Foreign Exchange TestBank

CHAPTER SIX Balance of Payments and Foreign Exchange Markets True/False 1. In the balance of payments accounts the sum of all debits is equal to the value transferred out of the economy in the given period. Ans: True Dif: M 2. A $5,000 computer shipped abroad from the U.S. is a credit entry in the U.S. capital account. Ans: False Dif: M 3. If a domestic resident receives payment from abroad a credit entry is made in the balance of payments accounts. Ans: True Dif: M 4. An import of foods would result in a debit in the goods category of the current account. Ans: True Dif: M 5. The most accurately measured balance of payments category is the capital account. Ans: False Dif: E 6. The cost to ship military equipment to Afghanistan to bring down the Taliban resulted in resulted in an entry in the services category of the current account. Ans: True Dif: M 7. Purchases of foreign securities by domestic residents results in a decrease to the capital account but the interest received from those securities results in an increase to the current account. Ans: True Dif: M 8. A net capital inflow means the net purchases of foreign assets by domestic residents exceed the net purchases of domestic assets by private foreign residents. Ans: False Dif: M

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9. A balance of payments deficit refers to a situation where the official settlements balance is negative. Ans: False Dif: D 10. If one includes the statistical discrepancy the overall balance of payments for a country is always zero. Ans: True Dif: E 11. A country’s balance of payments account has a statistical discrepancy of zero, a current account surplus of $50 billion and a capital account deficit of $35 billion. The official settlements balance must be a net $15 billion credit. Ans: True Dif: D 12. The current price to buy a unit of foreign currency now is called the spot exchange rate. Ans: True Dif: E 13. Foreign exchange risk is eliminated for all parties to an import transaction if the purchase is denominated in the local currency. Ans: False Dif: M 14. In most wholesale foreign exchange transactions hard currencies never cross national boundaries. Ans: True Dif: E 15. Banks and foreign exchange brokers account for about 90% of all foreign exchange market transactions. Ans: False Dif: M 16. The foreign exchange market is more than twenty–five times larger than the combined volume of the world’s ten largest stock markets. Ans: True Dif: E 17. The market to buy or sell a currency for delivery within 2 to 3 days is called the forward market. Ans: False Dif: E 18. You buy the British pound at £0.67 per $ and sell it at $1.55 per £. Ignoring commissions, you came out ahead on the deal. Ans: True Dif: M

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19. You have Euros and you buy the dollar at $1.03 per € and sell it at € 1.05 per $. Ignoring commissions, you came out ahead on the deal. Ans: False Dif: M 20. In a cross rate table, reading across the U.S. dollar row gives the U.S. dollar per unit of foreign currency for the various country columns. Ans: False Dif: D 21. The real exchange rate is always less than the nominal exchange rate. Ans: False Dif: M 22. The effective exchange rate is an exchange rate that has been adjusted for different price levels the two countries under consideration. Ans: False Dif: E 23. A weighted average measure of the value of a currency relative to two or more other currencies is termed an effective exchange rate. Ans: True Dif: E 24. The risk that the revenues or costs associated with a transaction expressed in terms of the domestic currency may change due to variations in exchange rates is called translation exposure. Ans: False Dif: E 25. The risk that changes in exchange values might change today’s value of a firm’s future income streams is called economic exposure. Ans: True Dif: E 26. Entering into a derivatives contract to offset the risk of another position is termed hedging. Ans: True Dif: E 27. A firm sells the pound short in the spot market in hopes of buying it back at a lower price in the future. The firm is engaging in currency speculation. Ans: True Dif: E 28. You buy an option that you can exercise only on the expiration date of the option. You must have purchased a European option. Ans: True Dif: E

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29. An American currency call option gives the holder the right, but not the obligation, to purchase the underlying currency at a preset price at any time until the option expires. Ans: True Dif: E 30. A U.S. firm has entered into a contract to buy textiles from Hong Kong. Payment will be in Hong Kong dollars in 6 months. The U.S. importer could reduce its currency risk by selling the Hong Kong dollar forward. Ans: False Dif: M

