Keeping Up With a Changing World-Trade Flows, Capital Flows, and the Balance Of Payments

Transcription

1 Chapter 1: Keeping Up With a Changing World-Trade Flows, Capital Flows, and the Balance Of Payments 1. Globalization refers to: A. only increasing market integration, while international economic integration refers to the strengthening of existing international linkages of commerce and the addition of new international linkages. B. only the expansion of world governance and global society, while international economic integration refers to the strengthening of existing international linkages of commerce and the addition of new international linkages. C. only the increased mobility of peoples and information, while international economic integration refers to the strengthening of existing international linkages of commerce and the addition of new international linkages. D. the increasing market integration, the expansion of world governance and global society, and the increased mobility of peoples and information, while international economic integration refers to the strengthening of existing international linkages of commerce and the addition of new international linkages. 2. International economic integration refers to: A. the expansion of world governance and society. B. the increased mobility of peoples and information. C. the strengthening of existing international linkages of commerce and the addition of new linkages. D. the strengthening of existing international linkages of commerce but not the addition of new linkages. 3. Globalization refers to, and international economic integration refers to. A. a broader scope of the internationalization process, a narrower focus of the internationalization process. B. a narrower scope of the internationalization process, a broader focus of the internationalization process. C. the same thing as international economic integration, the strengthening of international linkages of commerce. D. None of the above.

2 4. Open trade in goods, services, and financial assets by leading economies of the world at levels close to those observed today: A. have never been experienced. B. had been experienced before World War I. C. had been experienced between World War I and World War II. D. had been experienced only immediately before the Korean conflict. 5. Real sector transactions deal with: A. transactions in goods and services. B. transactions in financial assets. C. transactions in both goods and services and financial assets. D. transactions in neither goods and services nor in financial assets. 6. Financial sector linkages deal with: A. transactions in goods and services. B. transactions in financial assets. C. transactions in both goods and services and financial assets. D. transactions in neither goods and services nor in financial assets. 7. In terms of real sector activity, world trade in goods and services: A. is important only to developed economies. B. is important only to developing economies. C. is important to both developed and developing economies. D. is important to neither developed nor developing economies. 8. In the last 35 years, the nearly 6 percent per annum growth in world trade has led to a -fold cumulative increase in world trade. A. two B. three C. four D. five

3 9. When measured as a multiple of world exports of goods and services, foreign exchange turnover in 2004 was approximately: A. 12:1. B. 38:1. C. 61:1. D. 50: Over the last 35 years, the data on trade and financial flows show: A. decreased real flows and decreased financial flows. B. increased real flows and decreased financial flows. C. decreased real flows and increased financial flows. D. increased real flows and increased financial flows. 11. If domestic investment is greater than domestic saving, A. expenditures equal domestic income and net exports equal zero. B. expenditures are greater than domestic income and net exports are negative. C. expenditures are less than domestic income and net exports are positive. D. expenditures are greater than domestic income and net exports are positive zero. 12. If domestic investment is less than domestic saving, A. expenditures equal domestic income and net exports equal zero. B. expenditures are greater than domestic income and net exports are negative. C. expenditures are less than domestic income and net exports are positive. D. expenditures are greater than domestic income and net exports are positive zero. 13. If domestic savings equals 10 and domestic investment equals 6, then the current account balance equals: A. -16 B. -4 C. +4 D. +16

4 14. If a nation's domestic savings equals 6 and a nation's domestic investment equals 10, then the nation is experiencing: A. a net capital outflow. B a net capital inflow. C. no net capital inflow or outflow. D. a current account surplus. 15. If a nation's domestic saving is 25 and the nation's domestic investment is 30, then the nation is experiencing: A. a current account surplus. B. a current account deficit C. a net capital inflow D. both B and C 16. A current account deficit in the U.S. is: A. necessarily bad because it represents a lack of domestic saving. B. necessarily good because it represents foreign savings in the U.S. C. necessarily bad because it undermines the U.S.'s ability to experience economic growth. D. is neither good nor bad. 17. The balance of payments system A. is another method for calculating GDP. B. insures that the net exports are always equal to zero. C. measures the total value of a domestic economy's transactions with the rest of the world. D. attempts to limit the fluctuation in international exchange rates. 18. The balance on merchandise trade is a component of A. the current account.

5 B. the capital account. C. foreign direct investment. D. portfolio investment. 19. A debit entry in the balance of payments accounts represents A. a transaction that includes a payment from abroad a domestic resident. B. a transaction that includes a payment abroad by a domestic resident. C. a decrease in the current account deficit. D. an increase in the capital account surplus. 20. Which of the following transactions are not included in the current account? A. Exports of manufactured goods. B. Imports of manufactured goods. C. Payments of interest and dividends on foreign assets held by a domestic U.S. resident. D. The purchase of foreign assets by a domestic U.S. resident. 21. When a country faces a current account deficit, it also faces: A. a services trade deficit. B. a capital account deficit. C. a capital account surplus. D. a merchandise trade deficit. 22. In terms of balance of payments accounting, which of the following would be recorded as a debit entry? A. Exports of merchandise. B. Exports of services. C. A foreigner's purchase of a U.S. Treasure bond. D. An increase in a U.S. citizen's account at a foreign bank.

