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Incoterms 2010 and International Business - 101
Incoterms 2010 and International Business - Wild - Chapter 9 - QUIZ
Incoterms 2010 and International Business - 101
International Business: The Challenges of Globalization, 8th Edition, Wild & Wild
Incoterms 2010 and International Business - Wild - Chapter 9 - QUIZ
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International Business, 8e (Wild/Wild)
Chapter 9 International Financial Markets
1) Company debt normally takes the form of ________.
- A) bonds
- B) equity
- C) stocks
- D) bank loans
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
2) A loan in which the borrower promises to repay the borrowed amount plus a predetermined rate of interest is called a(n) ________.
- A) equity
- B) exchange rate
- C) stock
- D) debt
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
3) Which of the following is a debt instrument that specifies the timing of principal and interest payments?
- A) stock
- B) bond
- C) share
- D) equity
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
4) ________ refers to shares of ownership in a company's assets that give shareholders a claim on the company's future cash flows.
- A) Stock
- B) A bond
- C) Debt
- D) A draft
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
5) The ease with which bondholders and shareholders may convert their investments into cash is called ________.
- A) barter
- B) clearing
- C) countertrade
- D) liquidity
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
6) An expanded money supply ________.
- A) reduces the cost of borrowing
- B) increases interest rates
- C) makes it difficult for financial institutions to lend money
- D) diminishes entrepreneurial initiatives in a country
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
7) Which of the following is a major purpose of the international capital market?
- A) to reduce entrepreneurial initiatives
- B) to increase the cost of borrowing
- C) to reduce risk for lenders
- D) to reduce the money supply for borrowers
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
8) One of the major forces responsible for the rapid growth rate of the international capital market is ________.
- A) economic nationalism
- B) information technology
- C) currency control
- D) extensive regulation
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
9) The unbundling and repackaging of hard-to-trade financial assets into more liquid, negotiable, and marketable financial instruments is called ________.
- A) currency hedging
- B) commercialization
- C) currency arbitrage
- D) securitization
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
10) The international bond market consists of all bonds sold by issuing companies, governments, or other organizations ________.
- A) within their own countries
- B) outside their own countries
- C) within developing nations
- D) within developed nations
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
11) Eurobonds are popular because ________.
- A) they are less risky than traditional bonds
- B) they are always denominated in euros
- C) governments of nations in which they are sold do not regulate them
- D) European companies are considered very stable
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
12) The absence of government regulation in the Eurobond market ________.
- A) substantially reduces the cost of issuing a bond
- B) lowers the risk level of the bond
- C) makes Eurobonds less popular than foreign bonds
- D) exists because of the difficulty of regulating a multi-country market
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
13) Bonds sold outside the borrower's country and denominated in the currency of the country in which they are sold are called ________.
- A) municipal bonds
- B) foreign bonds
- C) Eurobonds
- D) domestic bonds
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
14) Foreign bonds issued in the U.S. are called ________.
- A) bulldog bonds
- B) yankee bonds
- C) samurai bonds
- D) dragon bonds
Answer: B
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
15) Liquidity refers to the ease with which bondholders and shareholders may convert their investments to cash.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
16) An excess money supply creates a borrower's market, forcing down interest rates and the cost of borrowing.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
17) Investors increase risk by holding international securities whose prices move independently.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
18) With the help of microfinance, low-income entrepreneurs can borrow money at competitive rates without having to put anything up as collateral.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
19) Increased regulation of national capital markets has been instrumental in the expansion of the international capital market.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
20) Securitization is the unbundling and repackaging of hard-to-trade financial assets into liquid financial instruments.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
21) An offshore financial center is a territory whose financial sector features very few regulations and few, if any, taxes.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
22) Booking centers are usually located on small territories with favorable tax and/or secrecy laws.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
23) Major financial activities take place in booking centers.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
24) The international bond market consists of all bonds sold by issuing companies outside their own countries.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.1: Explain the importance of the international capital market.
25) Describe the purposes of the international capital market. What factors account for its rapid growth?
Answer: The international capital market is a network of individuals, companies, financial institutions, and governments that invest and borrow across national boundaries. It consists of both formal exchanges (in which buyers and sellers meet to trade financial instruments) and electronic networks (in which trading occurs anonymously). This market makes use of unique and innovative financial instruments specially designed to fit the needs of investors and borrowers located in different countries that are doing business with one another. Large international banks play a central role in the international capital market. They gather the excess cash of investors and savers around the world and then channel this cash to borrowers across the globe.
- Expands the Money Supply for Borrowers-The international capital market is a conduit for joining borrowers and lenders in different national capital markets. A company that is unable to obtain funds from investors in its own nation can seek financing from investors elsewhere, making it possible for the company to undertake an otherwise impossible project.
- Reduces the Cost of Money for Borrowers-An expanded money supply reduces the cost of borrowing.
- Reduces Risk for Lenders-The international capital market expands the available set of lending opportunities.
