University of Delaware International Finance Paper

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Shapiro6thTESTBANK Chapter 1 CHAPTER 1 Introduction EASY 1.1 Historically, the primary motive for U.S. multinationals to produce abroad has been to a. lower costs b. respond more quickly to the marketplace c. avoid trade barriers d. gain tax benefits ANSWER: b: evolution of multinational 1.2 The primary objective of the multinational corporation is to a. maximize shareholder wealth b. maximize world production c. minimize debt d. minimize the cost of doing business globally ANSWER: a: Multinational Financial Management: Theory and Practice 1.3 ____________ is defined as the purchase of assets or commodities on one market for immediate resale on another in order to profit form a price discrepancy. a. internationalization b. arbitrage c. financing d. total risk ANSWER: b: evolution of multinational 1.4 The value of good financial management is ___________ in the global markets because of the much greater probability of market imperfections and multiple tax rates. a. minimized b. neutralized c. enhanced d. arbitraged away ANSWER: c: role of the financial executive 1.5 When a firm operates globally it offers advantages such as a. greater political power at home b. less taxes on its profits c. greater negotiating power with foreign minority groups d. greater negotiating power with labor unions ANSWER: d: rise of the multinational Shapiro6thTESTBANK Chapter 1 1.6 The prime transmitter of global competitive forces is the a. public utility firm b. financial management experience of the U.S. markets c. the multinational corporation d. the Federal Reserve System of the U.S. ANSWER: c: rise of the multinational 1.7 ___________ were the earliest multinationals. a. raw-material seekers b. market seekers c. cost minimizers d. oil companies. ANSWER: a: raw material seekers 1.8 The ___________ are the archetype of the modern multinational firm that goes overseas to produce and sell in foreign markets. a. cost minimizers b. market seekers c. raw-material seekers d. whaling companies ANSWER: b: market seekers 1.9 ___________ are a recent category of multinationals that seek out and invest in lower cost production sites overseas. a. Cost minimizers b. Market seekers c. Raw-material seekers d. High tech firms ANSWER: a: cost minimizers 1.10 Which one of the following is a consequence of increased global competition? a. the creation of new steel plants in the old industrial countries b. the end of free-trade agreements between governments of the world c. increased comfort level of trade unions with the consequences d. increased anxiety among workers in the old industrial countries ANSWER: d: Consequences of Global Competition 1.11 The defenders of multinationals believe that __________ are the appropriate reward for efficiently providing the global economy with products and services. a. profits b. subsidies c. tax holidays d. low-interest, government-subsidized loans ANSWER: a: Criticisms of the Multinational Corporation Shapiro6thTESTBANK Chapter 1 1.12 International ________ can reduce the volatility of an investment portfolio because national financial markets tend to move independently of each other. a. arbitrage b. centralization of the MNC’s cash c. diversification d. investment ANSWER: c: The Importance of Total Risk MODERATE 1.13 Into which category of multinational is IBM most likely to fall? a. raw materials seeker b. market seeker c. cost minimizer d. all of the above ANSWER: b: market seeker 1.14 Which one of the following did NOT accelerate the growth of the global economy in the past decade? a. the U.S.-Canada-Mexico free-trade pact b. the creation of the European Union c. China’s entrance into the WTO d. The Southeast Asia Currency Crisis ANSWER: d: Consequences of Global Competition 1.15 The multinational financial system enables companies to a. avoid currency controls b. reduce taxes c. access lower cost financing sources d. all of the above ANSWER: d: rise of the multinational 1.16 An alternative to the set up of an production facility overseas is to license a local firm to manufacture the company’s products. One disadvantage of this method is a. the establishment of a competitor with loss of future revenues to the licensing firm b. the time to market entry c. the degree of financial and legal risks d. the amount of the investment required ANSWER: a: The Process of Overseas Expansion Shapiro6thTESTBANK Chapter 1 1.17 Which of the following is an example of reverse foreign investment for the U.S.? a. Honda builds a factory in Ohio b. Apple builds a plant in Ireland that exports to the United States c. British Telecom issues new stock in the United States d. American investors buy shares in Sony ANSWER: a: market seeker 1.18 Which of the following is NOT a failing of the theory of comparative advantage? a. it ignores the role of uncertainty and economies of scale b. it assumes that factors of