If Assignment

Amity CampusUttar PradeshIndia 201303

ASSIGNMENTSPROGRAM: BFIA

SEMESTER-II

Subject Name: ITERNATIONAL FINANCEStudy COUNTRY: SOMALIARoll Number (Reg. No.):

BFIA01512010-2013019

Student Name: MOHAMED ABDULLAHI KHALAF

INSTRUCTIONS

a) Students are required to submit all three assignment sets.ASSIGNMENT DETAILS MARKSAssignment A Five Subjective Questions 10Assignment B Three Subjective Questions + Case

Study10

Assignment C Objective or one line Questions 10b) Total weight-age given to these assignments is 30%. OR 30 Marksc) All assignments are to be completed as typed in word/pdf.d) All questions are required to be attempted.e) All the three assignments are to be completed by due dates and need to be submitted for evaluation by Amity University.f) The students have to attach a scanned signature in the form.

Signature : _________________________

Date: 01 April, 2013

( √ ) Tick mark in front of the assignments submitted

Assignment A’ Ö Assignment ‘B’ Ö Assignment ‘C’ Ö

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INTERNATIONAL FINANCE

ASSIGNMENT A

Q: 1). What are implications of integration of global financial markets? Explain.

Answer:

The implications of integration of global financial markets are in two folds: its benefits or positive impacts and its costs. This can be viewed either from the point of view of individual investors (such as, for instance, the opportunity for international risk diversification, as indicated earlier) or from the point of view of the countries initiating the process of integration.

a. Potential Benefits

Analytical arguments supporting financial openness (or, equivalently, an open capital account) revolve around four main considerations: the benefits of international risk sharing for consumption smoothing; the positive impact of capital flows on domestic investment and growth; enhanced macroeconomic discipline; and increased efficiency, as well as greater stability, of the domestic financial system associated with foreign bank penetration.

(i) Consumption smoothing

Access to world capital markets may allow a country to engage in risk sharing and consumption smoothing, by allowing the country to borrow in ‘bad’ times (say, during a recession or a sharp deterioration in the country’s terms of trade) and lend in ‘good’ times (say, in an expansion or following an improvement in the country’s terms of trade). By enabling domestic households to smooth their consumption path over time, capital flows can therefore increase welfare. This ‘counter-cyclical’ role of world capital markets is particularly important if shocks are temporary in nature.

(ii) Domestic investment and growth

The ability to draw upon the international pool of resources that financial openness gives access to may also affect domestic investment and growth. In many developing countries, the capacity to save is constrained by a low level of income. As long as the marginal return from investment is at least equal to the cost of (borrowed) capital, net foreign resource inflows can supplement domestic saving, increase levels of physical capital per worker, and help the recipient country raise its rate of economic growth and improve

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living standards. These potential benefits can be particularly large for some types of capital inflows, most notably foreign direct investment (FDI).

(iii) Enhanced macroeconomic discipline

It has also been argued that by increasing the rewards of good policies and the penalties for bad policies, the free flow of capital across borders may induce countries to follow more disciplined macroeconomic policies and thus reduce the frequency of policy mistakes. To the extent that greater policy discipline translates into greater macroeconomic stability, it may also lead to higher rates of economic growth, as emphasized in the recent literature on endogenous growth. A related argument is that external financial liberalization can act as a ‘signal’ that a country is willing (or ready to) adopt ‘sound’ macroeconomic policies, for instance by reducing budget deficits and forgoing the use of the inflation tax. From that perspective, an open capital account may also encourage macroeconomic and financial stability, ensuring a more efficient allocation of resources and higher rates of economic growth.

(iv) Increased banking system efficiency and financial stability

An increasingly common argument in favour of financial openness is that it may increase the depth and breadth of domestic financial markets and lead to an increase in the degree of efficiency of the financial intermediation process, by lowering costs and ‘excessive’ profits associated with monopolistic or cartelized markets. In turn, improved efficiency may lead to lower markup rates in banking, a lower cost of investment and higher growth rates.

b. Potential Costs

The experience of the past two decades has led economists and policymakers to recognise that, in addition to the potential benefits just discussed, open financial markets may also generate significant costs. These costs include a high degree of concentration of capital flows and lack of access to financing for small countries, either permanently or when they need it most; an inadequate domestic allocation of these flows, which may hamper their growth effects and exacerbate preexisting domestic distortions; the loss of macroeconomic stability; pro-cyclical movements in short-term capital flows; a high degree of volatility of capital flows, which relates in part to herding and contagion effects; and risks associated with foreign bank penetration.