Around 40 years ago, national capital markets functioned largely as independent markets. But since that time, the amount of debt, equity, and currencies traded internationally has increased dramatically. This rapid growth can be traced to three main factors:
Information Technology: Information is the lifeblood of every nation's capital market because investors need information about investment opportunities and their corresponding risk levels. Large investments in information technology over the past two decades have drastically reduced the costs, in both time and money, of communicating around the globe. Investors and borrowers can now respond in record time to events in the international capital market. The introduction of electronic trading after the daily close of formal exchanges also facilitates faster response times.
Deregulation: Deregulation of national capital markets has been instrumental in the expansion of the international capital market. The need for deregulation became apparent in the early 1970s, when heavily regulated markets in the largest countries were facing fierce competition from less regulated markets in smaller nations.
Financial Instruments: Greater competition in the financial industry is creating the need to develop innovative financial instruments.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
26) Explain the role of equity in a national capital market. What factors are responsible for the growth of the international equity market?
Answer: Equity is part ownership of a company in which the equity holder participates with other part owners in the company's financial gains and losses. Equity normally takes the form of stock–shares of ownership in a company's assets that give shareholders (stockholders) a claim on the company's future cash flows. Shareholders may be rewarded with dividends– payments made out of surplus funds–or by increases in the value of their shares. Of course, they may also suffer losses due to poor company performance–and thus decreases in the value of their shares. Dividend payments are not guaranteed but are determined by the company's board of directors and based on financial performance. In capital markets, shareholders can sell one company's stock for that of another or liquidate them–exchange them for cash. Liquidity, which is a feature of both debt and equity markets, refers to the ease with which bondholders and shareholders may convert their investments into cash.
Four factors are responsible for much of the past growth in the international equity market.
- Spread of Privatization-As many countries abandoned central planning and socialist-style economics, the pace of privatization accelerated worldwide. A single privatization often places billions of dollars of new equity on stock markets.
- Economic Growth in Emerging Markets-Continued economic growth in emerging markets is contributing to growth in the international equity market. Companies based in these economies require greater investment as they succeed and grow. The international equity market becomes a major source of funding because only a limited supply of funds is available in these nations.
- Activity of Investment Banks-Global banks facilitate the sale of a company's stock worldwide by bringing together sellers and large potential buyers. Increasingly, investment banks are searching for investors outside the national market in which a company is headquartered. In fact, this method of raising funds is becoming more common than listing a company's shares on another country's stock exchange.
- Advent of Cybermarkets-The automation of stock exchanges is encouraging growth in the international equity market. The term cybermarkets denotes stock markets that have no central geographic locations. Rather, they consist of global trading activities conducted on the Internet. Cybermarkets (consisting of supercomputers, high-speed data lines, satellite uplinks, and individual personal computers) match buyers and sellers in nanoseconds. They allow companies to list their stocks worldwide through an electronic medium in which trading takes place 24 hours a day.
AACSB: Application of knowledge
Skill: Synthesis
Difficulty: Moderate
LO: 9.1: Explain the importance of the international capital market.
27) The world's three most important financial centers are ________.
- A) Zurich, Paris, and Washington
- B) China, Brazil, and Mexico
- C) Tokyo, London, and New York
- D) Dubai, Beijing, and Germany
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
28) Which of the following represents a country or territory whose financial sector features very few regulations and few, if any, taxes?
- A) offshore financial center
- B) interbank market
- C) international financial services district
- D) Eurocurrency market
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
29) An offshore financial center is usually characterized by ________.
- A) extensive regulations
- B) economic and political instability
- C) excellent telecommunications
- D) high taxes
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
30) ________ is a prominent operational center.
- A) Dubai
- B) London
- C) Singapore
- D) Mexico
Answer: B
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
31) ________ are usually located on small island nations or territories with favorable tax and/or secrecy laws.
- A) Cybermarkets
- B) Over-the-counter markets
- C) Booking centers
- D) Operational centers
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
32) A bond issued by a Venezuelan company, denominated in U.S. dollars, and sold in Britain, France, and Germany is an example of a ________.
- A) dragon bond
- B) yankee bond
- C) Eurobond
- D) samurai bond
Answer: C
AACSB: Analytical thinking; Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
33) Which of the following factors is responsible for growth in the international equity market?
- A) advent of cybermarkets
- B) spread of countertrade
- C) centrally planned economies
- D) government partnerships
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
34) Which of the following terms refers to a stock market with no central geographic location?
- A) cybermarket
- B) foreign exchange market
- C) capital market
- D) international bond market
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
35) The market consisting of all the world's currencies that are banked outside their countries of origin is called the ________.
- A) foreign exchange market
- B) interbank market
- C) Eurocurrency market
- D) offshore financial center
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
36) British pounds of a British trading company that are deposited in a U.S. bank are called ________.
- A) Eurodollars
- B) U.S. dollars
- C) Europounds
- D) Pounds
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
37) Rates that the world's largest banks charge one another for loans are called ________.
- A) interbank interest rates
- B) London Interbank Bid Rates
- C) exchange rates
- D) official bank rates
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
38) A currency used as an intermediary to convert funds between two other currencies in the foreign exchange market is called a ________.