6 23. Given the following data, what is the country's current account balance? Merchandise trade balance = -120; Services trade balance = +45; Unilateral transfers made in excess of those received = 15. A. -60 B. -90 C D Suppose an American tourist travels to Mexico, and uses U.S. dollars to purchase a hotel room in Mexico City. This transaction is recorded as a A. credit in the current account and debit in the capital account. B. debit in the capital account and a credit in the current account. C. credit in the capital account and debit in the current account. D. credit in the capital account and debit in the capital account. 25. Foreign direct investment is a component of A. portfolio investment. B. the current account. C. total trade in services. D. the capital account. 26. In order for the purchase of stocks to be categorized as foreign direct investment, it must represent at least percent of the foreign entity's outstanding stock A. 1 B. 10 C. 25 D Purchases of stock that are too small too be considered foreign direct investment are classified as A. depreciation. B. investment spending. C. portfolio investment. D. capital investment.

7 28. After accounting for statistical discrepancies, a capital account A. surplus will always imply a current account surplus. B. surplus will always imply a current account deficit. C. surplus will always exceed the associated current account surplus. D. deficit will always exceed the associated current account surplus. 29. The United States is currently a net debtor nation. This necessarily implies that the A. federal government owes money to foreign investors. B. value of U.S. held assets abroad is lower than the value of foreign held assets in the U.S. C. value of the U.S. dollar is less than the average value of foreign currencies. D. U.S. is running a deficit in manufactured goods trade. 30. A balance of payments deficit is defined as a situation in which A. the value of payments made to foreigners exceeds the value of payments received from foreigners in a given period of time. B. the federal government must borrow in order to meet its budget obligations. C. the value of manufactured good exports is less than the value of imported manufactured goods. D. balance of payments credits exceed balance of payments debits. 31. In recent years, the U.S. has generally had a capital account A. surplus and a current account surplus. B. surplus and a current account deficit. C. deficit and a current account surplus. D. deficit and a current account deficit.

8 Chapter 2: The Market for Foreign Exchange 1. A market that involves the immediate sale or purchase of an asset is known as a(n) A. currency market. B. bond market. C. spot Market. D. free market. 2. The minimum value of a spot currency transaction is generally A. $100,000. B. $500,000. C. $1 million. D. $5 million. 3. If the currency-per-u.s. dollar exchange rate of the New Zealand dollar is 1.5, what is one New Zealand dollar worth in terms of U.S. dollars? A. $0.50 B. $0.67 C. $1.00 D. $ Suppose exchange rate of the Argentinean peso relative to the U.S. dollar is 3 (Peso/$). If the peso were to undergo a 50 percent depreciation, the new exchange value would be: A B C D For which of the following sets of exchange rates has the cross rate been correctly calculated? A. 1 = 2 Swiss francs; $1.50 = 1; $1 = 0.75 Swiss francs B. 200 = $1.00; 1 ringgit = $0.15; 20 ringgit = 1 C. 1 = 1.5 euro; 3 Swiss francs = 2 euros; 2.25 Swiss francs = 1 D. 100 = $1.00; 1 ringgit = $0.15; 20 ringgit = 1

9 6. A Korean trader wishes to make a purchase of Czech crystal worth 3 million Czech korunas. Unfortunately, there is no published value of the Korean won to Czech koruna exchange rate. In order to calculate the current price of the crystal in won, the trader will need to calculate A. the real exchange rate. B. a cross rate. C. the purchasing power parity rate. D. South Korea's effective exchange rate. 7. Suppose the exchange rate between the U.S. dollar and the Canadian dollar is 1.37 (C$/$), while the exchange rate for the British pound is 0.66 ( /$). What is the cross rate of Canadian dollars to the British pound (C$/ )? A B C D An American tourist is planning to visit Mexico. The exchange rate at which the tourist can buy pesos in a retail bank is the: A. bid price. B. ask price. C. forward rate. D. cross rate. 9. Suppose the bid price of British pounds is $1.49 U.S., and the ask price is $1.51 U.S. What is the bid ask margin? A. 0.02% B. 0.99% C. 1.01% D. 1.32% 10. The spot exchange rates published in financial newspapers are: A. nominal exchange rates. B. real exchange rates. C. effective exchange rates.

10 D. forward exchange rates. 11. Which of the following exchange rates is adjusted for price changes? A. Nominal exchange rate. B. Real exchange rate. C. Effective exchange rate. D. Forward exchange rate. 12. The table below reports the movements of prices and exchange rates for the U.S. and Indonesia over a year's time. July 1, 2003 July 1, 2004 Indonesian rupiah/$u.s. 2,435 14,500 Indonesian price level (CPI) U.S. price level (CPI) During this time, the Indonesian rupiah experienced a nominal A. depreciation and a real appreciation. B. depreciation and a real depreciation. C. appreciation and a real appreciation. D. appreciation and a real depreciation. 13. Based on the values in the table below, the percentage change in the value of the rupiah was and the rate of inflation in Indonesia was. July 1, 2003 July 1, 2004 Indonesian rupiah/u.s. 2,435 14,500