(i) Concentration of capital flows and lack of access

There is ample historical evidence to suggest that periods of ‘surge’ in cross border capital flows tend to be highly concentrated to a small number of

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recipient countries. The dramatic increase in capital inflows in the early 1990s, for instance, was directed to only a small number of large, middle-income countries of Latin America and Asia. The share of total private capital flows going to low-income countries actually fell during the 1990s (from levels that were already quite low), whereas the share going to the top ten recipients increased significantly. Little foreign capital is directed at sub-Saharan African countries, and most of what flows to the region is limited to a few countries (such as Angola, Nigeria and South Africa) with significant natural resources. Thus, a number of developing countries (particularly the small ones) may simply be ‘rationed out’ of world capital markets – regardless of how open their capital account is.

(ii) Domestic misallocation of capital flows

Although the inflows of capital associated with an open capital account may raise domestic investment, their impact on long-run growth may be limited (if not negligible) if such inflows are used to finance speculative or low-quality domestic investments – such as investments in the real estate sector. Low-productivity investments in the non-tradable sector may reduce over time the economy’s capacity to export and lead to growing external imbalances.

The misallocation of capital inflows may in part be the result of pre-existing distortions in the domestic financial system. In countries with weak banks (that is, banks with low or negative net worth and a low ratio of capital to risk-adjusted assets) and poor supervision of the financial system, the direct or indirect intermediation of large amounts of funds by the banking system may exacerbate the moral hazard problems associated with (explicit or implicit) deposit insurance.

(iii) Loss of macroeconomic stability

The large capital inflows induced by financial openness can have undesirable macroeconomic effects, including rapid monetary expansion (due to the difficulty and cost of pursuing sterilisation policies), inflationary pressures (resulting from the effect of capital inflows on domestic spending), real exchange rate appreciation and widening current account deficits. Under a flexible exchange rate, growing external deficits tend to bring about a currency depreciation, which may eventually lead to a realignment of relative prices and induce self-correcting movements in trade flows. By contrast, under a fixed exchange rate regime, losses in competitiveness and growing external imbalances can erode confidence in the viability and sustainability of the peg, thereby precipitating a currency crisis and increasing financial instability.

(iv) Pro-cyclicality of short-term flows

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As noted earlier, small developing economies are often rationed out of world capital markets. Moreover, among those countries with a greater potential to access these markets (such as oil producers), the availability of resources may be asymmetric. These countries may indeed be able to borrow only in ‘good’ times, whereas in ‘bad’ times they tend to face credit constraints. Access may thus be pro-cyclical. Clearly, in such conditions, one of the alleged benefits of accessing world capital markets, the ability to borrow to smooth consumption in the face of temporary adverse shocks, is simply a fiction. Pro-cyclicality may, in fact, have a perverse effect and increase macroeconomic instability: favourable shocks may attract large capital inflows and encourage consumption and spending at levels that are unsustainable in the longer term, forcing countries to over-adjust when an adverse shock hits.

(v) Herding, contagion and volatility of capital flows

A high degree of financial openness may be conducive to a high degree of volatility in capital movements, a specific manifestation of which being large reversals in short-term flows associated with speculative pressures on the domestic currency. The possibility of large reversals of short-term capital flows raises the risk that borrowers may face costly ‘liquidity runs’, as discussed for instance by Chang and Velasco (2000). The higher the level of short-term debt is relative to the borrowing country’s international reserves, the greater the risk of such runs will be. High levels of short-term liabilities intermediated by the financial system also create risks of bank runs and systemic financial crises.

(vi) Risk of entry by foreign banks

Although foreign bank penetration can yield several types of benefits (as discussed earlier), it also has some potential drawbacks as well. First, foreign banks may ration credit to small firms (which tend to operate in the non-tradable sector) to a larger extent than domestic banks, and concentrate instead on larger and stronger ones (which are often involved in the production of tradable).