production are relatively immobile c. it assumes that there are no differentiated products d. it deals with trade only differentiate rather than undifferentiated products ANSWER: d: rise of the multinational DIFFICULT 1.19 Which of the following theories identifies specialization as the main reason for international business activity? a. product life cycle theory of international trade b. theory of diversification c. doctrine of comparative advantage d. theory of globalization ANSWER: c: rise of the multinational 1.20 Critics of the multinational corporation would NOT fault its tendency to a. shift production from one location to another in search of lower costs b. avoid taxes c. cause balance of payments difficulties d. engage in environmental protection measures ANSWER: d: criticisms of the MNC 1.21 Multinational firms would most likely be a. riskier than purely domestic firms because of the exposures of operating abroad b. less risky than purely domestic firms because of international diversification c. less risky than domestic firms if the added risks of operating overseas are more than offset by the ability to operate in nations whose economic cycles are not perfectly in phase d. invested in developed countries only and avoid developing economies ANSWER: c: the importance of total risk 1.22 According to the capital asset pricing model Shapiro6thTESTBANK Chapter 1 a. b. c. d. ANSWER: only the systematic component of risk affects the required return foreign investments whose returns are uncorrelated with the market's return should have a higher required return than comparable domestic investments total risk of the investment is most relevant for small to medium-sized firms diversification is secondary to risk levels of the investment a: capital asset pricing 1.23 The internationalization process most likely tends to a. proceed in a preprogrammed series of steps b. begin by licensing foreign producers c. inevitably involve foreign production d. begin by exporting ANSWER: d: capital asset pricing 1.24 According to the efficient market hypothesis, which one of the following is NOT correct? a. markets place a premium on the future b. today’s stock price is the best predictor of tomorrow’s stock price c. stock prices reflect all available information d. today’s stock price incorporates the past history of prices ANSWER: a: market efficiency 1.25 Which one of the following provides strong evidence that internationalization continues to grow in the world economy? a. import restrictions by the Bush Administration on foreign steel b. efforts suggested by politicians to restrict the sourcing of foreign products by locally headquartered multinationals c. the growing volume of foreign direct investment by U.S. as well as other multinational companies d. pressure on governments to embargo unfriendly nations ANSWER: c: Evolution of the Multinational Corporation 1.26 For the multinational corporation, which one of the following complements to the integration of world wide operations is MOST critical? a. flexibility b. adaptability c. speed d. economies of scale of distribution ANSWER: c: A Behavioral Definition of the Multinational Corporation Shapiro6thTESTBANK Chapter 1 1.27 According to Shapiro, if you were the CEO of a multinational corporation, which of the following would be MOST important to you in hiring a manager? One that a. Avoids risk at any price b. Manages effectively the political environment of the subsidiary country c. Anticipates every future disturbance related to the supply chain d. Makes decisions that anticipates problems and provides solutions that enhances the firm’s prospects for growth ANSWER: d: The Global Manager CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES EASY 2.1 The explanation for the rise of the U.S. dollar during the early 1980s is that a. the U.S. budget deficit lowered U.S. interest rates b. the U.S. trade deficit caused more U.S. inflation c. the U.S. budget deficit raised U.S. interest rates d. the U.S. economy deteriorated dramatically ANSWER: c: Expectations and the Asset Market Model of Exchange Rates 2.2 The U.S. dollar weakened during the 1970s because a. control of Congress changed political parties b. the U.S. economy grew c. foreigners wanted to hold more dollars than before d. U.S. inflation accelerated ANSWER: d: Expectations and the Asset Market Model of Exchange Rates 2.3 Exchange rates depend on a. relative inflation rates b. relative interest rates c. relative trade deficits d. a and b ANSWER: d: The Nature of Money and Currency Values 2.4 Beginning in 1997, the ruble came under attack by speculators and resulted in accelerating a. stock market prices b. capital flight c. efforts by the Russian government to address the root causes of the crisis d. decontrol by the government on the foreign exchange market ANSWER: b: Illustration The Ruble is Rubble 2.5 During the second half of 1997, currencies and stock market prices plunged in value across