- A) local currency
- B) vehicle currency
- C) community currency
- D) private currency
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
39) ________ dominates the foreign exchange market.
- A) London
- B) New York
- C) Tokyo
- D) Beijing
Answer: A
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
Scenario: ABC Software
ABC Software is a producer of educational software for children below the age of twelve. The company has operations in Switzerland and would like to expand its foreign operations with a new facility in China.
40) The company's financial advisors recommend that ABC Software conduct most of its business in a vehicle currency. Which of the following is true of vehicle currencies?
- A) A vehicle currency is a contract that requires the exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate.
- B) The U.S. dollar, Australian dollar, Japanese yen, and British pound are all examples of vehicle currencies.
- C) The U.S. dollar became a vehicle currency after World War II when all of the world's major currencies were tied indirectly to the dollar because it was the most stable currency.
- D) The Chinese yuan is expected to become a vehicle currency in the near future as China's position in world trade continues to grow.
Answer: C
AACSB: Analytical thinking; Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
41) The spread of privatization encourages the growth of the international equity market.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
42) All of Europe's currencies combined are referred to as Eurocurrency.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
43) The London Interbank Bid Rate (LIBID) is the interest rate that London banks charge other large banks for borrowing Eurocurrency.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
44) The forces of supply and demand determine currency prices.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
45) The practice of insuring against potential losses that result from adverse changes in exchange rates is called currency arbitrage.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
46) Interest arbitrage is the profit-motivated purchase and sale of interest-paying securities denominated in different currencies.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market.
47) What is an offshore financial center? Differentiate between an operational center and a booking center, providing examples for each.
Answer: An offshore financial center is a country or territory whose financial sector features very few regulations and few, if any, taxes. These centers tend to be economically and politically stable and provide access to the international capital market through an excellent telecommunications infrastructure. Most governments protect their own currencies by restricting the amount of activity that domestic companies can conduct in foreign currencies. So companies can find it hard to borrow funds in foreign currencies and thus turn to offshore centers, which offer large amounts of funding in many currencies. In short, offshore centers are sources of (usually cheaper) funding for companies with multinational operations.
Offshore financial centers fall into two categories:
Operational centers see a great deal of financial activity. Prominent operational centers include London (which does a good deal of currency trading) and Switzerland (which supplies a great deal of investment capital to other nations).
Booking centers are usually located on small island nations or territories with favorable tax and/or secrecy laws. Little financial activity takes place here. Rather, funds simply pass through on their way to large operational centers. Booking centers are typically home to offshore branches of domestic banks that use them merely as bookkeeping facilities to record tax and currency-exchange information. Some important booking centers are the Cayman Islands and the Bahamas in the Caribbean; Gibraltar, Monaco, and the Channel Islands in Europe; Bahrain and Dubai in the Middle East; and Singapore in Southeast Asia.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
48) How does the international capital market reduce the cost of money for borrowers? What are the two components for every quoted exchange rate?
Answer: An expanded money supply reduces the cost of borrowing. Similar to the prices of potatoes, wheat, and other commodities, the "price" of money is determined by supply and demand. If its supply increases, its price–in the form of interest rates–falls. That is why excess supply creates a borrower's market, forcing down interest rates and the cost of borrowing. Projects regarded as infeasible because of low expected returns might be viable at a lower cost of financing.
There are two components to every quoted exchange rate: the quoted currency and the base currency. If an exchange rate quotes the number of Japanese yen needed to buy one U.S. dollar (¥/$), the yen is the quoted currency and the dollar is the base currency. When any exchange rate is designated, the quoted currency is always the numerator and the base currency is the denominator.
AACSB: Application of knowledge
Skill: Synthesis
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
49) What is the role of debt in national capital markets, and what form does company debt normally take? Describe the different types of international bonds.
Answer: Debt consists of loans, for which the borrower promises to repay the borrowed amount (the principal) plus a predetermined rate of interest. Company debt normally takes the form of bonds–instruments that specify the timing of principal and interest payments. The holder of a bond (the lender) can force the borrower into bankruptcy if the borrower fails to pay on a timely basis. Bonds issued for the purpose of funding investments are commonly issued by private-sector companies and by municipal, regional, and national governments.
One instrument used by companies to access the international bond market is called a Eurobond–a bond issued outside the country in whose currency it is denominated. In other words, a bond issued by a Venezuelan company, denominated in U.S. dollars, and sold in Britain, France, Germany, and the Netherlands (but not available in the United States or to its residents) is a Eurobond. Because this Eurobond is denominated in U.S. dollars, the Venezuelan borrower both receives the loan and makes its interest payments in dollars.
Eurobonds are popular (accounting for 75 to 80 percent of all international bonds) because the governments of countries in which they are sold do not regulate them. The absence of regulation substantially reduces the cost of issuing a bond. Unfortunately, it increases its risk level–a fact that may discourage some potential investors. The traditional markets for Eurobonds are Europe and North America.
Companies also obtain financial resources by issuing so-called foreign bonds–bonds sold outside the borrower's country and denominated in the currency of the country in which they are sold. For example, a yen-denominated bond issued by the German carmaker BMW in Japan's domestic bond market is a foreign bond. Foreign bonds account for about 20 to 25 percent of all international bonds.