Multiple Choice 1. A U.S. tourist traveling in Europe spends money on a hotel room and food in Paris. These transactions result in a __________ to the __________ category of the U.S. balance of payments. A) debit; goods B) credit; goods C) debit; services D) credit; services E) credit; income Ans: C Dif: M 2. In the U.S. balance of payments accounts U.S. firms importing goods results in a __________ and U.S. residents purchasing foreign stocks and bonds results in a __________. A) debit; credit B) credit; debit C) credit; credit D) debit; debit Ans: D Dif: E 3. Activities in the services category of the balance of payments accounts include I. international tourism & travel. II. royalties and fees received from overseas. III. military transactions. A) I only B) II only C) I and II only D) II and III only E) I, II and III Ans: E Dif: E

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4. A German resident buys a long term U.S. Treasury bond and receives coupon interest in the same year. The purchase price of the Treasury bond is recorded in the German __________ account and the income is recorded in the German __________ account. A) capital; current B) capital; capital C) current; capital D) current; official settlements E) official settlements; capital Ans: A Dif: M 5. A Swiss resident buys a long term U.S. Treasury bond and receives coupon interest in the same year. The purchase of the Treasury bond is a __________ in the Swiss balance of payments and the income received is a __________. A) debit; debit B) credit; credit C) debit; credit D) credit; debit Ans: C Dif: E 6. Suppose that in a given month U.S. residents buy $16 million of foreign stocks and bonds, at the same time foreigners buy $25 million of U.S. stocks and bonds and the official settlement account increases $10 million. The net effect of these three sets of transactions is to A) increase the capital account by $51 million. B) decrease the capital account by $41 million. C) increase the capital account by $19 million. D) decrease the capital account by $1 million. E) none of the above Ans: C Dif: D 7. Changes in the financial assets and deposits of government agencies are recorded in the A) current account. B) services account. C) capital account. D) official settlements account. E) income account. Ans: D Dif: E

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8. A country imports $800 million worth of goods and services and exports $600 million. The country’s private agents purchase $200 million of foreign assets and foreigners buy $300 million of domestic assets. If the statistical discrepancy is –$100 million, what must be the net official settlements balance if there are no other transactions? A) $400 million credit B) $200 million credit C) $300 million debit D) $200 million debit E) $400 million debit Ans: B Dif: D 9. A country has a current account surplus of $300 million and a capital account deficit of $400 million. If the statistical discrepancy is zero this situation must result in A) a balances of payment deficit. B) a positive official settlements balance. C) a negative official settlements balance. D) both A) and B) E) both A) and C) Ans: D Dif: M 10. The current account includes which of the following categories? I. II. III. IV.

goods services income unilateral transfers

A) I and II only B) I and III only C) II and IV only D) I, II and IV only E) I, II, III and IV Ans: E Dif: E 11. A capital account surplus implies that a country’s domestic residents A) purchased more foreign assets than foreigners purchased domestic assets. B) purchased less foreign assets than foreigners purchased domestic assets. C) imported more goods and services than they exported. D) exported more goods and services than they imported. E) received more income from foreign asset holdings than foreigners received on their domestic asset holdings. Ans: B Dif: M

Balance of Payments and Foreign Exchange Markets

NARRBEGIN: Table 1, Balance of Payment Data Hypothetical U.S. BOP Data Bill $ Exports of merchandise $125 Imports of merchandise Exports of services $ 55 Imports of services U.S. foreign aid payments to Income received from domestic $ 10 Afghanistan holdings of foreign assets Statistical discrepancy Foreign purchases of U.S. assets Official Settlements Balance $ 5 U.S. purchases of foreign assets Income paid to foreigners on their $ 9 domestic asset holdings