Southeast Asia, beginning in a. Thailand b. Malaysia c. Indonesia d. South Korea ANSWER: a: Asian Currencies Sink in 1997 2.6 The asset market view of exchange rate determination says that the spot rate a. b. c. d. ANSWER: should follow a random walk is affected primarily by a nation's long-run economic prospects both a and b should be strongly affected by a nation's balance of trade c: Expectations and the Asset Market Model of Exchange Rates 2.7 When monetary authorities have not insulated their domestic money supplies from the foreign exchange transactions, it is known as ________ intervention. a. unsterilized b. sterilized c. foreign market d. subsidized ANSWER: a: Sterilized versus Unsterilized Intervention 2.8 When the U.S. Federal Reserve sells or purchases Treasury securities in order to sterilize the impact of their foreign exchange market interventions, it is referred to as a(n) ________ operation. a. floating currency b. spot rate c. revaluation d. open market ANSWER: d: Sterilized versus Unsterilized Intervention 2.9 Under which one of the following systems is there no central bank? a. Floating exchange rates b. Currency board c. Pegged exchange rates d. Sterilized intervention ANSWER: b: Central Bank Reputations MODERATE 2.10 On Friday, September 13, 1992, the lira was worth DM 0.0013. Over the weekend the lira devalued against the DM to DM 0.0012. By how much had the lira devalued against the DM? a. 7.69% b. 8.33% c. 5.21% d. 9.27% ANSWER: a: Setting the Equilibrium Spot Exchange Rate 2.11 Suppose that the Brazilian real devalues by 40% against the U.S. dollar. By how much will the dollar appreciate against the real? a. 67% b 40% c. 32% d. 28% ANSWER: a: Setting the Equilibrium Spot Exchange Rate 2.12 If the French euro devalued by 17% against the U.S. dollar, this is equivalent to a revaluation of the dollar against the euro by a. 17% b. 16.31% c. 20.48% d. 17.54% ANSWER: c: Setting the Equilibrium Spot Exchange Rate 2.13 If the Australian dollar devalues against the Japanese yen by 10%, the yen will appreciate by a. 33.32% b. 25.55% c. 10.11% d. 11.11% ANSWER: d: Setting the Equilibrium Spot Exchange Rate 2.14 If the euro depreciates against the U.S. dollar by 50%, the dollar appreciates against the euro by a. 55% b. 100% c. 200% d. 1,000% ANSWER: b: Setting the Equilibrium Spot Exchange Rate 2.15 If the U.S. dollar appreciates against the Nigerian naira by 150%, the naira depreciates against the dollar by a. 60% b. 75% c. 125% d. 300% ANSWER: a: Setting the Equilibrium Spot Exchange Rate 2.16 If the dinar devalues against the U.S. dollar by 45%, the U.S. dollar will appreciate against the dinar by a. 45% b. 82% c. 55% d. 32% ANSWER: b: Setting the Equilibrium Spot Exchange Rate 2.17 If the peso depreciates against the U.S dollar by 80%, the US dollar will appreciate against the peso by a. 300% b. 200% c. 250% d. 400% ANSWER: d: Setting the Equilibrium Spot Exchange Rate 2.18 If the U.S. dollar appreciates against the euro by 25%, the euro will depreciate against the U.S. dollar a. 25% b. 20% c. 30% d. 10% ANSWER: b: Setting the Equilibrium Spot Exchange Rate 2.19 If a foreigner purchases a U.S. government security a. the supply of dollars rises b. the federal government deficit declines c. the demand for dollars rises d. the U.S. money supply rises ANSWER: c: Setting the Equilibrium Spot Exchange Rate 2.20 The price of foreign goods in terms of domestic goods is called a. the real exchange rate b. the balance of trade c. the trade-weighted exchange rate d. purchasing parity ANSWER: a: The Fundamentals of Central Bank Intervention 2.21 An increase in the real exchange rate will a. raise national income b. lower national income c. make a country less competitive in international trade d. ANSWER: raise the cost of foreign goods c: The Fundamentals of Central Bank Intervention 2.22 A slowdown in U.S. economic growth will a. boost the value of the dollar because inflation fears will be calmed b. boost the value of the dollar because the Federal Reserve will expand the money supply c. lower the value of the dollar because the U.S. will be a less attractive place to invest in d. lower the value of the dollar because interest rates will rise ANSWER: c: The Fundamentals of Central Bank Intervention 2.23 The willingness of people to hold money a. increases with the interest rate b. rises with price stability c. rises with national income d. b and c only ANSWER: d: The Fundamentals of Central Bank Intervention 2.24 Sound economic policies will a. raise the value of a nation's currency by boosting the economy b. lower the value of a nation's currency by increasing the precautionary demand for money c. lower the value of a nation's currency by leading to lower interest rates d. both b and c ANSWER: a: The Fundamentals of Central Bank Intervention 2.25 Large government budget deficits will a. raise the value of a nation's currency by raising domestic interest rates b. raise the value of a