ECO 410 Week 6 Quiz 5 Chapter 9 and 10 – Strayer

ECO 410 Week 6 Quiz – Strayer (All Possible Questions With Answers)

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Chapter 9 Foreign Exchange Rate Determination and Forecasting

9.1 Exchange Rate Determination: The Theoretical Thread

Multiple Choice

1) An important thing to remember about foreign exchange rate determination is that parity conditions, asset approach, and balance of payments approaches are ________ theories rather than ________ theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing

2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets in the 1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.

3) The ________ provides a means to account for international cash flows in a standardized and systematic manner.
A) parity conditions
B) asset approach
C) balance of payments
D) International Fisher Effect

4) The ________ approach argues that equilibrium exchange rates are achieved when the net inflow of foreign exchange arising from current account activities is equal to the net outflow of foreign exchange arising from financial account activities.
A) balance of payments
B) monetary
C) asset market
D) law of one price

5) The ________ approach states that the exchange rate is determined by the supply and demand for national currency stocks, as well as the expected future levels and rates of growth of monetary stock.
A) balance of payments
B) monetary
C) asset market
D) law of one price

6) The ________ approach argues that exchange rates are determined by the supply and demand for a wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price

7) The ________ approach to the determination of spot exchange rates hypothesizes that the most important factors are the relative real interest rate and a country’s outlook for economic growth and profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market

8) The asset market approach to forecasting assumes that whether foreigners are willing to hold claims in monetary form depends on an extensive set of investment considerations. These include all but which of the following choices?
A) relative real interest rates
B) capital market liquidity
C) political safety
D) All of the above are considered by investors in their decision process.

9) ________ is defined as the spread of a crisis in one country to its neighboring countries and other countries with similar characteristics.
A) Speculation
B) Contagion
C) Capital market liquidity
D) Political science

10) Critics of the balance of payments approach to exchange rate determination point to the emphasis on ________ of currency and capital rather than ________ of money or financial assets.
A) flows; stocks
B) stocks; flows
C) import; export
D) export; import

11) Which of the following versions of PPP is thought to be the most relevant to possibly explaining what drives exchange rate values?
A) The Law of One Price
B) Absolute Purchasing Power Parity
C) Relative Purchasing Power Parity
D) The International Fisher Effect

True/False

1) It is safe to say that most determinants of the spot exchange rate are also affected by changes in the spot rate. i.e., they are linked AND mutually determined.

2) The balance of payments approach of exchange rate theory is largely dismissed by the academic community today, while the practitioner public still rely on different variations of the theory for their decision making.

3) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of fundamental exchange rate theories.

4) The authors claim that theoretical and empirical studies appear to show that fundamentals do apply to the long-term for foreign exchange.

5) The authors claim that random events, institutional frictions, and technical factors may cause currency values to deviate significantly from their long-term fundamental path.

6) The asset market approach to forecasting is not applicable to emerging markets.

7) Most theories of technical analysis differentiate fair value from market value.

Essay

1) Describe the asset market approach to exchange rate determination. How is this consistent with economic theory of (say, security) prices in general?

9.2 Currency Market Intervention

Multiple Choice

1) ________ is the active buying and selling of the domestic currency against foreign currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Federal Funding

2) Which of the following is NOT a technique used by governments or central banks to impact domestic currency valuation?
A) Indirect Intervention
B) Direct Intervention
C) Capital Controls
D) All of the above are techniques used to control currency valuation.

3) Which of the following is NOT a motivation for a government or central bank to manipulate domestic currency valuation?
A) fight inflation
B) slow too rapid economic growth
C) spur too slow economic growth
D) All of the above are motivations for the government or central bank to manipulate currency values.

True/False

1) Slow economic growth and continued unemployment problems are common reasons for central banks to hold currency values down.

2) The fall in the value of the domestic currency will sharply reduce the purchasing power of foreign tourists in the country whose currency values are falling.

3) The International Monetary Fund, as one of its basic principles (Article IV), encourages members to pursue “currency manipulation” to gain competitive advantages over other members as opposed to engaging in military action to achieve the same advantage.

4) If a central bank wishes to “defend its currency,” it might follow an expansive monetary policy, which would drive real rates of interest up.

5) A country wishing for its currency to fall in value, particularly when confronted with a continual appreciation of its value against major trading partner currencies, the central bank may work to lower real interest rates, reducing the returns to capital.

6) Indirect intervention for domestic currency valuation typically uses tools of monetary policy as opposed to using tools of fiscal policy.

7) Direct intervention for currency valuation involves limiting the ability to exchange domestic currency for foreign currency.

Essay

1) Explain how a central bank would engage in direct intervention to decrease the value of its domestic currency. Since the 1970s it has been difficult for central banks alone to engage in direct intervention to alter the value of their domestic currency. Identify and explain at least two other activities in which a central bank could engage to alter the value of their domestic currency.

9.3 Disequilibrium: Exchange Rates in Emerging Markets

Multiple Choice

1) Which of the following was NOT an international currency crisis in the 1990s and early 2000s?
A) the Asian Crisis
B) the Canadian Crisis
C) the Argentine Crisis
D) All of the above were currency crises in the 1990s and 2000s.