If foreign banks do indeed follow a strategy of concentrating their lending operations only to the most creditworthy corporate (and, to a lesser extent, household) borrowers, their presence will be less likely to contribute to an overall increase in efficiency in the financial sector. More importantly, by leading to a higher degree of credit rationing to small firms, they may have an adverse effect on output, employment and income distribution.

Second, entry of foreign banks, which tend to have lower operational costs, can create pressures on local banks to merge in order to remain competitive. The process of concentration (which could also arise as foreign banks acquire

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local banks) could create banks that are ‘too big to fail’ or ‘too political to fail’ – as monetary authorities may fear that the failure of a single large bank could seriously disrupt financial markets and lead to social disruptions. Although these potential problems could be mitigated through enhanced prudential supervision or an outright ban on mergers that are perceived to increase systemic risks sharply, they may lead to an undesirable extension of the scope and cost of the official safety net. A too-big-to-fail problem may, in turn, increase moral hazard problems: knowing the existence of an (implicit) safety net, domestic banks.

Q: 2). Explain

a) Interest rate parity b) Reasons for introduction of Bretton woods system

Answer:

a) Interest rate parity

Interest rate parity is one of the most important theories in international finance because it is probably the best way to explain how exchange rate values are determined and why they fluctuate as they do. Most of the international currency exchanges occur for investment purposes, and therefore understanding the prime motivations for international investment is critical.

Interest rate parity (IRP) is a theory used to explain the value and movements of exchange rates. It is also known as the asset approach to exchange rate determination.

The interest rate parity theory assumes that the actions of international investors—motivated by cross-country differences in rates of return on comparable assets—induce changes in the spot exchange rate. In another vein, IRP suggests that transactions on a country’s financial account affect the value of the exchange rate on the foreign exchange (Forex) market. This contrasts with the purchasing power parity theory, which assumes that the actions of importers and exporters, whose transactions are recorded on the current account, induce changes in the exchange rate.

According to interest rate parity theory, the currency of the country with a lower interest rate should be at a forward premium in terms of the currency of the country with the higher rate. More specifically, in an efficient market with no transaction costs, the interest differential should be approximately equal to the forward differential. When this condition is met, the forward rate is said to be at interest parity, and equilibrium prevails in the money markets.

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Interest parity ensures that the return on a hedged (or covered) foreign investment will adjust equal the domestic interest rate on investments of identical risk, thereby eliminating the possibility of having a money machine.

When this condition holds, the covered interest differential- the difference between the domestic interest rate and the hedged foreign rate is zero. If the covered interest differential between two money markets is nonzero, there is an arbitrage incentive to move money from one market to the other.

According to interest rate parity the difference between the (risk free) interest rates paid on two currencies should be equal to the differences between the spot and forward rates.

F-S = ih - if

In fact, the forward discount or premium is closely related to the interest differential between the two currencies.

b) Reasons for introduction of Bretton woods system

The Bretton Woods was established at Bretton Woods, New Hampshire in 1944 where 44 nations met.

There are several reasons why the Bretton Woods system came into being. Firstly, it was meant to overcome the short comings of the gold standard regime. For example, the supply of gold coins was limited so much so that the growth of world trade and investment was negatively impacted. Further there was no obligation to the part of any nation to adhere to the rules of the gold standard.

Secondly, during the interwar period, 1915 – 1944, countries used predatory depreciations of their currencies as a means of gaining advantage on the export market. The result was the wild fluctuations of monetary exchange rates. There was also a noticeable reluctance by many countries to return to the gold standard let alone to adhere to obligations attached thereto.

Thus, the Bretton Woods was established to the effect that the US Dollar was pegged at $35 per ounce of gold and other currencies were pegged to the US Dollar.

According to financial dictionary, a currency swap is an agreement between two parties to exchange two currencies at a certain exchange rate at a certain time in future. For example if a company knows that it will need British Pounds I the future and another company knows that it will need US dollars , they agree to swap the two at agreed upon exchange rates. This

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eliminates the risk that the exchange rate will change in a way that is disadvantageous to either party.