nation's currency by stimulating the domestic economy c. lower the value of a nation's currency by leading to higher inflation d. lower the value of a nation's currency by leading to added political risk e. historical experience shows no correlation between government budget deficits and the value of the nation's currency ANSWER: e: The Nature of Money and Currency Values DIFFICULT 2.26 Which type of money is MOST likely to see its value fluctuate in the foreign exchange market? a. fiat money b. c. d. ANSWER: commodity money price-indexed money pegged-exchange rate a: Central Bank Reputations and Currency Values 2.27 An increase in the supply of U.S. dollars by the Federal Reserve will a. raise the value of the dollar because it will stimulate U.S. economic growth b. raise the value of the dollar because it will lead to higher U.S. interest rates c. reduce the value of the dollar because of inflation fears in the United States d. decrease the value of the dollar because it will force other countries to raise their interest rates ANSWER: c: The Fundamentals of Central Bank Intervention 2.28 Which one of the following is probably the best advice for governments when it comes to exchange rate arrangements? a. The complete replacement of the local currency with the U.S. dollar. b. Currency boards are the next best arrangement after fixed exchange rates. c. There is no substitute for good macroeconomic policy. d. Fixed exchange rates are the most completely sound and credible. ANSWER: c: Central Bank Reputations 2.29 Which of the following is an example of foreign exchange market intervention? a. the U.S. government pays Social Security checks to pensioners living in Poland b. IBM sells euros it received in international trade c. the Canadian government pays interest to Saudi Arabian investors d. the Japanese central bank sells yen in the foreign exchange market to prop up the value of the yen ANSWER: d: The Fundamentals of Central Bank Intervention 2.30 During 1995, the yen went from $0.0125 to $0.0095238. By how much did the dollar appreciate against the yen? a. 23.81% b. 31.25% c. 15.67% d. 40.78% ANSWER: b: Setting the Equilibrium Spot Exchange Rate 2.31 Which one of the following effects would MOST likely be caused by a government artificially holding its currency value down? a. a massive rise in foreign exchange reserves. b. the value of the nation’s exports rises dramatically c. d. ANSWER: the outsourcing a the nation’s manufacturing jobs to offshore markets a growing trade deficit with foreign economies a: Central Bank reputation CHAPTER 3 The International Monetary System EASY 3.1 The ________ is an exchange rate system that is relatively free from central bank and other government interventions. a. managed float b. clean float c. dirty float d. target-zone arrangement ANSWER: b: Free Float 3.2 When government intervention attempts to reduce for exporters and importers the uncertainty caused by disruptive exchange rate changes for the short and medium term, it is referred to as _________. a. smoothing out daily fluctuations b. leaning against the wind c. unofficial pegging d. a dirty float ANSWER: b: Managed Float 3.3 Under a _________, countries adjust their national economic policies to maintain their exchange rates within a specific margin around agreed-upon, fixed central exchange rates. a. managed float b. ‘beggar-thy-neighbor” devaluation c. dirty float d. target-zone agreement ANSWER: d: Target-Zone Agreement 3.4 ________ is nonconvertible paper money backed only by faith that the monetary authorities will not issue more money. a. Specie b. Fiat money c. Seignorage d. Par value ANSWER: b: the classical gold standard 3.5 Under the classic gold standard, if prices began rising in the U.S. a. the dollar value of the pound would rise b. the dollar value of the pound would fall c. the U.S. would begin running a balance of trade surplus d. gold would flow out of the U.S. and the U.S. money supply would drop ANSWER: d: the classical gold standard 3.6 The Bretton Woods system a. ended in 1971 b. ended in 1939 when World War II began c. is currently the basis for the international monetary system d. is currently in use only by the major industrial nations ANSWER: a: introduction 3.7 The current exchange rate system can best be characterized as a a. free float b. managed float c. target-zone arrangement d. fixed-rate system e. hybrid system ANSWER: e: the current system of exchange rate determination 3.8 Managed floats would NOT fall into which of the following categories of central bank intervention? a. smoothing out daily fluctuations b. leaning against the wind c. unofficial pegging d. target-zone arrangements ANSWER: d: managed float 3.9 The European Monetary System is best described as a a. clean float b. target-zone arrangement c. dirty float d. managed float ANSWER: b: the European monetary system 3.9 A weak peso is most likely to cause a. added employment and inflation in Mexico b. less