Chapter 9

Question 1

Markets in which cash flows from the sale of products or assets denominated in a foreign currency are transacted
- may use own currency
- may use shared currency (euro, east caribbean)
- may use multiple currencies

Answer 1

foreign exchange markets

Question 2

Risk that cash flows will vary as the actual amount of U.S. dollars received on a foreign investment changes due to a change in foreign exchange rates.

Answer 2

foreign exchange risk

Question 3

When a country’s currency falls in value relative to other currencies, meaning the country’s goods become cheaper for foreign buyers and foreign goods become more expensive for foreign sellers.

Answer 3

currency depreciation

Question 4

When a country’s currency rises in value relative to other currencies, meaning that the country’s goods are more expensive for foreign buyers and foreign goods are cheaper for foreign sellers.

Answer 4

currency appreciation

Question 5

• required to pay in legal currency of seller’s country
• $78 billion dollars in good per day cross boarders
• $6.6 trillion in FOREX daily volume globally

Answer 5

international trade

Question 6

dollar backed by gold, other currencies tightly ‘pegged’ to dollar

Answer 6

bretton wood agreement (1944)

Question 7

the bretton woods agreement led to what situation

Answer 7

some currencies (such as US dollar) became overvalued and others (like the german mark) became undervalued
- smithsonian agreement of 1971 sought to address this situation

Question 8

1973: US ___ gold backing, world drops ___ ___

Answer 8

drops; dollar peg

Question 9

most currencies were backed by

Answer 9

gold/silver

Question 10

1944 gold redemption rates:

the rate of exchange was fixed by governments
- ___ pounds per ounce of gold
- ___ dollars per ounce of gold
- pound had to be worth = 7.96 dollars

Answer 10

4.25; 33.85

Question 11

simplify trade among european union member countries:

1999: exchanges rates ____
2002: national currencies phased out for ___

Answer 11

fixed; euro

Question 12

secondary benefit/curse: non-EU trade
- economic health drives the value of a fiat currency

2000s: ____ value
2010s: ____ value

Answer 12

increasing; decreasing

Question 13

The use of a foreign currency in parallel to, or instead of, the local currency.

Answer 13

dollarization

Question 14

major countries allowed the dollar to be devalued and the boundaries between which exchange rates could fluctuate were increased from 1% to 2 1/4%
- exchange rate boundaries were eliminated altogether

Answer 14

Smithsonian Agreement II

Question 15

trade tomorrow
- when matched to future transaction, zero volatility
- trade 1-6 months in the future

Answer 15

forward rates

Question 16

• leggett and platt (furniture)
• manufacture in china, sell in US –> Exchange risk (inputs)
• sell in china
  —> sell furniture to receive yuan
  –> generate sufficient yuan cash flow to cover inputs/manufacturing costs
  –> profit from sales in dollars independent of $/yuan exchange rate

Answer 16

hedging without forwards

Question 17

• first decade of 2000s the US experienced an increasing national debt that led to the ___ increasing value by 35% against the US dollar

Answer 17

euro

Question 18

in 2019 88% of all foreign exchange transactions were dominated in ___

32% were denominated in ___

-because 2 currencies are involved in each transaction the sum of % shares of individual currencies totals 200%

Answer 18

dollars; euros

Question 19

theorizes that nominal IR observed in financial markets must

(1) compensate investors for any reduced purchasing power due to inflationary price changes
(2) provide an additional premium above the expected rate of inflation for forgoing present consumption due to the time value of money (which reflect the real risk-free rate)

Answer 19

the fisher effect

Question 20

the country with the higher nominal interest rate will see its currency ____

Answer 20

depreciate

Question 21

The theory explaining the change in foreign currency exchange rates as inflation rates in the countries change.

Answer 21

purchasing power parity (PPP)

Question 22

according to PPP the most important factor determining exchange rates is in open economies, differences in ___ (and by implication, price level changes with inflation) drive ___ ___ and thus demand for and supplies of ____

Answer 22

prices; trade flows; currencies

Question 23

The theory that the domestic interest rate should equal the foreign interest rate minus the expected appreciation of the domestic currency.

Answer 23

interest rate parity theorem (IRPT)

Question 24

the IRPT a change in US interest rates, foreign interest rates, and expected exchange rates affect the __ __ __

Answer 24

current exchange rate

Question 25

hedge by taking a position in the forward or other derivative markets for foreign currencies
-ex: the one-year forward market for selling pounds for dollars

any forward position taken would not appear on the balance sheet
- instead it would appear as a contingent off-balance-sheet claim

Answer 25

hedging with forwards

Question 26

Foreign exchange transactions involving the immediate exchange of currencies at the current exchange rate.

Answer 26

spot foreign exchange transactions

Question 27

the role of the forward FX contract is to ___ the uncertainty regarding future spot rate on pounds at the end of the one-year investment horizon

Answer 27

offset

Question 28

The exchange of currencies at a specified exchange rate at some specified date in the future.

Answer 28

forward foreign exchange transaction

Question 29

foreign contracts are normally written in

Answer 29

one- ,three- , or six-month periods

Question 30

Summary of all transactions between citizens of two countries

Answer 30

balance of payment (international transactions) accounts

Question 31

the balance of payments is divided into 3 accounts:

Answer 31

(1) current account
(2) capital accounts
(3) financial accounts

Question 32

The section of the balance of payment table that summarizes foreign trade in goods and services, net investment income, and gifts, grants, or aid given to other countries.

Answer 32

current account

Question 33

The section of the balance of payment table that summarizes capital flows into and out of a country.

Answer 33

capital accounts

Question 34

The section of the balance of payments table that records transactions between U.S. residents and nonresidents for direct investment, portfolio investment, other investment, reserves, and financial derivatives other than reserves.

Answer 34

financial accounts

Question 35

result from the import of more foreign goods relative to the export of domestic goods

Answer 35

trade deficit (in goods)