Bill $ $120 $ 45 $ 11 $ 25 $ 55

NARREND 12. Refer to Table 1 to answer the following question: The current account must be equal to a A) $27 billion surplus. B) $17 billion surplus. C) $15 billion surplus. D) $27 billion deficit. E) $17 billion deficit. Ans: A NAR: Table 1 Balance of Payment Data Dif: M 13. Refer to Table 1 to answer the following question: The capital account must be equal to a A) $28 billion deficit. B) $30 billion deficit. C) $28 billion surplus. D) $18 billion surplus. E) $30 billion surplus. Ans: B NAR: Table 1 Balance of Payment Data Dif: M 14. Refer to Table 1 to answer the following question: The statistical discrepancy must be equal to ________ billion. A) +$3 B) –$3 C) $0 D) +$2 E) –$2 Ans: E NAR: Table 1 Balance of Payment Data Dif: D

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15. Which one of the following does not belong in the current account? A) humanitarian foreign aid payments B) income earned on foreign assets C) purchases of domestic financial assets by foreigners D) payments for military services abroad E) exports and imports of services Ans: C Dif: E 16. The foreign exchange market is a market for the exchange of A) currency. B) goods. C) services. D) income streams. E) none of the above Ans: A Dif: E 17. The U.S. had a capital account surplus in 2001. This means that the U.S. A) either net sold assets to foreigners and/or net increased its indebtedness to foreigners. B) exported more than goods than services. C) exported more goods and services than it imported. D) imported more goods and services than it exported. E) must have had a positive official settlements balance. Ans: A Dif: M 18. The bulk of foreign exchange trading activity is A) hard currency transfers across borders. B) due to tourism, travel and illegal activities. C) in the forward market. D) done with currency futures. E) electronic or phone originated trades of foreign currency denominated financial instruments. Ans: E Dif: E 19. Citigroup has a £10 million deposit in the U.K. that they wish to convert to Swiss francs (Sfr). UBS is willing to switch the pounds to francs at a rate of 2.32 Sfrs per pound. Deutsche Bank will accept £0.43 per franc. Based on these quotes, what is the greatest amount of francs that Citigroup can get for its £10 million? A) 23,255,813 B) 23,200,000 C) 4,310,345 D) 25,433,336 E) 4,300,000 Ans: A Dif: E

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20. Rank the following foreign exchange participants from largest to smallest in trading activity: I. banks II. foreign exchange trading websites III. foreign exchange brokers A) I, II, III B) I, III, II C) II, III, I D) III, II, I E) III, I, II Ans: B Dif: M 21. The currency per U.S. dollar quote for the British pound is 1.55. If you wish to buy $1,000 worth of pounds, how many pounds could you get? A) 1,550 B) 645 C) 450 D) 1000 E) 550 Ans: B Dif: E 22. The exchange rate for the euro changed from 0.9968 on December 2, 2002 to 0.9966 (U.S. dollar equivalent) on December 3, 2002. If you used $1 million to buy euros on December 2 and sold them on December third you made A) +$200.68. B) –$144.45. C) –$200.64. D) +$144.79. E) none of the above Ans: C Dif: M 23. The Canadian dollar is worth 64 cents U.S. If the Canadian dollar drops in value by 2% the Canadian dollar will be worth __________ cents U.S. A) 62.72 B) 65.28 C) 66.00 D) 62.00 E) none of the above Ans: A Dif: E

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24. The Canadian dollar is worth 64 cents U.S. If the U.S. dollar drops in value by 3% the Canadian dollar will be worth __________ cents U.S. A) 65.28 B) 65.92 C) 65.31 D) 62.08 E) none of the above Ans: C Dif: D 25. The currency per U.S. $ for the South Korean won is 1217. The similar quote for the Japanese yen against the dollar is 124.533. What is the implied won per yen cross exchange rate? A) 151,556.66 B) 0.000007 C) 9.9986 D) 0.102328 E) none of the above Ans: E Dif: M 26. The British pound is worth 2.3198 Swiss francs and the Mexican peso is worth 0.14512 Swiss francs. How many pesos is the British pound worth? A) 0.0626 B) 0.3354 C) 2.9818 D) 15.985 E) none of the above Ans: D Dif: M 27. The CPI is now at 181 and last year it was at 170. Inflation over the year was A) 9.00%. B) 1.065%. C) 11.00%. D) 6.47%. E) 3.23%. Ans: D Dif: E 28. Suppose that the CPI in Britain is at 125 and the CPI in the U.S. is at 120. If the nominal exchange rate is $1.5625 to the pound, what is the real exchange rate for the dollar? A) $1.6276 B) $1.5000 C) £0.6667 D) £0.6144 E) none of the above Ans: D Dif: M