2) The Asian Currency crisis appeared to begin in:
A) South Korea.
B) Taiwan.
C) Thailand.
D) Japan.

3) The “tequila effect” is a slang term used to describe a form of financial panic called:
A) run on the market.
B) speculation.
C) contrary investing.
D) contagion.

4) Prior to July 2, 1997, the Thai government:
A) allowed the Thai Bhat to float against major currencies.
B) fixed the Bhat’s value against the Korean won only.
C) fixed the Bhat’s value against major currencies especially the U.S. dollar.
D) none of the above

5) The authors did NOT identify which of the following as a root of the Asian currency crisis?
A) the collapse of some Asian currencies
B) the rate of inflation in the United States
C) corporate socialism
D) banking stability and management

6) The authors refer to the practice of many Asian firms being largely controlled by families of groups related to the governing body of the country as:
A) illegal.
B) insider trading.
C) cronyism.
D) not in my back yard.

7) The principle focus of the IMF bailout efforts during the Asian financial crisis was:
A) banking liquidity.
B) shareholder’s wealth.
C) reestablishing fixed currency exchange rates in Asia.
D) dollarization of Asian currencies.

8) The ________ is the Argentine currency unit.
A) peso
B) dollar
C) real
D) peseta

9) A currency board is:
A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the economy.
B) a recipe for conservative and prudent financial management.
C) designed to eliminate the power of politicians to exercise judgment by relying on an automatic and unbendable rule.
D) all of the above

10) Argentina’s economic performance in the 1990s while their peso was pegged to the U.S. dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.
A) high; high
B) low; low
C) low; high
D) high; low

11) Which of the following did NOT contribute to the Russian currency crisis of 1998?
A) an accelerated flight of capital
B) generally deteriorating economic conditions
C) a surprisingly healthy government surplus that was neither funding internal investment nor external debt service
D) all of the above

True/False

1) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.

2) Leading up to the Russian currency collapse of 1998, Russia followed a currency policy of managed float that allowed their currency to slide daily at a 1.5% per month rate.

9.4 Forecasting in Practice

Multiple Choice

1) ________, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future.
A) Mappists
B) Trappist monks
C) Filibusters
D) Technical analysts

2) Examples of a business motivation for long-run exchange rate forecasts include all but which of the following?
A) a major capital investment in a foreign country
B) the desire to hedge a 90-day security
C) a portfolio manager considering investing in foreign securities
D) All of the above are examples of a business motivation for long-run exchange rate forecast.

3) Short-term foreign exchange forecasts are often motivated by such activities as ________ whereas long-term forecasts are more likely motivated by ________.
A) long-term investment; long-term capital appreciation
B) long-term capital appreciation; desire to hedge a receivable
C) the desire to hedge a payable; the desire for long-term investment
D) the desire for long-term investment; the desire to hedge a payable

4) A major U.S. multinational firm has forecast the euro/dollar rate to be €1.10/$ one year hence, and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this imply the company’s expected rate for the euro per pound to be in one year?
A) €1.40/£
B) £1.40/€
C) £1.54/€
D) €1.54/£

True/False

1) The longer the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

Comment: The shorter the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

2) The single most important element of technical analysis is that future exchange rates are based on the current exchange rate.

3) The more efficient the foreign exchange market is, the more likely it is that exchange rate movements are random walks.

4) Technical analysts, traditionally referred to as chartists, focus on fundamental data to determine past trends that are expected to continue into the future.

Essay

1) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and contrast the motivation for and the techniques a forecaster might use for each of the time periods.
Answer: Short-run forecasts are usually more tactical in nature as a firm may desire to reduce exchange rate risk associated with foreign receivable or payables. Technical factors and short-term market expectations are often more important for short-run forecasters than long-run parity or fundamental economic conditions.
Long-run forecasts are more strategic in nature as firms make key decisions about entering new foreign markets. Longer time horizons tend to be less accurate but also require less accuracy. What forecasters typically desire is a general long-run understanding of the relationships between markets. Fundamental analysis and parity conditions tend to be more important than technical factors in this type of forecasting.

Chapter 10 Transaction Exposure

10.1 Types of Foreign Exchange Exposure

Multiple Choice

1) ________ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Transaction
C) Translation
D) Economic

2) ________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.
A) Operating
B) Transaction
C) Translation
D) Accounting

3) Each of the following is another name for operating exposure EXCEPT:
A) economic exposure.
B) strategic exposure.
C) accounting exposure.
D) competitive exposure.

4) Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.
A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above

5) ________ exposure is the potential for accounting-derived changes in owner’s equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.
A) Transaction
B) Operating
C) Economic
D) Accounting (aka translation)

6) Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.
A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting

7) Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible.
A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation

8) MNE cash flows may be sensitive to changes in which of the following?
A) exchange rates
B) interest rates
C) commodity prices
D) all of the above

9) Assuming no transaction costs (i.e., hedging is “free”), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

10) Which of the following is NOT cited as a good reason for hedging currency exposures?
A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.

11) Which of the following is cited as a good reason for NOT hedging currency exposures?
A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.