11 Indonesian price level (CPI) 100 U.S. price level (CPI) 100 A. 16.8% depreciation, 2% B % depreciation, 52% C. 16.8% appreciation, 52% D % appreciation, 52% 14. The effective exchange rate is A. the exchange rate facing large banks and other high-volume traders. B. the exchange rate facing retail customers. C. the nominal exchange rate adjusted for inflation. D. a measure of the weighted-average value of a currency relative to a selected group of countries. 15. An exchange rate that is weighted by the share of each partner in a nation's trade is an example of a A. spot exchange rate. B. effective exchange rate. C. nominal exchange rate. D. real exchange rate. 16. The Special Drawing Right (SDR) is a A. means by which banks offer their best clients preferential loan rates. B. preliminary form of the proposed common currency in Europe. C. composite currency created by the International Monetary Fund. D. type of bank account used by currency traders. 17. A currency trader engaging in spatial arbitrage would be doing what? A. Purchasing real estate in major financial centers. B. Purchasing an asset in one market and simultaneously selling it at a different price in another market.

12 C. Choosing an investment portfolio that contained assets from many different countries. D. Selling borrowed currency in the hopes that there will be a large appreciation. 18. The demand for a currency is an example of A. an aggregate demand. B. a derived demand. C. spatial arbitrage. D. a perfectly elastic demand. 19. A depreciation of the Japanese yen relative to the U.S. dollar is illustrated as a: A. rightward movement along the demand curve for Japanese yen. B. leftward movement along the demand curve for Japanese yen. C. shift rightward in the demand for Japanese yen. D. shift leftward in the demand for Japanese yen. 20. An increase in the demand for French goods and services will: A. induce a rightward shift in the demand for euros. B. induce a leftward shift in the demand for euros. C. result in a leftward movement along the demand curve for euros. D. result in a leftward movement along the demand curve for euros. 21. The demand for the U.S. dollar in terms of Swedish krona: A. is perfectly inelastic. B. shifts leftward in response to an increase in Swedish demand for U.S. goods. C. is upward sloping. D. may also be represented as the supply of Swedish krona in terms of U.S. dollars. 22. An increase in U.S. demand for foreign assets will result in a:

13 A. rightward shift in the supply of U.S. dollars. B. rightward movement along the supply schedule for U.S. dollars. C. a leftward shift in the supply of U.S. dollars. D. a leftward movement along the supply schedule for U.S. dollars. 23. If U.S. demand for German products increases at the same time as German demand for U.S. products rises, what is the effect on the U.S. dollar to euro exchange rate? A. The U.S. dollar will appreciate relative to the euro. B. The U.S. dollar will depreciate relative to the euro. C. The U.S. dollar will not change relative to the euro. D. The U.S. dollar may appreciate, depreciate, or remain unchanged relative to the euro. 24. An increase in the demand for the Canadian dollar will lead to A. an appreciation of the Canadian dollar and a higher quantity of Canadian dollars traded. B. a depreciation of the Canadian dollar and a higher quantity of Canadian dollars traded. C. an appreciation of the Canadian dollar and a lower quantity of Canadian dollars traded. D. a depreciation of the Canadian dollar and a lower quantity of Canadian dollars traded. 25. An increase in the supply of the Mexican peso will lead to: A. an appreciation of the peso and a higher quantity of pesos traded. B. a depreciation of the peso and a higher quantity of pesos traded. C. an appreciation of the peso and a lower quantity of pesos traded. D. a depreciation of the peso and lower quantity of pesos traded. 26. Which basket of goods would be most likely to exhibit absolute purchasing power parity? A. The goods in the Consumer Price index. B. Specialized luxury goods, which are subject to different tax rates across countries.

14 C. Locally produced goods, such as transportation services, which are not easily traded. D. Highly tradable commodities, such as wheat. 27. The difference between relative and absolute purchasing power parity (PPP) is A. relative PPP includes a measure of the aggregate price level in each country, while PPP does not. B. empirical studies show that relative PPP holds in both the short and long run, w while absolute PPP holds only in the short run. C. relative PPP relates interest rate differentials, while absolute PPP relates goods prices. D. relative PPP implies that exchange rate movements will offset changes in relative prices over time, while absolute PPP implies that exchange-rate adjusted prices will always be equal. 28. If the price of a pair of shoes in the U.S. is $80, the price of the same pair of shoes in Germany is 120, and the exchange rate is 1.5 $/, the euro: A. is correctly valued according to PPP. B. is overvalued according to PPP. C. is undervalued according to PPP. D. correctly valued according to relative PPP. 29. Assume that PPP holds in the long run. If the price of a tradable good is $20 in the U.S. and 100 pesos in Mexico and the exchange rate is 7 pesos/$, which of the following changes might we expect in the future? A. an increase in the price of the good in the U.S. B a decrease in the price of the good in Mexico. C. an appreciation of the peso in nominal terms. D. a depreciation of the peso in nominal terms.