Foreign bonds are subject to the same rules and regulations as the domestic bonds of the country in which they are issued. Countries typically require issuers to meet certain regulatory requirements and to disclose details about company activities, owners, and upper management. Thus BMW's samurai bonds (the name for foreign bonds issued in Japan) would need to meet the same disclosure and other regulatory requirements that Toyota's bonds in Japan must meet. Foreign bonds in the United States are called yankee bonds, and those in the United Kingdom are called bulldog bonds. Foreign bonds issued and traded in Asia outside Japan (and normally denominated in dollars) are called dragon bonds.
AACSB: Reflective thinking
Skill: Synthesis
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
50) Briefly describe any two of the three main components of the international capital market.
Answer: The international bond market consists of all bonds sold by issuing companies, governments, or other organizations outside their own countries. Issuing bonds internationally is an increasingly popular way to obtain needed funding. Typical buyers include medium-sized to large banks, pension funds, mutual funds, and governments with excess financial reserves. Large international banks typically manage the sales of new international bond issues for corporate and government clients.
The international equity market consists of all stocks bought and sold outside the issuer's home country. Companies and governments frequently sell shares in the international equity market. Buyers include other companies, banks, mutual funds, pension funds, and individual investors. The stock exchanges that list the greatest number of companies from outside their own borders are Frankfurt, London, and New York. Large international companies frequently list their stocks on several national exchanges simultaneously and sometimes offer new stock issues only outside their country's borders.
All the world's currencies that are banked outside their countries of origin are referred to as Eurocurrency and trade on the Eurocurrency market. Thus U.S. dollars deposited in a bank in Tokyo are called Eurodollars, and British pounds deposited in New York are called Europounds. Japanese yen deposited in Frankfurt are called Euroyen, and so forth.
Because the Eurocurrency market is characterized by very large transactions, only the very largest companies, banks, and governments are typically involved. Deposits originate primarily from four sources:
- Governments with excess funds generated by a prolonged trade surplus
- Commercial banks with large deposits of excess currency
- International companies with large amounts of excess cash
- Extremely wealthy individuals
Skill: Concept
Difficulty: Moderate
LO: 9.2: Describe the main components of the international capital market.
51) Foreign bonds issued and traded in Asia outside Japan and normally denominated in dollars are called ________.
- A) bulldog bonds
- B) yankee bonds
- C) samurai bonds
- D) dragon bonds
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.2: Describe the main components of the international capital market. Define the fundamental concepts of international business.
52) The market in which currencies are bought and sold and their prices determined is called the ________.
- A) Eurocurrency market
- B) international capital market
- C) international bond market
- D) foreign exchange market
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.3: Outline the functions of the foreign exchange market.
53) The ________ is the currency that dominates the foreign exchange market.
- A) Japanese yen
- B) British pound
- C) U.S. dollar
- D) Australian dollar
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.3: Outline the functions of the foreign exchange market.
54) The world's largest banks exchange currencies at spot and forward rates in the ________.
- A) International Finance Corporation
- B) Eurocurrency market
- C) interbank market
- D) World Bank
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.3: Outline the functions of the foreign exchange market.
55) Banks in the interbank market ________.
- A) provide long-term loans to small-sized and medium-sized companies
- B) provide long-term loans to large companies
- C) offer advice on trading strategies
- D) exchange currencies exclusively at spot rates
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.3: Outline the functions of the foreign exchange market.
56) In the interbank market, the process of aggregating the currencies that one bank owes another and then carrying out that transaction is called ________.
- A) swapping
- B) dumping
- C) hedging
- D) clearing
Answer: D
Skill: Concept
Difficulty: Easy
LO: 9.3: Outline the functions of the foreign exchange market.
57) What is the foreign exchange market? Explain why investors use this market.
Answer: Unlike domestic transactions, international transactions involve the currencies of two or more nations. To exchange one currency for another in international transactions, companies rely on a mechanism called the foreign exchange market–a market in which currencies are bought and sold and their prices are determined. Financial institutions convert one currency into another at specific exchange rate–the rate at which one currency is exchanged for another. Rates depend on the size of the transaction, the trader conducting it, general economic conditions, and sometimes government mandate.
The foreign exchange market is not really a source of corporate finance. Rather, it facilitates corporate financial activities and international transactions. Investors use the foreign exchange market for four main reasons.
Currency Conversion-Companies use the foreign exchange market to convert one currency into another.
Currency Hedging-The practice of insuring against potential losses that result from adverse changes in exchange rates is called currency hedging. International companies commonly use hedging for one of two purposes:
- To lessen the risk associated with international transfers of funds.
- To protect themselves in credit transactions in which there is a time lag between billing and receipt of payment.
Currency Arbitrage-It is the instantaneous purchase and sale of a currency in different markets for profit.
Currency Speculation-It is the purchase or sale of a currency with the expectation that its value will change and generate a profit. The shift in value might be expected to occur suddenly or over a longer period. The foreign exchange trader may bet that a currency's price will go either up or down in the future.
