What is absolute PPP?

Answer 8

States that the exchange rate simply reflects the different cost of living in two countries

Question 9

Disadvantage of absolute PPP?

Answer 9

They are of limited practical use in financial management

Question 10

What is relative PPP?

Answer 10

The future spot exchange rate is based on the current spot rate and the inflation rate differential between the two currencies

Question 11

What does interest rate parity state?

Answer 11

The forward exchange rate is based on the spot rate and the interest rate differential between the two currencies

Question 12

What does PPP predict?

Answer 12

The future spot rate

Question 13

What does IRP predict?

Answer 13

The forward rate

Question 14

What happens according to the fisher effect?

Answer 14

Countries with a higher rate of inflation have higher nominal interest rates in order to offer the same real return as countries with low inflation

Question 15

What is the concept of arbitage?

Answer 15

The forces of supply and demand would lead to a change in the forward exchange rate so that risk-free profit making was not possible

Question 16

What is the forward rate?

Answer 16

The forward rate is an unbiased estimate of the future spot rate

Question 17

What are the two principal parts of monetary transactions between a country and the rest of the world?

Answer 17

Current account

Capital account

Question 18

What is current account?

Answer 18

Shows the net amount a country is earning if it is in surplus, or spending if it is in defic

Question 19

What is capital account?

Answer 19

Records the net change in ownership of foreign assets and includes the foreign exchange market operations of a nation’s central bank

Question 20

What is the main component of a current account?

Answer 20

The balance of trade, which is net earnings on exports minus payments for imports

Question 21

How must any current account surplus (deficit) be balanced by?

Answer 21

A capital account deficit (surplus) of equal size

Question 22

What does a rise in the value of a nation’s currency make its exports?

Answer 22

Less competitive and imports cheaper, with these effects tending to correct a current account surplus.

Question 23

What does a fall in value of a nation’s currency cause?

Answer 23

Imports more expensive and increases the competitiveness of exports, and so helps to correct a deficit

Question 24

What if a country exports more than it imports?

Answer 24

The demand for its currency will tend to increase. Extra demand tends to cause a rise of the currency’s price relative to others.

Question 25

What if a country imports more than it exports?

Answer 25

The supply of its own currency on the international market tends to increase as it tries to exchange it for foreign currency to pay for its imports