15 Chapter 3: Exchange Rate Systems, Past to Present 1. The principle function of the International Monetary Fund was originally to A. lend to member nations experiencing a shortage of foreign exchange reserves. B. finance postwar reconstruction, particularly in Europe and Japan. C. reduce trade barriers and settle disputes among countries relating to currency negotiations. D. act as a supranational regulatory agency for domestic central banks. Answer: A 2. The U.S. dollar today is an example of a A. commodity money. B. fiat money. C. commodity-backed money. D. currency basket. 3. The gold standard was in place for most major economics of the world during the period A. from the beginning of the Great Depression until World War II. B. from 1973 until the present. C. from the mid-1870s until World War I. D. since the end of World War II. 4. Under the gold standard, if the mint parity condition for the French franc was set at Ffr107.1 per ounce of gold, and the German mark was set at DM88.7 per ounce of gold, then it is possible to compute the exchange rate between the German mark and the French franc (DM/f) as approximately A B C D. It is not possible to compute the exchange rate between the mark and the franc with these values, because these values are relative to the price of gold.

16 5. Under the Bretton Woods system, most of the major currencies of the system, other than the U.S. dollar, A. pegged their values against the value of an ounce of gold. B. pegged their values against the value of the dollar. C. allowed their currencies to float. D. pegged their values against the value of the Euro. 6. Which of the following is not an institution that arose under the Bretton Woods Agreement? A. The International Monetary Fund. B. The International Bank for Reconstruction and Development. C. The League of Nations. D. The General Agreement on Tariffs and Trade. 7. In the Plaza Agreement of September, 1985, the "Group of Five" or "G5" countries announced that they believed that A. the "G5" needed to be expanded to include an additional five major industrialized countries to make up what is now referred to as the "G10". B. the Bretton Woods system would no longer be sustainable. C. it was necessary to "float" the dollar relative to gold. D. the exchange value of the dollar was too strong and that they would coordinate their central bank interventions in order to drive down the value of the dollar. 8. Which of the following is not a member of the "Group of Ten" industrialized countries? A. Japan B. Belgium C. Switzerland D. Sweden 9. An example of a country that maintained a crawling-peg exchange-rate system during the early 2000s is A. the United States. B. Canada.

17 C. France. D. Nicaragua. 10. A currency board is an A. exchange market in which the major currencies of the world are exchanged on the open market among private banks at prevailing rates. B. independent monetary agency that substitutes for a central bank by pegging the growth of the domestic money stock to the foreign-exchange holdings of the board. C. independent monetary agency which is responsible for setting bank reserve requirements for the domestic currency. D. exchange market in which the notes and bills issued by the domestic government are traded on the open market among private banks. 11. Which of the following arrangements places the greatest restriction on policymakers and requires the greatest sacrifice of policy autonomy? A. a free float. B. a currency-basket peg. C. dollarization. D. a currency board. 12. If the Chinese renminbi, whose unit of currency is the yuan, is revalued relative to the U.S. dollar, then A. for each yuan, one can expect to buy fewer dollars. B. for each yuan, one can expect to buy more dollars. C. the exchange rate between the renminbi and the dollar will remain constant. D. it is impossible to tell what will happen to the exchange rate or the number of dollars that one can buy with each yuan, since this depends on the supply and the demand for the yuan relative to the dollar. 13. Currency basket pegs usually involve pegging the domestic currency to A. each of the major currencies of the world. B. the relative price of a chosen basket of consumer goods. C. a weighted average of only a small selected number of different currencies.

18 D. within an upper and lower limit of a band relative to either the U.S. dollar or the Japanese yen. 14. A "dirty float" exchange rate system refers to A. an exchange rate system wherein policymakers allows the value of the domestic currency to be determine only by the forces of supply and demand. B. an exchange rate system whereby each of the members of the system peg their currency against one of the major currencies, such as the U.S. dollar, which is in turn pegged against a commodity, such as gold. C. an exchange rate arrangement in which the domestic currency is primarily managed by the central bank of a foreign country, which is typically the major trading partner. D. an exchange rate arrangement in which a nation allows the international value of its currency to be primarily determined by market forces, but intervenes occasionally to stabilize its currency. 15. The G7/G8 economic summits were started by: A. Russian President Bois Yeltsin B. U.S. President Gerald Ford C. U.S President William Clinton. D. French President Valery Giscard d Estaing. 16. The Smithsonian agreement refers to A. the understanding that most of the major industrialized countries came to at the end of the depression era regarding the non-sustainability of the gold standard as it was currently practiced. B. an agreement that was made to establish new par values for the G10 countries that had participated in the Bretton Woods system. C. the agreement that President Nixon came to vis a vis the other G10 members to suspend temporarily the convertibility of the dollar into gold or other reserve assets. D. the initial agreement that set forth future economic cooperation under the North American Free Trade Association. 17. Which of the following did not contribute to the eventual collapse of the Bretton Woods system?

19 A. Increased federal spending for social programs termed the "Great Society" under the Johnson administration. B. Heightened U.S. involvement in Vietnam. C. The conditions set forth in the Louvre Accord. D. U.S. balance of payments deficits with Germany and Japan. 18. A Monetary Order is A. a set of rules that determine the international value of a currency. B. a set of laws and regulations that establishes the framework within which individuals conduct and settle transactions. C. an exchange rate arrangement in which a country pegs the international value of the domestic currency relative to the currency of another nation. D. a specialized form of a currency board. 19. Which of the following is an example of a commodity money that has been used extensively? A. Credit cards. B. Demand deposits and certificates of deposit. C. Gold. D. The Euro. 20. A key challenge to the exchange rate system of the leading industrialized countries in the 1970s came as a consequence of A. a rapid increase in the price of petroleum. B. the formation of the Bundesbank. C. the heightening of Cold War tensions. D. the establishment of many currency baskets worldwide. 21. The IMF constitution was amended to allow member nations to determine their own exchange rate arrangements under the A. Smoot-Hawley Act. B. Jamaica Accord. C. Smithsonian Agreement.

