Ch 9

Question 1

Exchange Rate

Answer 1

The price of one currency expressed in terms of another; the number of units of one currency that can be exchanged for another

*Fluctuate
-Appreciate (go up in value)
-Depreciate (go down in value)

Question 2

Currency Risk (Financial)

Answer 2

Potential Harm that arises from changes in the price of one currency relative to another

-If the foreign currency fluctuates in your favor, you may gain a windfall

1. The prices the firm changes can be quoted in the firm’s currency or in the currency of each foreign customer
2. Several months can pass between placement and delivery of an order, fluctuations in the exchange rate during that time can cost or earn the firm money
3. The firm and its customers can use the exchange rate as it stands on the date of each transaction, or can agree to use a specific exchange rate

Question 3

Who can face risk?

Answer 3

Exporters, licensors, and foreign direct investors

Question 4

Convertible Currency

Answer 4

-Can be easily exchanged for other currencies

-Most easily convertible (hard currency)
*British pound
*European Euro
*Japanese Yen
*U.S Dollar

Question 5

Nonconvertible Currency

Answer 5

Not acceptable for international transactions

*To preserve supply of hard currencies or avoid the problem of capital flight

Question 6

Capital Flight

Answer 6

Rapid sell-off by residents or foreigners of their holdings in a nation’s currency or other assets, usually in response to a domestic crisis that causes investors to lose confidence in the country’s economy

Question 7

Foreign Exchange

Answer 7

All forms of money that are traded internationally, including foreign currencies, bank deposits, checks, and electronic transfers

Question 8

Foreign Exchange Market

Answer 8

The global marketplace for buying and selling national currencies

Question 9

How exchange rates are dettermined

Answer 9

The price of any currency is determined by supply and demand

-Adjust according to market forces; some are pegged to fixed exchange rates and may not respond

Free market:
-The greater the supply, the lower price
-The lower the supply, the higher the price
-The greater the demand, the higher the price
-The lower the demand, the lower the price

Question 10

The 4 factors that influence supply and demand

Answer 10

-Economic Growth
-Inflation
-Interest Rates
-Market Psychology

Question 11

Economic Growth

Answer 11

Increase in the value of goods and services an economy produces

-Central bank increases nation’s money supply and manages exchange rate

Question 12

Inflation

Answer 12

Increase in the price of goods and services

-With high inflation, the purhcasing power of a nation’s currency is constantly falling

-Inflation occurs when demand for money grows more rapidly than supply or when the central bank increases the national money supply faster than the rise in national productive output

-There is a relationship between real interest rates and the value of currency

Question 13

Market Psychology

Answer 13

Unpredictable behavior of investors

Herding: Tendency of investors to mimic others’ actions

Momentum Training: When investors buy stocks whose prices have been rising and sell stocks whose prices have been falling

Question 14

-When a nation’s currencies are too expensive, exports are likely to fall

-When a nation’s currency is cheap, exports increase

Answer 14

Trade Surplus: When a nation’s exports exceed imports for a short period of time

Trade Deficit: When a nations imports exceed exports for a short period of time

**Balance of trade

Question 15

When a trade deficit becomes severe, the nations central bank may devalue its currency

Answer 15

-Devaluation deters nation’s residents from importing from other countries, potentially reducing trade deficit

Question 16

Balance of Payments

Answer 16

Annual accounting of all economic transactions of a nation with all other nations

Question 17

Bretton Woods Agreement

Answer 17

-Pegged the value of the U.S dollar to an established value of gold at a rate of $35 per ounce.

-Kept exchange rates of major currencies fixed at a prescribed level relative to the U.S dollar and to each other

-Link between U.S dollar and gold was suspended in 1971.

Question 18

Exchange Rate Today

Answer 18

1. Floating System
2. Fixed System

Question 19

Floating Exchange Rate

Answer 19

-Currency values are determined by market forces and by supply and demand

-Gives governments the flexibility to modify monetary policy to fit the circumstances they face at any time

Question 20

Fixed Exchange Rate (Pegged)

Answer 20

-Similar to Bretton Woods Agreement

-Value of currency is set relative to the value of another at a specified rate

Question 21

International Monetary System

Answer 21

Institutional framework, rules, and prodedures by which national currencies are exchanged for one another

-System facilitates international trade and investment

Question 22

Global Financial System

Answer 22

Collective of financial institutions that facilitate and regulate investment and capital flows worldwide, such as central banks, commercial banks, and national stock exchanges

Question 23

Stock Exchange

Answer 23

Facility for trading securities and other financial instruments, including shares issued by companies, trust funds, pension funds, and corporate and government bonds

Question 24

Bonds

Answer 24

-Type of security sold through banks and stockbrokers

-Form of debt that corporations and governments incur by issuing interest-bearing certificates to raise capital

Question 25

For Firms; most important functions of banks

Answer 25

-lend money to finance business activity, exchange foreign currencies, and facilitate adjustments in national money supplies

*investment banks
*merchant banks
*private banks
*offshore banks
*commerical banks

Question 26

Central Bank

Answer 26

-Goal is to keep inflation low

Regulates nation’s money supply by:
*Buying and selling money in the banking system
*Increasing or decreasing interest rates on funds loaned to commerical banks
*Buying and selling government securities, such as treasury bills and bonds

Question 27

Monetary Intervention

Answer 27

The buying and selling of currencies by a central bank to maintain the exchange rate of a country’s currency at some acceptable level

Question 28

International Monetary Fund

Answer 28

Promotes international monetary cooperation, exchange rate stability, and orderly exchange arrangements and encourages countries to adopt sound economic policies

*Currency Crisis
*Banking Crisis
*Foreign Debt Crisis

Question 29

Currency Crisis

Answer 29

When the value of a nation’s currency depreciates sharply or when its central bank must expend substantial reserves to defend the value of its currency

*Interest rates rise

Question 30

Banking Crisis

Answer 30

When domestic and foreign investors lose confidence in a nation’s banking system that leads to widespread withdrawls of funds from banks and other financial institutions

-Great Depression!!

-Can lead to other problems such as exchange rate fluctuations, inflation, abrupt withdrawl of FDI funds, and general economic instability

Question 31

Foreign Debt Crisis

Answer 31

When a national government borrows an excessive amount of money, either from banks or from the sale of goverment bonds

Question 32

International Monetary Funds

Answer 32

Provides assistance by setting fiscal policy, devising monetary and exchange rate policies, and supervising and regulating banking and financial systems

-Also provides loans

Question 33

The World Bank

Answer 33

Aims to reduce poverty and is active in various development projects to bring water, electricity, and transportation to infrastructure to poor countries