MODULE 3

Question 1

is the conversion of one currency into another at a specific rate known as the ___. The conversion rates for almost all currencies are constantly floating as they are driven by the market forces of supply and
demand.

Answer 1

Foreign exchange (Forex or FX) / FOREIGN EXCHANGE RATE

Question 2

is a decentralized and over-the-counter market where all currency exchange trades occur. It is the largest (in terms of trading volume) and the most liquid market in the world.

one of the most accessible financial markets.

Answer 2

The Foreign Exchange Market

Question 3

is a theory regarding the relationship between the spot exchange rate and the expected spot rate or forward exchange rate of two currencies, based on interest rates. The theory holds that the forward exchange rate should be
equal to the spot currency exchange rate times the interest rate of the home country, divided by the interest rate of the foreign country.

Answer 3

The interest rate parity (IRP)

Question 4

refers to the state in which no-arbitrage is satisfied without the use of a forward contract.

IRP, the expected exchange rate adjusts so that
IRP holds. This concept is a part of the expected spot exchange rate determination.

Answer 4

Uncovered Interest Rate Parity

Question 5

refers to the state in which no-arbitrage is satisfied with
the use of a forward contract.

investors would be indifferent as to
whether to invest in their home country interest rate or the foreign country interest rate
since the forward exchange rate is holding the currencies in equilibrium. This concept is part of theforward exchange rate determination.

Answer 5

Covered Interest Rate Parity

Question 6

This theory states that the
exchange rate between currencies of two countries should be equal to the ratio of the countries’ price levels.

is a tool used to make multilateral comparisons between the national incomes and living standards of different countries.

Answer 6

Purchasing Power Parity (PPP)

Question 7

is measured by the price of a specified basket of goods and services.

Answer 7

purchasing power

Question 8

measures deviation from the condition of parity between two countries and
represents the total number of the baskets of goods and services that a single unit of a country’s currency can buy.

Answer 8

PPP ratio

Question 9

is the risk incurred due to the fluctuations in exchange rates before the contract is settled.

Answer 9

Transaction exposure

Question 10

Financial Techniques for Managing Transaction Exposure

Answer 10

• FORWARD CONTRACTS
• FUTURE CONTRACTS
• MONEY MARKET HEDGE
• OPTIONS

Question 11

Operational Techniques for Managing Transaction Exposure

Answer 11

• RISK SHIFTING
• CURENCY RISK SHARING
• LEADING AND LAGGING
• REINVOICING CENTERS

Question 12

If a firm is required to pay a specific amount of foreign currency in the future, it can enter into a contract that fixes the price for the foreign currency for a future date. This eliminates the chances of suffering due to currency fluctuations.

Answer 12

Forward Contracts

Question 13

are similar to ‘forward contracts. However, futures contracts have standardized and limited maturity dates, initial collateral and contract sizes.

Answer 13

Futures Contracts

Question 14

the forward price is equal to current spot price multiplied by the ratio of the currency’s riskless returns. This also creates the finance for the foreign currency transaction.

Answer 14

Money Market Hedge

Question 15

involve an upfront fee and do not oblige the owner to trade currencies at a specified price, time period and quantity.

Answer 15

options contracts

Question 16

The firm can completely avoid transaction exposure by not involving itself in foreign exchange at all. All the transactions can be conducted in the home currency. However,
this is not possible for all types of businesses.

Answer 16

Risk Shifting

Question 17

The two parties involved in the deal can have the understanding to share the transaction risk.

Answer 17

Currency Risk Sharing

Question 18

involve manipulating currency cash flows in accordance with the
fluctuations.

Answer 18

Leading and Lagging

Question 19

Paying off liabilities when the currency is appreciating IS KNOWN AS –

Answer 19

LEADING

Question 20

While collecting receivables when the currency is at a low value in called ___

Answer 20

LAGGING

Question 21

is a single third-party subsidiary used to conduct all intra-company
trades.

carry out transactions in domestic currency, thereby
bearing the losses from the transaction exposures.

Answer 21

Reinvoicing Centers

Question 22

refers to an effect caused on a company’s cash flows due to unexpected currency rate fluctuations. Economic

exposures are long-term in nature and have a substantial impact on a company’s market value.

Answer 22

Economic exposure, also known as operating exposure

Question 23

The following are the operational strategies which can be used to alleviate the risk of
economic exposure:

Answer 23

A. Diversifying Production Facilities and Markets for Products
B. Sourcing Flexibility
C. Diversifying Financing

Question 24

The following are the currency risk mitigation strategies which can be used to alleviate
the risk of economic exposure:

Answer 24

A. Matching Currency Flows
B. Currency Risk-Sharing Agreements
C. Back-to-Back Loans
D. Currency Swaps