chapter 7

Fundamentals of Multinational Finance, 3e (Moffett) Chapter 7

Foreign Exchange Rate Determination and Forecasting

7.1

Multiple Choice and True/False Questions

1)

The important thing to remember about foreign exchange rate determination is that parity conditions, asset approach, and balance of payments approaches are ________ theories rather than ________ theories.

A)

competing; complementary B)

competing; contemporary C)

complementary; contiguous D)

complementary; competing Answer:

D Topic:

Complementary Theories Skill:

Recognition

2)

Which of the following did NOT contribute to the exchange rate collapse in emerging markets in the 1990s?

A)

Infrastructure weaknesses. B)

Speculation on the part of market participants. 1

C)

The sharp reduction of cross-border foreign direct investment. D)

All of the above contributed to the emerging markets exchange rate collapse of the 1990s. Answer:

D Topic:

Market Collapse Skill:

Recognition

3)

It is safe to say that most determinants of the spot exchange rate are also affected by changes in the spot rate. i.e., they are linked AND mutually determined.

Answer:

TRUE Topic:

Determinants of Spot Exchange Rates Skill:

Conceptual

4)

A popular speculation in the 1990s was A)

U.S. investors investing in Japanese securities to take advantage of Japan's higher nominal and real interest rates.

B)

Japanese investors investing in the United States securities to take advantage of the higher U.S. nominal and real interest rates.

C)

selling short the U.S. dollar against the Russian Ruble. D)

None of the above was a popular speculation technique in the 1990s. 2

Answer:

B Topic:

International Speculation Skill:

Recognition

3

5)

The ________ provides a means to account for international cash flows in a standardized and systematic manner.

A)

parity conditions B)

asset approach C)

balance of payments D)

international Fisher effect Answer:

C Topic:

Balance of payments Skill:

Recognition

6)

Which of the following is NOT a current account activity? A)

Net import/export of goods (Balance of Trade). B)

Net import/export of services. C)

Net portfolio investment. D)

All of the above are activities of the current account. Answer:

C Topic:

4

Current Account Skill:

Conceptual

7)

The ________ approach argues that equilibrium exchange rates are achieved when the net inflow of foreign exchange arising from current account activities is equal to the net outflow of foreign exchange arising from financial account activities.

A)

balance of payments B)

monetary C)

asset market D)

law of one price Answer:

A Topic:

Exchange Rates Skill:

Recognition

8)

The ________ approach states that the exchange rate is determined by the supply and demand for national currency stocks, as well as the expected future levels and rates of growth of monetary stock

A)


monetary C)

asset market

5

D)


B Topic:


Recognition

9)

The ________ argues that exchange rates are determined by the supply and demand for a wide variety of financial assets

A)


monetary C)

asset market D)


C Topic:


Recognition

10)

Technical analysis of exchange rates developed in part due to the forecasting inadequacies of fundamental exchange rate theories.

Answer:

TRUE

6

Topic:


Conceptual

11)

The ________ approach to the determination of spot exchange rates hypothesizes that the most important factors are the relative real interest rate and a country's outlook for economic growth and profitability.

A)


parity conditions C)

managed float D)

asset market Answer:

D Topic:

Asset Market Skill:

Recognition

12)

The authors compromise as to the key factors for exchange rate determination. They conclude that ________ is important in the short run, but that ________ determines long run exchange rates.

A)

Fisher effect; PPP B)

asset markets, interest rates, and expectations; PPP C)

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PPP; Fisher effect D)

Fisher effect; asset prices, interest rates, and expectations Answer:

B Topic:

Key Factors for Equilibrium in Foreign Exchange Markets Skill:

Conceptual

13)

________, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future.

A)

Mappists B)

Trappist Monks C)

Filibusters D)

Technical analysts Answer:

D Topic:

Technical Analysis Skill:

Recognition

14)

The longer the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

Answer:

FALSE 8

Topic:

Technical Analysis Skill:

Conceptual

9

15)

Short-term foreign exchange forecasts are often motivated by such activities as ________ whereas long-term forecasts are more likely motivated by ________.

A)

long-term investment; long-term capital appreciation B)

long-term capital appreciation; desire to hedge a receivable C)

the desire to hedge a payable; the desire for long-term investment D)

the desire for long-term investment; the desire to hedge a payable Answer:

C Topic:


Recognition

16)

The more efficient the foreign exchange market is, the more likely it is that exchange rate movements are random walks.

Answer:

TRUE Topic:

Market Efficiency Skill:

Conceptual

17)

A major U.S. multinational firm has forecast the euro/dollar rate to be euro1.10/$ one year hence, and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this imply the company's expected rate for the euro per pound to be in one year?

A)

10

euro 1.40/£ B)

£1.40£/euro C)

£1.54/euro D)

euro 1.54/£ Answer:

D Topic:

Currency Cross Rates Skill:

Analytical

18)

The authors claim that theoretical and empirical studies appear to show that fundamentals do apply to the long-term for foreign exchange.