20 D. Treaty of Rome. 22. An advantage of the gold standard system was that A. it promoted conditions that helped to avoid periodic financial and banking instability. B. it did not require countries to have central banks. C. it ensured short-run stability of the monetary stock. D. minting and transportation costs were relatively low as compared to other exchange rate systems. 23. The gold window for the U.S. dollar was closed by A. President Ronald Reagan. B. President James Carter. C. Federal Reserve Chairman Paul Volker. D. President Richard Nixon. 24. An advantage of a flexible exchange rate system is that it A. can help a country overcome external shocks such as an unusual inflow of capital from abroad. B. can reduce the volatility of nominal exchange rate over time. C. eliminates the need for the central bank to target interest rates. D. ensures a greater volume of trade in goods and services among member countries. 25. Which of the following is a principal function of the International Monetary Fund? A. To act as a forum for international monetary cooperation. B. To provide central banks with a range of financial services for managing their external reserves. C. To act as a lender of last resort for countries facing temporary external balance of payments problems. D. To act as an agent or trustee which facilitates the implementation of various international financial agreements.

21 Chapter 4: The Forward Currency Market and International Financial Arbitrage 1. Your Canadian-based firm expects to receive a euro-payment in 30 days. Your firm is: A. short the Canadian dollar. B. long the Canadian dollar. C. short the euro. D. long the euro. 2. Your Canadian-based firm expects to receive a euro-payment in 30 days. This is an example of: A. covered arbitrage. B. transaction exposure. C. translation exposure. D. risk premium. 3. The act of offsetting exposure to risk is known as A. dodging. B. hedging. C. speculating. D. avoidance. 4. A covered exposure is one A. that is backed by the government. B. in which exposure to foreign exchange risk is offset. C. that is established via foreign direct investment. D. that is impossible in most bond markets. Answer: B 5. A market in which contracts for a future delivery of a foreign currency are established is: A. the S&P 500. B. the spot exchange market.

22 C. the forward exchange market. D. global capital market. 6. A short position in a foreign currency implies that the investor A. will deliver the foreign currency in the future. B. will receive the foreign currency in the future. C. has an economic exposure. D. has a translation exposure. 7. If the forward exchange rate, defined as the domestic currency price of the foreign currency, is greater than the spot exchange rate there is a: A. forward premium on the foreign currency. B. forward discount on the foreign currency. C. shortage of dollars. D. surplus of dollars. 8. If the foreign currency is selling at a forward discount, then according to the efficient markets hypothesis one would A. a depreciation of the currency. B. an appreciation of the currency. C. a devaluation of the currency. D. a revaluation of the currency. 9. The forward premium has proved to be A. a stable predictor of the future spot rate. B. a near-perfect predictor of future spot rates. C. a biased predictor of future spot rates. D. of no help in predicting future spot rates. 10. The existence of unexploited profit opportunities is referred to as A. the parity condition.

23 B. equilibrium. C. interest rate parity. D. an arbitrage opportunity. 11. Interest rate equalization across countries on similar financial instruments is called A. sterilization. B. optimization. C. interest rate parity. D. an arbitrage opportunity. 12. Covered interest rate parity implies that the difference between the domestic and foreign interest rates should equal A. zero. B. the forward premium or discount. C. the purchasing power parity exchange rate. D. the yield to maturity. 13. One limitation of using forward markets as a hedge is A. that a sizable minimum transaction is required in order to participate in forward markets. B. an insufficient number of speculators who are willing to absorb the riskiness of the transaction. C. an absence of government regulation in forward markets. D. that forward markets are exchange tradable. 14. The condition relating interest differentials to an expected change in the spot rate of the domestic currency is called A. covered interest rate parity. B. uncovered interest rate parity. C. absolute purchasing power parity. D. relative purchasing power parity.

24 15. Uncovered interest rate parity may not hold exactly due to A. a risk premium. B. a hedge adjustment. C. the inflation effect. D. an adjustment for nominal rather than real interest rates. 16. The additional risk of a currency due to political instability is referred to as A. anarchy. B. the discount factor. C. unhedgeable. D. country risk. 17. If market participants could forecast perfectly, then one would expect the A. forward premium to be equal to the difference between the future spot rate and the current spot rate, divided by the current spot rate. B. current spot rate to be equal to the future spot rate minus the current spot rate. C. forward premium to be equal to the future spot rate. D. forward premium to be equal to the current spot rate. Answer: A 18. Suppose that a currency speculator notes that the 90-day forward rate on the euro is $1.10/. Suppose further that the speculator believes that in 90 days the spot rate will be $1.20/. If this is the case, the speculator should do which of the following to earn a profit? A. Buy U.S. dollars on the forward market. B. Sell euros on the forward market. C. Buy euros on the forward market. D. Sell U.S. dollars in the spot market. 19. In which of the following situations, given that exchange rates are defined as domestic currency units to foreign currency units, would a speculator wish to sell foreign currency on the forward market? A. If S e +1 < F B. If S e +1 > F