Q: 3). What are Currency Swaps? Explain

Answer:

Currency Swaps are swaps that involve the exchange of principal and interest in one currency for the same in another currency. It is considered to be a foreign exchange transaction and is not required by law to be shown on a company's balance sheet.

Swaps are nothing but an exchange of two payment streams. Swaps can be arranged either directly between two parties or through a third party like a bank or a financial institution. Swap market has been developing at a fast pace in the last two decades, A currency swap enables the substitution of one debt denominated in one currency at a fixed or floating rate to a debt denominated in another currency at a fixed or floating rate. It enables both parties to draw benefit from the differences of interest rates existing on segmented markets. Thus, currency swaps can be fixed-to-fixed type as well as fixed-to-floating type.

A currency swap is a foreign-exchange agreement between two institutes to exchange aspects (principal and/or interest payments) of a loan in one currency for equivalent aspects of an equal in net present value loan in another currency. Currency swaps are motivated by comparative advantage. A currency swap should be distinguished from a central bank liquidity swap.

Currency swaps are over-the-counter derivatives, and are closely related to interest rate swaps. However, unlike interest rate swaps, currency swaps can involve the exchange of the principal.

There are three different ways in which currency swaps can exchange loans:

1) The simplest currency swap structure is to exchange only the principal with the counterparty at a specified point in the future at a rate agreed now. Such an agreement performs a function equivalent to a forward contract or futures. The cost of finding a counterparty (either directly or through an intermediary), and drawing up an agreement with them, makes swaps more expensive than alternative derivatives (and thus rarely used) as a method to fix shorter term forward exchange rates. However for the longer term future, commonly up to 10 years, where spreads are wider for alternative derivatives, principal-only currency swaps are often used as a cost-effective way to fix forward rates. This type of currency swap is also known as an FX-swap.

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http://en.wikipedia.org/wiki/Derivative_(finance)

2) Another currency swap structure is to combine the exchange of loan principal, as above, with an interest rate swap. In such a swap, interest cash flows are not netted before they are paid to the counterparty (as they would be in a vanilla interest rate swap) because they are denominated in different currencies. As each party effectively borrows on the other's behalf, this type of swap is also known as a back-to-back loan.

3) Last here, but certainly not least important, is to swap only interest payment cash flows on loans of the same size and term. Again, as this is a currency swap, the exchanged cash flows are in different denominations and so are not netted. An example of such a swap is the exchange of fixed-rate US dollar interest payments for floating-rate interest payments in Euro. This type of swap is also known as a cross-currency interest rate swap, or cross currency swap.

Q: 4). Discuss the various kinds of risks involved in foreign exchange markets. And how can we hedge them?

Answer:

When dealing in foreign exchange markets, individuals and firms face an assortment of risks. Currency risks and country risks come into play for firms dealing in international finance generally and more specifically due to what are termed transaction exposures as well as translation or accounting exposures.

Currency risks refers to possibility that the home currency or indeed the foreign currency will appreciate or depreciate leading to a loss on the part of the firm dealing in the foreign exchange markets. For example, if a firm has an account receivable of £1,000,000 at a time when the exchange rate to the Malawi Kwacha is £/MK = 1/230, the firm will receive MK250, 000,000 thereby losing MK20, 000,000. This scenario can be due to transaction exposure. It is similarly applicable to accounts payable maturing financial assets as well as liabilities.

Country risks involve the political situation and monetary policies of the country whose currency a firm deals with. For example Malawi has a limit on the amount of foreign exchange an individual or a company can externalize with a specified period of time. This means that there would be a delay in a foreign trader to receive his money at which time the exchange rate could have changed.

Q: 5). Define the following:

a) Direct and Indirect quoteb) Bid and Ask rate

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Answer:

a) Direct and Indirect quote

Quotations is the use of abbreviations to pair currencies to show the relative value of one currency unit against the unit of another currency in the foreign exchange market.