Skill: Concept
Difficulty: Moderate
LO: 9.3: Outline the functions of the foreign exchange market.
58) A(n) ________ is a system that allocates financial resources in the form of debt and equity according to their most efficient uses.
- A) international equity market
- B) forward market
- C) capital market
- D) eurocurrency market
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
59) ________ refers to the most commonly quoted interest rate that London banks charge other large banks that borrow Eurocurrency.
- A) London Interbank Offer Rate (LIBOR)
- B) London Interbank Bid Rate (LIBID)
- C) Spot rate
- D) Cross rate
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
60) The rate at which one currency is interchanged for another is called the ________.
- A) exchange rate
- B) interbank interest rate
- C) official cash rate
- D) prime rate
Answer: A
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
61) The bid-ask spread in the foreign exchange market is the ________.
- A) price at which a bank will buy a currency
- B) price of currency in the foreign exchange market
- C) difference between the bid and ask quotes for a currency
- D) the time lapsed between a bid quote and an ask quote
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
62) Investors use the foreign exchange market for ________.
- A) stock dilution
- B) currency speculation
- C) market capitalization
- D) mean reversion
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
63) The practice of insuring against potential losses that result from adverse changes in exchange rates is called currency ________.
- A) hedging
- B) arbitrage
- C) speculation
- D) conversion
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
64) ________ is the instantaneous purchase and sale of a currency in different markets for profit.
- A) Currency hedging
- B) Currency arbitrage
- C) Currency speculation
- D) Currency conversion
Answer: B
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
65) The profit-motivated purchase and sale of interest-paying securities denominated in different currencies is called ________.
- A) currency conversion
- B) currency hedging
- C) interest arbitrage
- D) interbank interest rates
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
66) The purchase or sale of a currency with the expectation that its value will change and generate a profit is called ________.
- A) currency hedging
- B) currency arbitrage
- C) currency speculation
- D) currency conversion
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
67) In a quoted exchange rate of $1.69/British pound, the British pound is called the ________.
- A) base currency
- B) counter currency
- C) cross currency
- D) quoted currency
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
68) An exchange rate of ¥117.87/$ indicates ________.
- A) that 117.87 yen buys one dollar
- B) that 117.87 dollars buys one yen
- C) a direct quote on the dollar
- D) an indirect quote on the yen
Answer: A
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
69) While designating an exchange rate, the numerator indicates the ________.
- A) base currency
- B) transaction currency
- C) quoted currency
- D) cross currency
Answer: C
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
70) While designating an exchange rate, the ________ is always the denominator.
- A) counter currency
- B) base currency
- C) cross currency
- D) quoted currency
Answer: B
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
71) The exchange rate between the euro (€) and the dollar is €0.8461/$. Which of the following is the correct direct quote on the dollar?
- A) $2.20/€
- B) $1.1819/€
- C) $5.50/€
- D) $0.8461/€
Answer: B
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.4: Explain the different types of currency quotes and exchange rates.
72) An exchange rate calculated using two other exchange rates is called a(n) ________.
- A) interest arbitrage
- B) forward contract
- C) forward rate
- D) cross rate
Answer: D
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
73) Which of the following is an exchange rate that requires delivery of the traded currency within two business days?
- A) forward rate
- B) spot rate
- C) cross rate
- D) prime rate
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
74) The exchange rate at which a bank will purchase a currency is called a ________ rate.
- A) prime
- B) buy
- C) ask
- D) forward
Answer: B
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
75) The exchange rate at which two parties agree to exchange currencies on a specified future date is called a ________ rate.
- A) forward
- B) prime
- C) spot
- D) cross
Answer: A
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
76) ________ is the simultaneous purchase and sale of foreign exchange for two different dates.
- A) Currency hedging
- B) Currency speculation
- C) Currency swap
- D) Currency arbitrage
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
77) A(n) ________ is a right to exchange a specific amount of a currency on a specific date at a specific rate.
- A) forward contract
- B) currency option
- C) currency hedging
- D) interest arbitrage
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
Scenario: Sally goes to Japan
Sally Johnson has identified a market for her company's products in Japan. She is excited about expanding her company, but knows that she needs to learn how the foreign exchange market works before she can successfully sell her products abroad.
78) If Sally sees a quote of ¥117.87/$, she should know that ________.
- A) the yen is the base currency here
- B) this is a direct quote on the dollar
- C) this is a direct quote on the yen
- D) the quote is in U.S. dollars
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.4: Explain the different types of currency quotes and exchange rates.
79) Which of the following is true about a quote of ¥117.87/$?
- A) It is equal to $.008484/¥.
- B) The quote is in U.S. dollars.
- C) This is an indirect quote on the yen.
- D) It costs a little more than a dollar to buy one yen.
Answer: A
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.4: Explain the different types of currency quotes and exchange rates.
Scenario: ABC Software
ABC Software is a producer of educational software for children below the age of twelve. The company has operations in Switzerland and would like to expand its foreign operations with a new facility in China.
80) If ABC Software simultaneously purchases and sells foreign exchange for two different dates, the company is said to be involved in ________.