25 C. If S e +1 = F D. If S e +1 = 1/F 20. In which of the following situations would a speculator wish to purchase foreign currency on the forward market? A. If S e +1 < F B. If S e +1 > F C. If S e +1 = F D. If S e +1 = 1/F 21. A market where prices adjust quickly to new and relevant information is called A. stable. B. opaque. C. rational. D. efficient. 22. The most likely reason why the forward rate actually does a poor job of forecasting the future spot exchange rate is the A. presence of irrational expectations. B. presence of a variable risk premium. C. unpredictability of interest rates. D. notoriously inaccurate nature of the data on forward rates. 23. A bank deposit denominated in a currency other than that of the nation in which the bank deposit is located is referred to as a(n): A. ADR. B. reciprocal transfer. C. Eurocurrency. D. Eurobond. 24. One theory of the of the origin of the Eurocurrency markets has to do with the

26 A. development of a black market for illegally obtained funds. B. former Soviet Union moving U.S. assets to Europeans banks for security reasons. C. U.S. lending to European allies during WWII. D. former Soviet Union selling off its reserves of U.S. dollars. 25. The most heavily traded currency on the Eurocurrency market is the A. British pound. B. Canadian dollar. C. Japanese yen. D. U.S. dollar. 26. Covered interest arbitrage in the eurocurrency markets is A. often profitable due to the avoidance of country risk. B. often profitable due to differing tax treatments on assets held outside of the country. C. seldom profitable due to equilibrium conditions with forward markets. D. seldom profitable due to investor indifference. 27. The uncovered interest rate parity is a condition regarding A. nominal interest rates and future spot exchange rates. B. real interest rates and future spot exchange rates. C. nominal interest rates and current spot exchange rates. D. real interest rates and current spot exchange rates.

27 Chapter 5: Interest Yields, Interest Rate Risk, and Derivative Securities 1. The amount of credit extended via the purchase of a financial instrument is the A. principal. B. front load. C. sum of the coupons. D. present discounted value. 2. To calculate the price of a financial instrument, one must find the A. present discounted value of the stream of coupon payments and principal. B. principal plus the present discounted value of the coupons. C. sum of the coupons divided by the principal. D. sum of the coupons plus the principal. 3. A bond with no fixed maturity date is called a A. discount bond. B. callable bond. C. treasury bill. D. perpetuity. 4. A bond with an infinite payment life will have a price A. equal to the present discounted value of its principal. B. equal to the coupon amount divided by the interest rate. C. equal to the coupon amount divided by one plus the interest rate. D. that is arbitrarily high, as it will produce coupon payments forever. 5. Suppose the price of a perpetuity is $1,000 and that the perpetuity pays a coupon of $60 per year. The interest rate on this bond is A percent. B percent. C. 6 percent.

28 D. 60 percent. 6. Suppose the interest rate on a perpetuity is 5 percent, and its price is $1,500. The annual coupon must therefore equal A. $75. B. $300. C. $750. D. $30, Suppose a perpetuity pays $100 per year and its interest rate is 8%. Its price is equal to A. $80. B. $125. C. $800. D. $1, Zero coupon bonds have the distinguishing feature that they A. have an indefinite life. B. pay a lump sum at maturity. C. are issued only by the Treasury. D. pay only coupons that carry an interest rate equal to the real interest rate. 9. Interest-rate risk arises because A. shorter terms to maturity expose bonds to greater risk of capital loss when interest rates rise. B. shorter terms to maturity expose bonds to greater risk of capital loss when interest rates fall. C. longer terms to maturity expose bonds to greater risk of capital loss when interest rates rise. D. longer terms to maturity expose bonds to greater risk of capital loss when interest rates fall.

29 10. The yield curve displays the relationship among yields on bonds that differ only in their A. country of origin. B. terms to maturity. C. bond rating. D. default risk. 11. The segmented markets theory is grounded in the assumption that A. inflation will be prevalent in only certain long-term bonds. B. investors have identical preferences for all bond maturities. C. bonds with different maturities are nonsubstitutable. D. domestic investors prefer domestic bonds. 12. An investor using the expectations theory would buy a two-year bond at the present time only if its yield is A. greater than or equal to the average of the one-year spot rate and the expected spot rate a year later. B. less than the average of the one-year spot rate and the expected spot rate a year later. C. greater than or equal to the expected spot rate a year later. D. greater than or equal to the one-year spot rate. 13. The preferred habitat theory suggests that investors A. have a preference for domestic over foreign bonds. B. will only select bonds over a small range of terms to maturity. C. have a preferred maturity length but are willing to move away from this if the interest rate differential is high enough. D. prefer, all else being equal, to hold the bonds issued by a particular group of firms in a region of the world with a shallow yield curve. 14. Because of the possibility of default and low liquidity, some bonds carry A. no premium. B. a risk premium.