When a currency is quoted, it is done in relation to another currency, so that the value of one is reflected through the value of another. Therefore, if you were trying to determine the exchange rate between the U.S. dollar (USD) and the Japanese yen (JPY), the quote would look like this:

USD/JPY = 119.50

This is referred to as a currency pair. The currency to the left of the slash is the base currency, while the currency on the right is called the quote or counter currency. The base currency (in this case, the U.S. dollar) is always equal to one unit (in this case, US$1), and the quoted currency (in this case, the Japanese yen) is what that one base unit is equivalent to in the other currency. The quote means that US$1 = 119.50 Japanese yen. In other words, US$1 can buy 119.50 Japanese yen.

Direct Quote vs. Indirect Quote

There are two ways to quote a currency pair, either directly or indirectly. The two methods are referred to as the direct (American) and indirect (European) methods of quotation.

A direct quote: A foreign exchange quote that states the number of units of the domestic currency needed to buy one unit of the foreign currency.

Indirect quote: A foreign exchange quotes that states the number of units of a foreign currency needed to buy one unit of the domestic currency. So if you were looking at the Canadian dollar as the domestic currency and U.S. dollar as the foreign currency, a direct quote would be CAD/USD, while an indirect quote would be USD/CAD.

Quotation of foreign exchange rate can either be direct or indirect. A direct quote is expressed as the amount in local currency required to purchase one unit of foreign currency. It also expresses the amount in local currency one will get after selling one unit of foreign currency.

An indirect quote is the opposite of a direct quote. It gives the amount of foreign currency paid or the amount one receives when one unit of local currency is exchanged.

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b) Bid and Ask rate

A bid price is the price at which a bank or a dealer is willing to buy a security for example a forex bureau will display the rate at which he is willing to buy foreign exchange. On the other hand the ask price is the price at which the forex bureau is willing to sell his foreign exchange. The difference between the ask price and the bid price is known as the Bid-Ask Spread.

As with most trading in the financial markets, when you are trading a currency pair there is a bid price (buy) and an ask price (sell). Again, these are in relation to the base currency. When buying a currency pair (going long), the ask price refers to the amount of quoted currency that has to be paid in order to buy one unit of the base currency, or how much the market will sell one unit of the base currency in relation to the quoted currency

The bid price is used when selling a currency pair (going short) and reflects how much of the quoted currency will be obtained when selling one unit of the base currency, or how much the market will pay for the quoted currency in relation to the base currency.

The quote before the slash is the bid price, and the two digits after the slash represent the ask price (only the last two digits of the full price are typically quoted). Note that the bid price is always smaller than the ask price. Let's look at an example:

If you want to buy this currency pair, this means that you intend to buy the base currency and are therefore looking at the ask price to see how much (in Canadian dollars) the market will charge for U.S. dollars. According to the ask price, you can buy one U.S. dollar with 1.2005 CAD.

However, in order to sell this currency pair, or sell the base currency in exchange for the quoted currency, you would look at the bid price. It tells you that the market will buy US$1 base currency (you will be selling the market the base currency) for a price equivalent to 1.2000 Canadian dollars, which is the quoted currency.

Whichever currency is quoted first (the base currency) is always the one in which the transaction is being conducted. You either buy or sell the base currency. Depending on what currency you want to use to buy or sell the

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base with, you refer to the corresponding currency pair spot exchange rate to determine the price.

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ASSIGNMENT B

Q: 1). If FF/$=5.5885/5.5892

and $/Can $=0.6505/0.6512

Calculate the Implied cross rate.

Answer:

FF/$ =5.5885/5.5892

$/CAN$ =0.6505/0.6512

Cross rate (FF/CAN$) BID =

(FF/CAN$) BID =

Q: 2). What do you understand by transaction and translation exposure? How can these be hedged?

Answer:

Dealing with foreign currency brings about some risks to the parties carrying out international trade. The risks came because of the possibility that the exchange rate may be unfavorable at the time that the transaction is finally completed or when it is finally reported.

Transaction exposure results from a firm taking on a fixed cash flow in foreign currency denominated contractual agreements.

For example, if a company is supposed to receive £1,000,000 from a debtor at the time the exchange rate is £/MK 250, the company expects MK25, 000,000. If then exchange rate changes to £/MK240, the company stands to lose MK10,000,000.