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29. A U.S. firm has contracted to purchase French wines and has agreed to pay € 5 million in 6 months. Which of the following methods could be used to reduce the U.S. firm’s exchange rate risk that results from the deal? I. Buy the euro forward. II. Buy a call option on the euro. III. Swap euros for dollars now. A) I only B) II only C) I and II only D) II and III only E) I, II and III Ans: C Dif: M 30. In foreign exchange, the European demand for the dollar also represents the A) European demand for dollar denominated goods and services. B) supply of the euro made available for foreign exchange. C) European supply of euro denominated goods and services. D) supply of the dollar made available for foreign exchange. E) both A) & B) Ans: E Dif: D 31. The Thai baht is currently trading at 42 baht to the dollar in the spot market. The 3 month forward rate is 0.025 dollars per baht. What is the standard forward premium or discount for the baht? A) 5% premium B) 19.04% premium C) 20% premium D) 4.76% discount E) 19.04% discount Ans: C Dif: D 32. The ruble is currently trading at 31 rubles to the dollar in the spot market. The 4 month forward rate is 35 rubles to the dollar. What is the standard forward premium or discount for the ruble? A) 12.90% premium B) 11.43% discount C) 20% premium D) 34.29% discount E) 11.43% premium Ans: D Dif: D

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33. The yen has a one year forward discount of 3% against the dollar. If the spot exchange rate is 124 yen to the dollar what is the expected future spot rate in one year given that there is no bias in the forward rate? A) 120.280 yen/$ B) 120.388 yen/$ C) 127.720 yen/$ D) 126.632 yen/$ E) 127.827 yen/$ Ans: E Dif: D 34. You believe the yen will increase in value by 4% against the dollar in one year. If you think the spot exchange rate in one year will be 120 yen to the dollar, what must the spot rate be right now? A) 124.80 yen/$ B) 125.76 yen/$ C) 115.20 yen/$ D) 119.81 yen/$ E) 125.00 yen/$ Ans: A Dif: M 35. If the spot exchange rate is $1.57 U.S. to the pound and the pound is expected to depreciate by 3% over the next year, what is the dollar expected to do against the pound? A) appreciate 3% B) depreciate 3% C) appreciate 3.09% D) depreciate 3.05% E) appreciate 3.05% Ans: C Dif: D 36. Which one of the following statements about differences in currency futures and forwards is not correct? A) Futures contracts are more standardized than forward contracts. B) Futures contracts may require the holder to pay out cash before contract maturity and forwards do not. C) Forward contracts are generally for smaller amounts of currency than futures contracts. D) Futures contracts are more liquid than forward contracts. E) Futures contracts are traded on organized exchanges and forwards are OTC contracts negotiated between two parties. Ans: C Dif: D

Balance of Payments and Foreign Exchange Markets

37. A contract that grants the holder the right to buy a given amount of a foreign currency at a predetermined exchange rate until or on a specified date is a currency A) forward contract. B) futures contract. C) call option. D) put option. E) swap agreement. Ans: C Dif: E 38. A contract that grants the holder the right to sell a given amount of a foreign currency at a predetermined exchange rate until or on a specified date is a currency A) forward contract. B) futures contract. C) call option. D) put option. E) swap agreement. Ans: D Dif: E 39. A contract that allows the holder to buy a given amount of a foreign currency at a predetermined exchange rate only on a specified date is a/an A) American put option. B) European put option. C) American call option. D) European call option. E) swap agreement. Ans: D Dif: E

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