30 C. a margin account. D. a lower interest rate. 15. The primary reason that municipal bonds earn a lower interest rate than treasury bonds is that A. municipal bonds have less risk. B. treasury bonds are in greater supply. C. municipal bonds are often serial type bonds. D. the interest earned on municipal bonds is tax-exempt. 16. Reinvestment risk arises from a situation in which A. long-term instruments prevent investors from acting to take advantage of increases in interest rates. B. an investor cannot be guaranteed the same interest rate when rolling over short-term instruments. C. the investor suffers from an inability to liquidate short-term instruments at opportune times. D. an instrument cannot be transferred back into the domestic currency immediately. 17. The real interest rate is defined as the A. nominal interest rate plus the expected rate of price inflation. B. expected rate of price inflation minus the nominal interest rate. C. nominal interest rate minus the expected rate of price inflation. D. nominal interest rate divided by the expected rate of price inflation. 18. Using the expression for purchasing power parity, we can show that the difference in expected rates of inflation between countries is equal to the A. future spot rates on the currency exchange market. B. sum of nominal interest rate plus expected inflation. C. sum of the nominal interest rates in the two countries. D. expected rate of deprecation or appreciation of the domestic currency.

31 19. Deviations from real interest parity can be decomposed into deviations from A. absolute purchasing power parity and relative purchasing power parity. B. relative purchasing power parity and uncovered interest rate parity. C. covered interest parity and relative purchasing power parity. D. covered and uncovered interest parity. 20. A swap is a contract between parties in which the parties A. exchange flows of payments. B. agree to the future price of a currency exchange. C. exchange future cash flows for past cash flows. D. have the right to buy an underlying asset at a fixed price. Answer: A 21. One way to lock in a future interest rate is to buy A. a stock index option. B. a series of short-term bonds. C. an interest rate forward contract. D. a currency exchange forward contract. 22. The largest loss on a derivative deal to date has been on the order of A. $5 million. B. $50 million. C. $100 million. D. $1,500 million. 23. A long position is an obligation to whereas a short position is an obligation to. A. sell; purchase. B. purchase; sell. C. exercise a call; exercise a put. D. exercise a put; exercise a call.

32 24. A major difference between a forward contract and a future contract is that only a future contract is A. a standardized contract that is traded over an exchange. B. available exclusively from commercial banks. C. available for any amount and maturity. D. limited to large contracts. 25. If an investor wants to speculate on the direction of the entire stock market, the most efficient method would be to acquire A. a portfolio containing stocks of all traded companies. B. a portfolio of stocks and bonds. C. an exchange forward. D. a stock index future. 26. An option on a financial instrument gives the holder the A. right to purchase or sell an underlying financial instrument at a given price. B. obligation to purchase or sell an underlying financial instrument at a given price. C. right to purchase or sell an underlying financial instrument at its future spot price. D. obligation to purchase or sell an underlying financial instrument at its future spot price. 27. A call option gives the holder the right to an instrument whereas a put option gives the holder the right to. A. exercise; confiscate. B. sell; purchase. C. purchase; sell. D. transfer; sell. 28. The process of combining separate risk exposures that a firm faces in its foreign-currency-denominated payments and receipts into a single net risk exposure is referred to as

33 A. netting. B. hedging. C. consolidating. D. diversifying.

34 Chapter 6: International Banking, Central Banks, and Supranational Financial Policymaking Institutions 1. Financial intermediation refers to A. the dealings between private banks and the central bank of that nation. B. legislation which is directed toward the regulation of the banking industry. C. the calculations involved in pricing financial instruments. D. indirect finance through the services of financial institutions that channel funds from savers to investors. 2. The fact that on party in a financial transaction often possesses information not available to another party is known as A. uncertainty. B. ethical hazard. C. asymmetric information. D. the double coincidence of wants. Answer: C 3. An example of adverse selection is when A. investors choose the riskiest financial instruments in an attempt to gain maximum returns. B. only the least creditworthy firms will be willing to borrow. C. the poorest run banks are mostly likely to be audited. D. banks display a bias in their dealings with customers. 4. An example of moral hazard is when A. the borrower engages in more risky behavior after receiving the funds than would have been the case prior to receiving the funds. B. the risks associated with a floating rate loan far exceed those associated with a fixed rate loan. C. borrowed funds are used to fund only the most creditworthy borrowers. D. the possibility of default on a loan is reduced by background checks.

35 5. Financial intermediaries most typically take advantage of economies of scale by A. insisting upon only large deposits. B. holding part of their portfolios in equities. C. pooling the funds of many people together. D. switching form human to automated systems. 6. International financial diversification can best be described as A. holding financial instruments of various durations in order to spread portfolio risks. B. holding financial instruments issued in various countries to spread portfolio risks. C. investing in multinational firms traded on the domestic stock exchange. D. using information on global trends to help forecast domestic trends. 7. An advantage to holding a world index fund is that it contains a group of globally issued financial instruments which historically have A. had higher returns. B. outperformed the S&P. C. displayed a tendency to move together. D. displayed a tendency to move in offsetting directions. 8. Megabanks can be characterized as A. banks that are better able to experience economies of scale by expanding beyond home borders. B. banks that experience economies of scale only by limiting themselves to domestic operations. C. institutions that make only domestic and foreign loans by refrain from holding securities. D. institutions that hold only domestic and foreign securities but refraining from lending. 9. One way that British, German, and Japanese businesses differ form those in the United States is that British German, and Japanese businesses