Answer:

TRUE Topic:


Recognition

19)

The authors claim that random events, institutional frictions, and technical factors may cause currency values to deviate significantly from their long-term fundamental path.

Answer:

TRUE Topic:


Recognition

11

20)

The authors claim that the theories of international currency values hold better for less liquid and poorly capitalized markets.

Answer:

FALSE Topic:


Recognition

12

21)

Which of the following was not an international currency crisis in the 1990s and early 2000s?

A)

The Asian Crisis B)

The Russian Crisis C)

The Argentine Crisis D)

All of the above were currency crises in the 1990s and 2000s. Answer:

D Topic:

International Currency Crises Skill:

Recognition

22)

The Asian Currency crisis appeared to begin in ________. A)

South Korea B)

Taiwan C)

Thailand D)

Japan Answer:

C Topic:

13


Recognition

23)

Prior to July 2, 1997, the Thai government A)

allowed the Thai Bhat to float against major currencies. B)

fixed the Bhat's value against the Korean won only. C)

fixed the Bhat's value against major currencies especially the U.S. dollar. D)

None of the above. Answer:

C Topic:


Recognition

24)

The "tequila effect" is a slang term used to describe a form of financial panic called ________.

A)

run on the market B)

speculation C)

contrary investing D)

contagion

14

Answer:

D Topic:


Recognition

25)

The authors did not identify which of the following as a root of the Asian currency crisis? A)

The collapse of some Asian currencies. B)

The rate of inflation in the United States. C)

Corporate socialism. D)

Banking stability and management. Answer:

B Topic:


Conceptual

15

26)

Corporate socialism in the Asian markets could be contributed in part A)

to the relatively short and stable post-WWII history of capitalism in their markets. B)

a belief by the owners of Asian companies that their governments would not allow them to fail.

C)

the practice of lifetime employment at many corporations. D)

all of the above. Answer:

D Topic:


Recognition

27)

The authors refer to the practice of many Asian firms being largely controlled by families of groups related to the governing body of the country as ________.

A)

illegal B)

insider trading C)

cronyism D)

not in my backyard Answer:

C Topic :

16


Recognition

28)

The principle focus of the IMF bailout efforts during the Asian financial crisis was ________. A)

banking liquidity B)

shareholder's wealth C)

reestablishing fixed currency exchange rates in Asia D)

dollarization of Asian currencies Answer:

A Topic:

Asian Crisis Skill:

Recognition

29)

In the years immediately preceding 1998 the Russian Ruble operated under a ________ type of exchange rate regime.

A)

fixed B)

free floating (market determined) C)

managed floating D)

pegged (to the U.S. dollar) 17

Answer:

C Topic:

Asian Crisis Skill:

Recognition

30)

________ is the official Chinese currency. A)

Baht B)

Won C)

Ringgit D)

Renminbi Answer:

D Topic:

Asian Crisis Skill:

Recognition

18

31)

The stability of the Russian Ruble in the 1990s (until the Russian debt crisis) was considered an observable success of the Yeltsin administration.

Answer:

TRUE Topic:

Russian Crisis Skill:

Recognition

32)

When the Russian Ruble reached the limits of the bands about its managed float targets (Ru5.70/$ to Ru6.35/$) in 1997, the Russian government would intervene in the markets to stabilize the Ruble. If the exchange rate approached Ru5.70/$ the government would ________ Rubles using foreign exchange and gold, or if the exchange rate approached Ru6.35/$ they would ________ Rubles.

A)

buy; sell B)

sell; buy C)

buy; buy D)

sell; sell Answer:

B Topic:


Conceptual

33)

After the Russian government (in August 1998) allowed the Ruble to move outside its official trading range of between Ru5.70/$-Ru6.35/$, the value of the Ruble eventually ________ to around ________ by May 1999.

19

A)

increased; Ru13/$ B)

increased; Ru4.50/$ C)

decreased; Ru13/$ D)

decreased; Ru25/$ Answer:

D Topic:


Recognition

34)

It is safe to say that the Russian transition from a communist economy to a capitalist economy has been smooth for the Russian people

Answer:

FALSE Topic:


Recognition

35)

The ________ is the Argentine currency unit. A)

peso B)

dollar C)

20

real D)

peseta Answer:

A Topic:

Argentine Crisis Skill:

Recognition

21

36)

Under a fixed exchange rate regime, the government of the country is officially responsible for:

A)

Intervention in the foreign exchange markets using reserves and gold. B)

Setting the fixed/parity exchange rate. C)

Maintaining the fixed/parity exchange rate. D)

All of the above. Answer:

D Topic:

Exchange Rate Equilibrium Skill:

Conceptual

37)

Which of the following is NOT a factor in determining exchange rate equilibrium? A)

relative inflation rates B)

relative interest rates C)

market expectations D)

All of the above are factors in determining equilibrium exchange rates. Answer:

D Topic:

22

Exchange Rate Equilibrium Skill:

Recognition

38)

The Asian currency crisis was primarily a A)

parity conditions problem. B)

an asset markets problem. C)

balance of payments problem. D)

PPP problem. Answer:

C Topic:

Asian Crisis Skill:

Recognition

39)

The Russian Ruble crisis of 1998 was a complex combination of speculative pressures best explained by ________ to exchange rate determination.