Translation exposure on the other hand results from an international firm need to consolidate its financial statements to include results from its foreign

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operations. Because of the volatility of the exchange rates. These could lead to gains or losses.

In order to hedge against exposures, a firm with a long position on foreign currency can offset that position with a short position o the same currency and vice versa. This can be attained by the employment of financial derivatives such as forwards, options and also by investing and borrowing.

Q: 3). What are different kinds of derivative instruments? How are forwards different from future. Explain with example.

Answer:

Derivatives are financial instruments that whose values are derived from other underlying assets like stocks bonds and currency. Financial derivatives include future contracts, forwards, options and swaps.

Swaps are a derivative in which counter parties exchange benefits of one party’s assets for those of the other. Options are the right but not obligations to buy or sell a particular asset at a particular price at a particular time.

Futures and forwards are agreements to purchase or sell an asset at a specified future date, at a price agreed upon today. For example a merchant agrees to by £5,000 at a rate of £/MK250 on 6th July 2013.

The difference between futures and forwards are as follows:

1) Forwards are private contracts and are therefore not rigid in their conditions while futures are exchange traded instruments.2) Because forwards are private agreements the risk of default is higher while the futures are well scrutinized.3) When dealing with futures, a settlement is expected on the agreed upon date while forwards are marked to market and can therefore change hands continuously until the end.

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Case study

(a) Freda plum established the following spread on the Remco Corporation’s stock:

(i) Purchased one 3-month call option with a premium of $3 and an exercise price of $ 55.

(ii) Purchased one 3-month put option with a premium of $0.50 and an exercise price of $45.

The current market price of Remco is $50. Determine Freda’s profit or loss if (a) the price of Remco stays at $50 after 3 months, (b) the price of Remco falls to $35 after 3 months, and (c) the price of Remco rises to $60.

(b) How are investments in forex market analyzed? Discuss any two methods of evaluating investment proposals.

Solution

= 1.5130/1.165

= 1.6140/ 1.6145

=

=0.9374 / 0.9393

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ASSIGNMENT C

MULTIPLE CHOICE QUESTIONS

Q: 1). Assume the Canadian dollar is equal to $.88 and the Peruvian Sol is equal to $.35. The value of the Peruvian Sol in Canadian dollars is:

a) About .3621 Canadian dollars.b) About .3977 Canadian dollars (√)c) About 2.36 Canadian dollars.d) About 2.51 Canadian dollars.

Q: 2). An increase in the current account deficit will place _______ pressure on the home currency value, other things equal.

a) Upwardb) Downward (√)c) nod) Upward or downward (depending on the size of the deficit)

Q: 3). Which of the following is true?

a) Most forward contracts between firms and banks are for speculative purposes.b) Most future contracts represent a conservative approach by firms to hedge foreign trade.c) The forward contracts offered by banks have maturities for only four possible dates in the future.d) None of the above (√)

Q: 4). Which of the following statements is true?

a) A fixed exchange rate automatically cushions the economy's output and employment by allowing an immediate change in the relative price of domestic and foreign goods.

b) A flexible exchange rate does not automatically cushion the economy's output and employment by allowing an immediate change in the relative price of domestic and foreign goods.

c) A flexible exchange rate automatically cushions the economy's output and employment by allowing an immediate change in the relative price of domestic and foreign goods (√)

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d) A flexible exchange rate automatically cushions the economy's output and employment by allowing an immediate change in the absolute price of domestic and foreign goods.

Q: 5). Under the gold standard,

a) Exchange rates did not change for long periods of time.

b) Businesses could trade and invest with little fear of exchange rates changes.

c) The price of each currency in terms of gold was fixed (√)

d) Inflation was a serious economic problem.

Q: 6). Punjab National Bank Mumbai Branch quoted USD 1= Rs 50.5000/52.5050. Which is the bid rate for USD?

a) 50.5000 (√)b) 52.5050c) 50.5050d) 52.5000

Q: 7). A company involved in foreign exchange transactions is exposed to______ risk.

a) Country riskb) Currency risk (√)c) Counterparty riskd) Exchange risk

Q: 8). Interest-rate parity refers to the concept that, where market imperfections are few,

a) The same goods must sell for the same price across countries.b) Interest rates across countries will eventually be the same.c) There is an offsetting relationship between interest rate differentials and differentials in the forward spot exchange market (√)d) There is an offsetting relationship provided by costs and revenues in similar market environments.