- A) increasing its foreign exchange rate risk
- B) conducting a currency swap
- C) entering an arbitrage situation
- D) buying and selling at the spot rate
Answer: B
AACSB: Analytical thinking
Skill: Application
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
81) If ABC Software holds a currency option to purchase Swiss francs at SF 1.67/$ in 30 days, at the end of which the exchange rate is SF1.70/$, then ABC Software ________.
- A) is required to follow through on a currency exchange
- B) has succeeded in hedging against exchange rate risk
- C) would exercise its currency option
- D) would not exercise its currency option
Answer: D
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.4: Explain the different types of currency quotes and exchange rates.
82) Currency speculation is the purchase or sale of a currency with the expectation that its value will remain constant.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
83) In any exchange rate, the quoted currency is always the numerator.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
84) Exchange rate risk is the risk of adverse changes in exchange rates.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
85) International transactions between two currencies other than the U.S. dollar often use the dollar as a vehicle currency.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
86) An exchange rate requiring delivery of the traded currency within two business days is called a cross rate.
Answer: FALSE
AACSB: Diverse and multicultural work environments
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
87) If an individual is traveling to another country and wants to exchange currencies at his bank before departing, he will be quoted the spot rate since he is exchanging on the spot.
Answer: FALSE
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.4: Explain the different types of currency quotes and exchange rates.
88) Forward rates represent the expectations of currency traders and bankers regarding a currency's future spot rate.
Answer: TRUE
Skill: Concept
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
89) The process of aggregating the currencies that one bank owes another and then carrying out the transaction is called clearing.
Answer: TRUE
Skill: Concept
Difficulty: Easy
LO: 9.4: Explain the different types of currency quotes and exchange rates.
90) Identify and explain the types of currency instruments used in the forward market.
Answer: When a company knows that it will need a certain amount of foreign currency on a certain future date, it can exchange currencies using a forward rate–an exchange rate at which two parties agree to exchange currencies on a specified future date. Forward rates represent the expectations of currency traders and bankers regarding a currency's future spot rate. Reflected in these expectations are a country's present and future economic conditions (including inflation rate, national debt, taxes, trade balance, and economic growth rate) as well as its social and political situation. The forward market is the market for currency transactions at forward rates.
To insure themselves against unfavorable exchange-rate changes, companies commonly turn to the forward market. It can be used for all types of transactions that require future payment in other currencies, including credit sales or purchases, interest receipts or payments on investments or loans, and dividend payments to stockholders in other countries. But not all nations' currencies trade in the forward market, such as countries experiencing high inflation or currencies not in demand on international financial markets.
A forward contract is a contract that requires the exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate. Forward contracts are commonly signed for 30, 90, and 180 days into the future, but customized contracts (say, for 76 days) are possible. Forward contracts belong to a family of financial instruments called derivatives–instruments whose values derive from other commodities or financial instruments. These include not only forward contracts but also currency swaps, options, and futures.
A currency swap is the simultaneous purchase and sale of foreign exchange for two different dates. Currency swaps are an increasingly important component of the foreign exchange market.
Recall that a forward contract requires exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate. In contrast, a currency option is a right, or option, to exchange a specific amount of a currency on a specific date at a specific rate. In other words, whereas forward contracts require parties to follow through on currency exchanges, currency options do not.
Similar to a currency forward contract is a currency futures contract–a contract requiring the exchange of a specific amount of currency on a specific date at a specific exchange rate, with all conditions fixed and not adjustable.
Skill: Concept
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
91) Explain the concept of cross rates. Include the description of a vehicle currency and the role it plays in the foreign exchange market.
Answer: International transactions between two currencies other than the U.S. dollar often use the dollar as a vehicle currency. For example, a retail buyer of merchandise in the Netherlands might convert its euros to U.S. dollars and then pay its Japanese supplier in U.S. dollars. The Japanese supplier may then take those U.S. dollars and convert them to Japanese yen. This process was more common years ago, when fewer currencies were freely convertible and when the United States greatly dominated world trade. Today, a Japanese supplier may want payment in euros. In this case, both the Japanese and the Dutch companies need to know the exchange rate between their respective currencies. To find this rate using their respective exchange rates with the U.S. dollar, the cross rate is calculated which refers to the exchange rate calculated using two other exchange rates.
Cross rates between two currencies can be calculated using both currencies' indirect or direct exchange rates with a third currency.
Although the United Kingdom is the major location of foreign exchange trading, the U.S. dollar is the currency that dominates the foreign exchange market. Because the U.S. dollar is so widely used in world trade, it is considered a vehicle currency–a currency used as an intermediary to convert funds between two other currencies. The currencies most often involved in currency transactions are the U.S. dollar, European Union euro, Japanese yen, and British pound.