A)

parity conditions approach B)

asset approach C)

balance of payments approach D)

PPP approach

23

B Topic:


Recognition

40)

Which of the following is a driver in the determination of foreign exchange rates under the Asset Market Approach to forecasting?

A)

relative inflation rates B)

relative real interest rates C)

forward exchange rates D)

the current account balance Answer:

B Topic:

Relative Real Interest Rates Skill:

Recognition

24

41)

The U.S. economic bubble burst after the attacks of September 11, 2001. Which of the following could be considered a contributing factor to the U.S. economic downturn?

A)

a negative reassessment of long-term economic growth prospects in the U.S. B)

a newly formed level of political risk C)

lower expected earnings D)

all of the above Answer:

D Topic:

September 11, 2001 Skill:

Conceptual

42)

A currency board is A)

a structure, rather than a mere commitment, to limiting the growth of the money supply in the economy.

B)

a recipe for conservative and prudent financial management. C)

designed to eliminate the power of politicians to exercise judgment by relying on an automatic and unbendable rule.

D)

all of the above. Answer:

D

25

Topic:

Currency Board Skill:

Recognition

43)

In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis. Answer:

TRUE Topic:

Argentine Financial Crisis Skill:

Recognition

44)

Argentina's economic performance in the 1990s while their peso was pegged to the U.S. dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.

A)

high; high B)

low; low C)

low; high D)

high; low Answer:

C Topic:


Conceptual

26

45)

During the 1990s Argentina's exports became some of the least expensive in all of South America thanks in part to the pegging of the Argentine peso to the U.S. dollar.

Answer:

FALSE Topic:


Recognition

46)

One of the solutions to the Argentine peso crisis of 2003 was to devalue the peso to the approximate value of $2.00 per Argentine peso.

Answer:

TRUE Topic:


Recognition

27

47)

"Overshooting" exchange rate changes in response to an action of the Federal Reserve would be an example of

A)

a market inefficiency. B)

a market efficiency. C)

the Fisher Effect. D)

none of the above. Answer:

A Topic:

Market Inefficiency Skill:

Recognition

48)

The Chinese government announces that on December 31, 2006 the value of the Yuan will officially change from 8.287 Yuan/$ to 7.500 Yuan/$. This would be an official ________ of the Chinese currency of ________.

A)

revaluation; 9.50% B)

revaluation; 10.49% C)

devaluation; 9.50% D)

devaluation; 10.49% Answer:

B

28

Topic:

Currency Revaluation Skill:

Analytical

7.2

Essay Questions

1)

Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and contrast the motivation for and the techniques a forecaster might use for each of the time periods.

Answer:

Short-run forecasts are usually more tactical in nature as a firm may desire to reduce exchange rate risk associated with foreign receivable or payables. Technical factors and short-term market expectations are often more important for short-run forecasters than long-run parity or fundamental economic conditions.

Long-run forecasts are more strategic in nature as firms make key decisions about entering new foreign markets. Longer time horizons tend to be less accurate but also require less accuracy. What forecasters typically desire is a general long-run understanding of the relationships between markets. Fundamental analysis and parity conditions tend to be more important than technical factors in this type of forecasting.

2)

Describe the asset market approach to exchange rate determination. How is this consistent with economic theory of (say, security) prices in general?

Answer:

The asset market approach to exchange rate determination looks at relative interest rates and prospects for economic growth and profitability. This is consistent with the pricing of equity securities in that the price of a share of stock should reflect expectations about the timing, magnitude, and risk of future cash flows. In other words, expectations about what is to come is more important to the price of an asset, including currency prices, than what has occurred in the past.

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3)

Assume your country has a balance of payments surplus. How would the government and markets react to "correct" this imbalance under a fixed exchange rate regime? Under a floating exchange rate regime?

Answer:

A BOP surplus means there is a surplus demand for the country's currency most likely due to a surplus of exports of goods and services. Under a fixed exchange regime, the government is obligated to attempt to keep the BOP at or near zero. This surplus demand for currency means the government must supply it to the international markets by using currency to buy gold or foreign currencies in the international market place.

Under a floating exchange rate regime, the excess demand for the home currency would result in an appreciating currency on the foreign exchange markets. Demand for the currency would in theory push the value up, thus reducing exports, increasing imports, and moving the balance of payments toward equilibrium.

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chapter 7

Documents

d topic

c topic

b topic

equilibrium exchange

foreign exchange markets

asset market skill

balance of payments

price answer