Q: 9). Suppose that the Japanese yen is selling at a forward discount in the forward-exchange market. This implies that most likely

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a) This currency has low exchange-rate risk.b) This currency is gaining strength in relation to the dollar.c) Interest rates are higher in Japan than in the United States (√)d) Interest rates are declining in Japan.

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Q: 10). If the dollar moves from 100 yen to 110 yen, then:

a) the dollar has depreciatedb) the yen has appreciatedc) both of the above have occurredd) none of the above have occurred (√)

Q: 11). A nation's currency will appreciate in the long run if the nation exhibits which of the following characteristics?

a) high inflation and high productivity growthb) high productivity growth and increased tariffs on imports

(√)c) high productivity growth and reduced tariffs on importsd) none of the above

Q: 12). In the long run, the U.S. dollar appreciates if:

a) U.S. prices rise and U.S. productivity fallsb) U.S. prices fall and the U.S. increases tariffs on imports

(√)c) U.S. prices fall and the U.S. removes all import quotasd) U.S. interest rates rise and the U.S. removes all tariffs on

imported goods

Q: 13). In the short-run model of exchange rate determination, if we consider the U.S.-European exchange rate (euros per dollar), if the European Central Bank unexpectedly boosts interest rates, then this will cause the

a) euro to depreciateb) dollar to appreciatec) euro to appreciate (√)d) all of the above

Q: 14). The largest volume of activity in foreign exchange markets is related to:

a) international flows of financial capitalb) exports and importsc) government transactions abroadd) firms building plants abroad (√)

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Q: 15). When the Swiss franc appreciates (holding everything else constant), then

a) Swiss watches sold in the United States become more expensive (√)

b) American computers sold in Switzerland become more expensive.

c) Swiss army knives sold in the United States become cheaper.d) American toothpaste sold in America becomes cheaper.e) Both (a) and (d) of the above are true.

Q: 16). If the interest rate on dollar-denominated assets is 10% and it is 8% on euro-denominated assets, then if the euro is expected to appreciate at a 5% rate.

a) Dollar-denominated assets have a lower expected return than euro-denominated assets (√)

b) The expected return on dollar-denominated assets in euros is 2%.

c) The expected return on euro-denominated assets in dollars is 3%.

d) None of the above will occur.

Q: 17). All other things equal, an increase in inflation in Mexico shifts the supply of dollars _______, the demand for dollars to the _________, and causes a (n) _______ in the peso

relative to the dollar.

a) right; left; appreciationb) left; right; depreciation (√)c) right; left; depreciationd) left; right; appreciation

Q: 18). When U.S. real interest rates rise, the

a) Expected returns for U.S. investments increases, and the dollar appreciates (√)

b) Expected return for U.S. investments decreases, and the dollar appreciates.

c) expected return U.S. investments increases, and the dollar depreciates

d) Expected return U.S. investments decreases, and the dollar depreciates.

Q: 19). A lower domestic money supply causes the domestic currency to

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a) Depreciate more in the short run than in the long run.b) Depreciate more in the long run than in the short run.c) Appreciate more in the short run than in the long run (√)d) Appreciate more in the long run than in the short run.

Q: 20). Which exchange rate system involves a strategy of “leaning against the wind?”

a) fixed exchange ratesb) floating exchange ratesc) managed floating exchange rates (√)d) pegged exchange rates

Q: 21). Market-determined exchange rates are best represented by a system of

a) fixed exchange ratesb) pegged exchange ratesc) managed floating exchange ratesd) floating exchange rates (√)

Q: 22). An increase in the current account deficit will place _______ pressure on the home currency value, other things equal.

a) upwardb) downward (√)c) nod) upward or downward (depending on the size of the deficit)

Q: 23). A weakening of the U.S. dollar with respect to the British pound would likely reduce the U.S. exports to Britain and increase U.S. imports from Britain.

a) True.b) False (√)

Q: 24). Assume that a bank's bid rate on Swiss francs is £0.25 and its ask rate is £0.26. Its bid-ask percentage spread is:

a) 4.00%.b) 4.26% (√)c) About 3.85%.d) About 4.17%.