One reason the U.S. dollar is a vehicle currency is because the United States is the world's largest trading nation. The United States is so heavily involved in international trade that many companies and banks maintain dollar deposits, making it easy to exchange other currencies with dollars. Another reason is that, following the Second World War, all of the world's major currencies were tied indirectly to the dollar because it was the most stable currency. In turn, the dollar's value was tied to a specific value of gold–a policy that held wild currency swings in check. Although world currencies are no longer linked to the value of gold (see Chapter 10), the stability of the dollar, along with its resistance to inflation, helps people and organizations maintain their purchasing power better than their own national currencies. Even today, people in many countries convert extra cash from national currencies into dollars.
AACSB: Reflective thinking
Skill: Synthesis
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
92) Explain the function of spot rates and the spot market.
Answer: Spot rates are exchange rates that require delivery of the traded currency within two business days. Exchange of the two currencies is said to occur "on the spot," and the spot market is the market for currency transactions at spot rates.
The spot market assists companies in performing any one of three functions:
- Converting income generated from sales abroad into their home-country currency
- Converting funds into the currency of an international supplier
- Converting funds into the currency of a country in which they wish to invest
The spot rate is available only for trades worth millions of dollars. That is why it is available only to banks and foreign exchange brokers. If an individual is traveling to another country and wants to exchange currencies at his bank before departing, he will not be quoted the spot rate. Rather, banks and other institutions will give him a buy rate (the exchange rate at which the bank will buy a currency) and an ask rate (the rate at which it will sell a currency). In other words, he will receive bid and ask quotes. These rates reflect the amounts that large currency traders are charging, plus a markup.
Skill: Concept
Difficulty: Moderate
LO: 9.4: Explain the different types of currency quotes and exchange rates.
93) ________ in the foreign exchange market specialize in currency futures and options transactions.
- A) Securities exchanges
- B) Eurocurrency markets
- C) Interbank markets
- D) Over-the-counter markets
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
94) ________ is a decentralized exchange encompassing a global computer network of foreign exchange traders and other market participants.
- A) Securities exchanges
- B) Eurocurrency market
- C) Interbank market
- D) Over-the-counter market
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
95) ________ is traded freely in the foreign exchange market, with its price determined by the forces of demand and supply.
- A) Representative money
- B) Private currency
- C) Hard currency
- D) Fiat money
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
96) Governments impose currency restrictions in their countries to ________.
- A) encourage future investment outflows
- B) indirectly reduce imports and exports
- C) protect currencies from speculators
- D) exhaust their reserve of hard currencies
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
97) Which of the following is used by governments for the convertibility of currencies in their countries?
- A) multiple exchange rates
- B) countertrade
- C) import deposit requirements
- D) OTC market
Answer: D
Skill: Concept
Difficulty: Easy
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
Scenario: Trader's Paradise
Trader's Paradise is a global merchant that sells a variety of products. The company operates in forty-eight different countries (some developed, some developing) and some former communist countries. The company faces substantial risks given the differing conditions in foreign exchange markets.
98) To insure against potential losses that result from adverse changes in exchange rates, Trader's Paradise should use currency ________.
- A) swap
- B) speculation
- C) hedging
- D) arbitrage
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
99) If Trader's Paradise purchases and sells the euros simultaneously in different markets for profit, it would be engaging in currency ________.
- A) swap
- B) speculation
- C) hedging
- D) arbitrage
Answer: D
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
100) If Trader's Paradise purchases euros expecting the value to rise and generate a profit for the company, it is engaging in currency ________.
- A) swap
- B) speculation
- C) hedging
- D) arbitrage
Answer: B
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
101) When doing business with former communist countries, Trader's Paradise insists on getting paid in a currency that can be traded freely in the foreign exchange market. The price of this currency is determined by the forces of supply and demand. Which of the following is the mode of payment illustrated in this scenario?
- A) community currency
- B) private currency
- C) local currency
- D) convertible currency
Answer: D
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
Scenario: ABC Software
ABC Software is a producer of educational software for children below the age of twelve. The company has operations in Switzerland and would like to expand its foreign operations with a new facility in China.
102) ABC Software has had difficulty obtaining funds to expand. A friend of the CEO recommends that the company should explore an offshore financial center, which ________.
- A) is a country or territory whose financial sector features very few regulations and few, if any, taxes
- B) tends to be characterized by political and economic instability making, it is an inexpensive but risky source of funds
- C) typically lends money to companies that have had difficulty getting financing elsewhere because of poor credit records
- D) is a financial center located in a resort community and is characterized by poor telecommunications infrastructure
Answer: A
AACSB: Analytical thinking
Skill: Application
Difficulty: Moderate
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
103) All foreign exchange transactions can be performed in the over-the-counter (OTC) market.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
104) A convertible currency is traded freely in the foreign exchange market with its price determined by London banks.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
105) One goal of currency restriction is to preserve hard currencies to pay for imports and to finance trade deficits.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
106) Differentiate between currency speculation and currency arbitrage.
Answer: Currency speculation is the purchase or sale of a currency with the expectation that its value will change and generate a profit. The shift in value might be expected to occur suddenly or over a longer period. The foreign exchange trader may bet that a currency's price will go either up or down in the future. Suppose a trader in London believes that the value of the Japanese yen will increase over the next three months. She buys yen with pounds at today's current price, intending to sell them in 90 days. If the price of yen rises in that time, she earns a profit; if it falls, she takes a loss. Speculation is much riskier than arbitrage because the value, or price, of currencies is quite volatile and is affected by many factors. Similar to arbitrage, currency speculation is commonly the realm of foreign exchange specialists rather than the managers of firms engaged in other endeavors.