12) The stages in the life of a transaction exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as:
A) backlog, quotation, and billing exposure.
B) billing, backlog, and quotation exposure.
C) quotation, backlog, and billing exposure.
D) quotation, billing, and backlog exposure.

13) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of a loss if:
A) the exchange rate changes to $1.52/£.
B) the exchange rate changes to $1.58/£.
C) the exchange rate doesn’t change.
D) all of the above

14) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $1.58/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

15) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $1.52/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

16) ________ is NOT a commonly used contractual hedge against foreign exchange transaction exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.

17) A ________ hedge refers to an offsetting operating cash flow such as a payable arising from the conduct of business.
A) financial
B) natural
C) contractual
D) futures

True/False

1) As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.

2) Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always matched with the country of origin.

3) Hedging, or reducing risk, is the same as adding value or return to the firm.

4) There is considerable question among investors and managers about whether hedging is a good and necessary tool.

5) The key arguments in opposition to currency hedging such as market efficiency, agency theory, and diversification do not have financial theory at their core.

6) The structure of a money market hedge is similar to a forward hedge. The difference is the cost of the money market hedge is determined by the differential interest rates, while the forward hedge is a function of the forward rates quotation.

7) In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

8) Management often conducts hedging activities that benefit management at the expense of the shareholders. The field of finance called agency theory frequently argues that management is generally LESS risk averse than are shareholders.

9) Managers CAN outguess the market. If and when markets are in equilibrium with respect to parity conditions, the expected net present value of hedging should be POSITIVE.

10) Shareholders are LESS capable of diversifying currency risk than is the management of the firm.

11) Hedging can be advantageous to shareholders because management is in a better position than shareholders to recognize disequilibrium conditions and to take advantage of single opportunities to enhance firm value through selective hedging.

12) TRANSACTION exposure measures gains or losses that arise from the settlement of existing financial obligations whose terms are stated in a foreign currency.

13) Transaction exposure could arise when borrowing or lending funds when repayment is to be made in the firm’s domestic currency.

Essay

1) Does foreign currency exchange hedging both reduce risk and increase expected value? Explain, and list several arguments in favor of currency risk management and several against.

2) Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

10.2 Trident’s Transaction Exposure

Multiple Choice

Instruction 10.2:
Use the information for the following problem(s).

Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 3,000,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

• The spot exchange rate is $1.250/euro
• The six month forward rate is $1.22/euro
• CVT’s cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December call options for euro 750,000; strike price $1.28, premium price is 1.5%
• CVT’s forecast for 6-month spot rates is $1.27/euro
• The budget rate, or the highest acceptable purchase price for this project, is
$3,900,000 or $1.30/euro

1) Refer to Instruction 10.2. If CVT chooses NOT to hedge their euro payable, the amount they pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) €3,000,000.
D) unknown today

2) Refer to Instruction 10.2. If CVT chooses to hedge its transaction exposure in the forward market, it will ________ euro 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; €1.25

3) Refer to Instruction 10.2. CVT chooses to hedge its transaction exposure in the forward market at the available forward rate. The required amount in dollars to pay off the accounts payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000.

4) Refer to Instruction 10.2. If CVT locks in the forward hedge at $1.22/euro, and the spot rate when the transaction was recorded on the books was $1.25/euro, this will result in a “foreign exchange accounting transaction ________ of ________.
A) loss; $90,000.
B) loss; €90,000.
C) gain; $90,000.
D) gain; €90,000.

5) Refer to Instruction 10.2. CVT would be ________ by an amount equal to ________ with a forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had been correct.
A) better off; $150,000
B) better off; €150,000
C) worse off; $150,000
D) worse off; €150,000

6) Refer to Instruction 10.2. What is the cost of a call option hedge for CVT’s euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm’s cost of capital as the appropriate interest rate for calculating future values.)
A) $57,600
B) $59,904
C) $62,208
D) $63,936

7) Refer to Instruction 10.2. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question.

8) ________ are transactions for which there are, at present, no contracts or agreements between parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above

9) According to a survey by Bank of America, the type of foreign exchange risk most often hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure.

True/False

1) When attempting to manage an account payable denominated in a foreign currency, the firm’s only choice is to remain unhedged.

2) The treasury function of most firms, the group typically responsible for transaction exposure management, is NOT usually considered a profit center.

3) According to the authors, firms that employ proportional hedges increase the percentage of forward-cover as the maturity of the exposure lengthens.

4) Remaining unhedged is NOT an option when dealing with foreign exchange transaction exposure.

5) A forward hedge involves a put or call option contract and a source of funds to fulfill that contract.

6) Like a forward market hedge, a money market hedge also involves a contract and a source of funds to fulfill that contract. In this instance, the contract is a loan agreement.

7) Hedging transaction exposure with option contracts allows the firm to benefit if exchange rates are favorable but protects the firm if exchange rates turn unfavorable.

8) A firm’s risk tolerance is a combination of management’s philosophy toward transaction exposure and the specific goals of treasury activities.

9) Although rarely acknowledged by the firms themselves, selective hedging is essentially speculation.