unemployment but more inflation in Mexico c. more unemployment but less inflation in Mexico d. less unemployment and less inflation in Mexico ANSWER: b: emerging market currency crises 3.10 The Bretton Woods system fell apart because a. of the oil crisis b. U.S. monetary policy was too expansionary c. the United States ran a large trade deficit d. the United States no longer supported a pegged gold standard ANSWER: b: the Bretton Woods System 3.11 The gold standard was dissolved in 1973 because a. the U.S. printed too many dollars to maintain gold at $35/oz b. some countries preferred to hold gold instead of dollars c. high interest rates raised the cost of holding gold d. a and b only ANSWER: d: the post-Bretton Woods System 3.12 The rising dollar in the early 1980s can be attributed to a. high real interest rates in the United States b. improved investment prospects in the United States c. the growing U.S. budget deficit d. a and b only ANSWER: d: the rising dollar: 1980-1985 3.13 The fall of the dollar beginning in 1985 can be attributed to a. the growing U.S. budget deficit b. the large U.S. trade deficit c. rapid U.S. economic growth d. the slowdown in U.S. economic growth relative to growth overseas ANSWER: d: the sinking dollar: 1985-1987 MODERATE 3.14 The characteristic of gold that is most important to the success of a gold standard is that it is a. portable b. storable c. easily standardized d. expensive to produce ANSWER: d: the classical gold standard 3.15 A gold standard ensures a long-run tendency toward price stability because a. gold is desirable b. gold is durable and storable c. the cost of producing an ounce of gold stays relatively constant overtime d. gold supply is directly related to consumer satisfaction ANSWER: c: the classical gold standard 3.16 Calls for a new gold standard reflect a. fundamental distrust of government's willingness to maintain the integrity of fiat money b. a general willingness to accept fiat money c. a short memory of what actually transpired under the gold standard d. the durability and desirability of gold ANSWER: a: the classical gold standard 3.17 Under the gold standard a. price levels rose dramatically b. price levels stayed constant over time c. the long-run stability of the price level includes alternating periods of inflation and deflation d. fiat money is more valuable ANSWER: c: the classical gold standard 3.18 Under a fixed-rate system, a country that followed policies that would lead to a higher rate of inflation than that experienced by its trading partners would a. experience a balance-of-payments deficit as its goods became more expensive b. see a decrease in the supply of its currency on the foreign exchange markets c. find its currency exchange rate subject to upward pressure d. experience a balance-of-payments surplus. ANSWER: a: fixed-rate system 3.19 Under a fixed-rate system, a country that followed policies leading to a lower inflation rate than that experienced by its trading partners would a. come under pressure to expand its money supply b. restrict the growth of its money supply c. experience a balance-of-payments deficit d. be forced to buy its currency in the foreign exchange market ANSWER: a: fixed-rate system 3.20 Underlying the emerging markets currency crises is a fundamental conflict among policy objectives that the target nations have failed to resolve. Which one of the following is NOT? a. IMF bailouts b. fixed exchange rates c. independent domestic monetary policy d. free capital movement ANSWER: a: emerging market currency crises DIFFICULT 3.21 In a fixed-rate system, central banks maintain currency values by a. reducing the money supplies of nations with overvalued currencies b. boosting the money supplies of nations with undervalued currencies c. buying up overvalued currencies in the foreign exchange market d. buying undervalued currencies in the foreign exchange market ANSWER: d: fixed-rate system 3.22 Governments intervene in the foreign exchange markets for all of the following except to a. b. c. d. ANSWER: earn foreign exchange reduce economic uncertainty improve the nation's export competitiveness reduce inflation a: managed float 3.23 Under a fixed-rate system, which of the following four alternatives to devaluation is MOST likely to succeed? a. foreign borrowing b. austerity c. wage and price controls d. exchange controls ANSWER: b: fixed-rate system 3.24 In order to boost the value of the euro relative to the dollar a. the Fed should sell dollars for euros and the European central bank should buy DM with dollars b. the Fed should sell dollars for euros and the European central bank should buy dollars with euros c. the Fed should sell euros for dollars and the European central bank should sell dollars for DM d. the Fed should sell DM for dollars and the European central bank should buy euros with dollars ANSWER: a: managed float CHAPTER 4 Parity Conditions in International Finance and Currency Forecasting