36 A. are typically much smaller. B. do not deposit reserves with the central banks. C. integration in international financial markets is much more limited. D. use bank loans to finance significantly larger shares of their investment. 10. A key rationale for the traditional U.S. prohibition against universal banking was that A. U.S. bank managers typically did not have the expertise to participate in equity markets. B. U.S. banks were ill suited to handle the foreign exchange risk inherent in universal banking. C. the specialty of banks U.S. banks was their ability to take in deposits and loans. D. U.S. equity shares tended to be riskier than government securities. 11. For a government desiring a profitable, safe banking system, which of the following is not an argument for allowing banks to hold equities in their portfolios? A. Equities typically offer larger returns than bonds. B. Equity and bond returns have a tendency to move in opposite directions. C. Banks would be able to gain access to additional information about portfolio risks. D. Banks already do in effect hold equities by virtue of the fact that they provide loans to private firms. 12. When a bank's assets fall below the value of its liabilities it is said to be A. illiquid. B. insolvent. C. below par. D. inseparable. 13. When a bank is temporarily unable to honor depositors requests to withdraw funds, it is A. illiquid. B. insolvent. C. below par. D. inseparable.

37 14. The world s single largest payment system is located in A. the United States B. Europe. C. Japan. D. China. 15. The risk that late receipt of a payment may generate a loss for a bank is an example of A. systemic risk. B liquidity risk. C. Herstaat risk. D. credit risk. 16. The possibility that a bank may experience a loss due to failure to receive a promised payment is an example of A. liquidity risk B. systemic risk. C. Herstaat risk. D. credit risk. 17. If the failure of a domestic bank to make a promised payment to another domestic bank causes the latter bank to fail to honor its own obligations to another party, this is an example of A. liquidity risk B. systemic risk. C. Herstaat risk. D. credit risk. 18. If the failure of a foreign bank to make a promised payment to a domestic bank causes the latter bank to fail to honor its own obligations to another party, this is an example of

38 A. liquidity risk B. systemic risk. C. Herstaat risk. D. credit risk. 19. Which of the following is typically not offered by governments as a rationale for bank regulation? A. preventing bank insolvency B. maximizing bank efficiency C. preventing bank illiquidity D. maximizing bank profits 20. A fundamental difficulty typically involved in the regulation of banks is A. how to balance the tradeoffs between solvency and normal profits. B. determining which legislation is federal or state. C. how to gain access to their financial statements. D. avoidance of adverse selection. 21. The Basel capital requirements, which established international banking standards, stipulate that banks must keep the ratio of to risk-adjusted assets and the ratio of to risk-adjusted assets at 4% and 8%, respectively. A. supplementary capital; total capital B. core capital; total capital C. deposits; loans D. bonds; equities 22. Bank regulation based on private purchases and sales of banks' risk is known as: A. credit risk regulation. B. liquidity risk regulation. C. systemic risk regulation. D. market based risk regulation.

39 23. The earliest central banks were established in A. Egypt and China. B. Pakistan and India. C. the U.S. and Canada. D. Sweden and England. 24. The growth in the total number of central banks throughout the world can be described as A. gradually increasing throughout the 1800s and increasing dramatically in the 1900s. B. increasing dramatically in the 1800s but declining somewhat throughout the 1900s. C. declining sharply in the 1800s but rising rapidly in the 1900s. D. steadily increasing since the early 1700s. 25. The interest rate the Federal Reserve charges banks on loans is called the A. interbank loan rate. B. cost-of-carry rate. C. discount rate. D. LIBOR. 26. The central banks in Japan and Europe differ from the Federal Reserve in that they A. also play a large role in fiscal policy. B. utilize central bank advances much more prevalently. C. usually do not become involved in foreign exchange interventions. D. are privately owned by the banks within their financial system. 27. Assets issued by the IMF as a type of international currency intended to compensate for the declining role of gold as a basis for the world's currency system are called A. gold certificates. B. turnover accounts. C. special drawing rights. D. American deposit receipts.

40 28. In addition to conducting monetary policy, a primary function of most central banks includes A. performance of banking functions for their government and the provision of financial services to private banks. B. monitoring the workings of fiscal policy and providing recommendations to the banking sector. C. assistance in the management of private banks and provision of governmental budget estimates. D. facilitating information exchange among commercial banks and investment firms. 29. The phenomenon in which large numbers of bank customers lose confidence in the ability of banks and seek to liquidate their deposits is known as a A. daylight overdraft. B. bank lock out. C. bank run. D. buy out. 30. A central bank can prevent insolvency of private banks by A. allowing banks to invest in equities. B. owning small shares in each individual bank. C. serving as the financial system's lender of last resort. D. disallowing certain types of international financial transactions. 31. A Lombard rate is A. a negative real interest rate. B. a penalty rate set above other market interest rates. C. a tax on delayed payments which can trigger systematic risk. D. an interest rate that lies somewhere in value between a subsidy rate and the prevailing market rates.