Currency arbitrage is the instantaneous purchase and sale of a currency in different markets for profit. Suppose a currency trader in New York notices that the value of the European Union euro is lower in Tokyo than it is in New York. The trader can buy euros in Tokyo, sell them in New York, and earn a profit on the difference. High-tech communication and trading systems allow the entire transaction to occur within seconds. But note that, if the difference between the value of the euro in Tokyo and the value of the euro in New York is not greater than the cost of conducting the transaction, the trade is not worth making.
Currency arbitrage is a common activity among experienced traders of foreign exchange, very large investors, and companies in the arbitrage business. Firms whose profits are generated primarily by another economic activity, such as retailing or manufacturing, take part in currency arbitrage only if they have very large sums of cash on hand.
Skill: Concept
Difficulty: Moderate
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
107) Briefly describe the three main institutions of the foreign exchange market.
Answer: The three main components of the foreign exchange market are the interbank market, securities exchanges, and the over-the-counter market.
It is in the interbank market that the world's largest banks exchange currencies at spot and forward rates. Companies tend to obtain foreign exchange services from the bank where they do most of their business. Banks satisfy client requests for exchange quotes by obtaining quotes from other banks in the interbank market. For transactions that involve commonly exchanged currencies, the largest banks often have sufficient currency on hand. Yet rarely exchanged currencies are not typically kept on hand and may not even be easily obtainable from another bank. In such cases, banks turn to foreign exchange brokers, who maintain vast networks of banks through which they obtain seldom-traded currencies.
In the interbank market, then, banks act as agents for client companies. In addition to locating and exchanging currencies, banks commonly offer advice on trading strategy, supply a variety of currency instruments, and provide other risk-management services. They also help clients manage exchange rate risk by supplying information on rules and regulations around the world.
Securities exchanges specialize in currency futures and options transactions. Buying and selling currencies on these exchanges entails the use of securities brokers, who facilitate transactions by transmitting and executing clients' orders. Transactions on securities exchanges are much smaller than those in the interbank market and vary with each currency.
The over-the-counter (OTC) market is a decentralized exchange encompassing a global computer network of foreign exchange traders and other market participants. All foreign exchange transactions can be performed in the OTC market, where the major players are large financial institutions.
Skill: Concept
Difficulty: Easy
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
108) What is currency speculation? Why do some governments protect their markets from currency speculation?
Answer: Currency speculation is the purchase or sale of a currency with the expectation that its value will change and generate a profit. The shift in value might be expected to occur suddenly or over a longer period. The foreign exchange trader may bet that a currency's price will go either up or down in the future. Suppose a trader in London believes that the value of the Japanese yen will increase over the next three months. She buys yen with pounds at today's current price, intending to sell them in 90 days. If the price of yen rises in that time, she earns a profit; if it falls, she takes a loss. Speculation is much riskier than arbitrage because the value, or price, of currencies is quite volatile and is affected by many factors. Similar to arbitrage, currency speculation is commonly the realm of foreign exchange specialists rather than the managers of firms engaged in other endeavors.
One goal of currency restriction is to protect a currency from speculators. For example, in the wake of the Asian financial crisis years ago, some Southeast Asian nations considered controlling their currencies to limit the damage done by economic downturns. Malaysia stemmed the outflow of foreign money by preventing local investors from converting their Malaysian holdings into other currencies. Although the move also curtailed currency speculation, it effectively cut off Malaysia from investors elsewhere in the world.
AACSB: Reflective thinking
Skill: Synthesis
Difficulty: Hard
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
109) Why do governments impose currency restrictions and how can companies get around such restrictions?
Answer: Certain government policies are frequently used to restrict currency convertibility. Governments can require that all foreign exchange transactions be performed at or approved by the country's central bank. They can also require import licenses for some or all import transactions. These licenses help the government control the amount of foreign currency leaving the country. Some governments implement systems of multiple exchange rates, specifying a higher exchange rate on the importation of certain goods or on imports from certain countries. The government can thus reduce importation while ensuring that important goods still enter the country. It also can use such a policy to target the goods of countries with which it is running a trade deficit.
Other governments issue import deposit requirements that require businesses to deposit certain percentages of their foreign exchange funds in special accounts before being granted import licenses. In addition, quantity restrictions limit the amount of foreign currency that residents can take out of the home country when traveling to other countries as tourists, students, or medical patients.
Finally, one way to get around national restrictions on currency convertibility is countertrade–the practice of selling goods or services that are paid for, in whole or in part, with other goods or services. One simple form of countertrade is a barter transaction, in which goods are exchanged for others of equal value. Parties exchange goods and then sell them in world markets for hard currency.
Skill: Concept
Difficulty: Moderate
LO: 9.5: Describe the instruments and institutions of the foreign exchange market.
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