Q: 25). The strike price is also known as the premium price

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a) Trueb) False (√)

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Q: 26). The exchange rate is the:

a) Total yearly amount of money changed from one country’s currency to another country’s currency

b) Total monetary value of exports minus importsc) Amount of country’s currency which can be exchanged for one

ounce of goldd) Price of one country’s currency in terms of another

country’s currency (√)

Q: 27). A multinational company that is faced with mild interference up to complete confiscation of all assets is encountering __________.

a) Translation risk exposureb) Transactions risk exposurec) Political risk exposure (√)d) A very bad day

Q: 28). The forward exchange rate __________.

a) is the rate today for exchanging one currency for another for immediate delivery

b) is the rate today for exchanging one currency for another at a specific future date (√)

c) is the rate today for exchanging one currency for another at a specific location on a specific future date

d) is the rate today for exchanging one currency for another at a specific location for immediate delivery

Q: 29). The spot exchange rate

a) is the rate today for exchanging one currency for another for immediate delivery (√)

b) is the rate today for exchanging one currency for another at a specific future date

c) is the rate today for exchanging one currency for another at a specific location on a specific future date

d) is the rate today for exchanging one currency for another at a specific location for immediate delivery

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Q: 30). Flexible exchange rates insulates the economy better than fixed exchange rates

a) against real and foreign monetary shocksb) against foreign monetary shocks onlyc) against real and domestic monetary shocksd) against domestic monetary shocks only

Q: 31). The forward market is especially well-suited to offer hedging protection against

a) Translation risk exposure.b) Transactions risk exposure (√)c) Political risk exposure.d) Taxation.

Q: 32). The euro is the name for

a) A currency deposited outside its country of origin.b) A bond sold internationally outside of the country in whose

currency the bond is denominated.c) a common European currency (√)d) a type of sandwich

Q: 33). The simplest method of currency translation is:

a) monetary/nonmonetaryb) temporalc) current rate (√)d) current/noncurrent

Q: 34). Which of the following is not a type of indirect fund-adjustment method?

a) exposure nettingb) lagsc) transfer pricingd) balance sheet hedge (√)

Q: 35). Investing in interest-bearing instruments in foreign exchange and earning a profit due to interest rate and exchange rate differentials is

a) Interest hedging.b) Interest optioning.c) Interest swapping.

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d) Interest arbitrage (√)

Q: 36). A U.S. company has an affiliate in Mexico. This affiliate has exposed assets of 200 million pesos and exposed liabilities of 300 million pesos. If the exchange rate appreciates from $0.0004 per peso to $0.0005 per peso, what is the company's translation gain or loss?

a) -$10,000 (√)b) -$15,000c) +$10,000d) +$15,000

Q: 37). The temporal method of currency translation is almost similar to the monetary/non monetary method except the following _____.

a) accounts receivable at historical costb) accounts receivable at market pricec) fixed assets at historical costd) inventory can be at historical coste) inventory can be at market price (√)

Q: 38). All of the following are hedges against exchange-rate risk EXCEPT

a) Balancing monetary assets and liabilities.b) Use of spot market (√)c) Foreign-currency swaps.d) Adjustment of funds commitments between countries.

Q: 39). Purchasing-power parity (PPP) refers to__________.

a) the concept that the same goods should sell for the same price across countries after exchange rates are taken into account(√)

b) the concept that interest rates across countries will eventually be the same

c) the orderly relationship between spot and forward currency exchange rates and the rates of interest between countries

d) the natural offsetting relationship provided by costs and revenues in similar market environments

Q: 40). Assume the nominal interest rates (annual) in the country of Fredonia and the United States are 6% and 12% respectively. What is the implied 90-day forward rate if the current spot rate is 5 Fredonia marks (FM) per U.S. dollar?

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a) 4.732b) 4.927c) 5.074 (√)d) 5.283

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If Assignment

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