Chapter 10

Question 1

What is a market?

Answer 1

A place where we buy and sell goods

Question 2

What does FOREX stand for?

Answer 2

Foreign Exchange Market

Question 3

What is the Foreign Exchange Market?

Answer 3

Marketing for converting. Buying and selling the currency of one country into that of another country.

Question 4

What are the two functions of the FOREX?

Answer 4

1. Enables currency conversion.
2. Provides some protection against foreign exchange risk.

Question 5

What is foreign exchange risk?

Answer 5

The adverse consequences of unpredictable changes in exchange rates.

Question 6

What is currency speculation?

Answer 6

Short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates.

Question 7

What is carry trade?

Answer 7

Borrowing one currency where interest rates are low and invests these in another currency where interest rates are high.

Question 8

What is hedging?

Answer 8

Protection against foreign exchange risk.

Question 9

What is a spot exchange rate?

Answer 9

An immediate transaction. Determined by supply and demand. Changes continuously.

Question 10

What is a forward exchange rate?

Answer 10

A transaction that is executed in the future. Typically quoted for 30,90, or 180 days into the future.

Question 11

What are currency swaps?

Answer 11

Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

Question 12

What is arbitrage?

Answer 12

The process of buying a currency low and selling it high without risk.

Question 13

What currency is typically on one side of an exchange?

Answer 13

US Dollar

Question 14

What are the 3 factors that impact future exchange rates?

Answer 14

1. A country’s price inflation
2. A country’s interest rates
3. Market psychology

Question 15

What is the law of one price?

Answer 15

In competitive markets free of transport costs and trade barriers, identical products should cost the same per their currency rate. Exchange=$2, *=1. Shirt price=$20, *=10

Question 16

What is the Purchasing Power Parity (PPP)?

Answer 16

Given a relatively efficient market, the price of a “basket of goods” should be roughly equivalent in each country.

Question 17

What is the Big Mac Index?

Answer 17

Conversion that shows price of a Big Mac in every country

Question 18

What is the PPP best at calculating?

Answer 18

Long-run underdeveloped countries with high inflation rates.

Question 19

What is the Fisher effect?

Answer 19

A country’s nominal interest rate = the sum of the required interest rate + the expected inflation rate over the period

Question 20

What is the bandwagon effect?

Answer 20

When expectations by the traders turn into self-fulfilling prophecies, and traders join in and move exchange rates based on expectations.

Question 21

What are some strong long-run predictors of changes in exchange rates?

Answer 21

Monetary growth, inflation rates, and interest rates.

Question 22

What are the best predictors of an efficient markets future spot rates?

Answer 22

Forward rates

Question 23

What does it mean for a currency to be freely convertible?

Answer 23

Both residents and non-residents can purchase unlimited amounts of foreign currency with the domestic currency

Question 24

What does it mean for a currency to be externally convertible?

Answer 24

Only nonresidents can convert their holdings of domestic currency into foreign currency.

Question 25

What does it mean for a currency to be nonconvertible?

Answer 25

Both residents and nonresidents are prohibited from converting their holdings

Question 26

What is capital flight?

Answer 26

When residents and nonresidents rush to convert their holdings of domestic currency into foreign currency.

Question 27

What is countertrade?

Answer 27

In nonconvertible currencies, goods and services can be traded for other goods and services

Question 28

What is transaction exposure?

Answer 28

Extent to which the income from individual transactions are affected by fluctuations in foreign exchange values.

Question 29

What is translation exposure?

Answer 29

Impact of currency exchange rate changes on the reported financial statements of a company

Question 30

What is economic exposure?

Answer 30

Extent to which a firm’s future international earning power is affected by changes in exchange rates.

Question 31

How can firms reduce economic exposure?

Answer 31

Firms need to distribute productive assets to various locations to avoid long-term financial problems associated with changes in exchange rates

Question 32

How can firms reduce transaction and translation exposure?

Answer 32

Using lead and lag strategies

Question 33

What is a lead strategy?

Answer 33

Collecting foreign receivables when currency expected to depreciate or paying early before currency appreciates

Question 34

What is a lag strategy?

Answer 34

Collecting receivables late when currency expected to appreciate or delaying payment if currency expected to depreciate