EASY 4.1 A currency is said to be at a forward _________ if the forward rate is below the spot rate. a. discount b. premium c. position d. forward ANSWER: a: arbitrage and the law of one price 4.2 The theory of relative purchasing power parity states that, between two nations, the a. inflation rates are unrelated b. exchange rate difference reflects the inflation rate difference c. inflation rate is greater in weaker currencies d. the interest rate is greater than the inflation rate during depreciations ANSWER: b: purchasing power parity 4.3 The Fisher effect states that the _________ rate is made up of a real required rate of return and an inflation premium. a. nominal exchange b. real exchange c. nominal interest rate d. adjusted dividend ANSWER: c: The Fisher Effect 4.4 A rise in the inflation rate in one nation relative to others will be associated with a fall in the first nation’s exchange rate and with a rise of its interest rate relative to foreign interest rates. The two conditions combined result in the _________ Effect. a. Fisher b. Herstatt c. Unbiased forward rate d. International Fisher ANSWER: d: The Fisher effect 4.5 The purchase of currency on one market for immediate resale in another market in order to profit from the rate discrepancy is known as _________. a. arbitrage b. financial innovation c. a line of credit d. countertrade 4.6 In its absolute version, _______ states that price levels should be equal worldwide when expressed in a common currency. a. interest rate parity b. purchasing power parity c. the international Fisher effect d. covered interest arbitrage 4.7 When there is a relative shortage of capital and high political risk in most developing countries, it is likely to drive real interest rates in these countries to a. decline below real interest rates in developed countries b. exceed nominal interest rates in developed countries c. exceed rate interest rates in developed countries d. parity conditions in all developing countries MODERATE 4.8 Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%, respectively, over the next several years. If the current spot rate for the Mexican peso is $.005, then the best estimate of the peso's spot value in 3 years is a. $.00276 b. $.01190 c. $.00321 d. $.00102 ANSWER: d: purchasing power parity 4.9 If the expected inflation rate is 5% and the real required return is 6%, then the Fisher effect says that the nominal interest rate should be a. 1% b. 11.3% c. 11% d. 6% ANSWER: b: The Fisher Effect 4.10 The inflation rates in the U.S. and France are expected to be 4% per annum and 7% per annum, respectively. If the current spot rate is $.1050, then the expected spot rate in three years is a. $.1150 b. $.1112 c. $.0964 d. $.0992 ANSWER: c: purchasing power parity 4.11 If inflation in the U.S. is projected at 5% annually for the next 5 years and at 12% annually in Italy for the same time period, and the lira/$ spot rate is currently at L2400 = $1, then the PPP estimate of the spot rate five years from now is a. 1738 b. 3314 c. 2560 d. 2250 ANSWER: b: purchasing power parity 4.12 If expected inflation is 20% and the real required return is 10%, then the Fisher effect says that the nominal interest rate should be exactly a. 30% b. 32% c. 22% d. 12% ANSWER: b: The Fisher effect 4.13 Annual inflation rates in the U.S. and Greece are expected to be 3% and 8%, respectively. If the current spot rate for the drachma is $.007, then the expected spot rate in three years is a. $.00607 b. $.00823 c. $.00751 d. $.00694 ANSWER: a: purchasing power parity 4.14 If a country's freely floating currency is undervalued in terms of purchasing power parity, its capital account is likely to be a. in deficit or tending toward a deficit b. in surplus or tending toward a surplus c. Subsidized by the International Monetary Fund d. a candidate for loans from the World Bank ANSWER: a: purchasing power parity 4.15 If the average rate of inflation in the world rises from 5% to 7%, this will tend to make forward exchange rates move toward a. smaller premiums or larger discounts in relation to the dollar b. larger premiums or smaller discounts in relation to the dollar c. no change on average d. can't tell what will happen ANSWER: c: purchasing power parity 4.16 A 150% real return in Brazil is higher than a 15% dollar return in the U.S. a. because arbitrage opportunities exist b. when the inflation controls are suspended in Brazil c. it depends on whether these are nominal or real returns d. regardless of nominal or real returns ANSWER: c: purchasing power parity 4.17 Annual inflation rates in the U.S. and Italy are expected to be 4% and 7%, respectively. If the current spot rate is $1 = L2,000, then the expected spot rate for the lira in three years is a. $.0004591 b. $.0011590 c. $.0009892 d. $.0005471 ANSWER: a: purchasing power parity 4.18 Annual inflation rates in the U.S. and France are expected to be 4% and 6%, respectively. If the current spot rate is $.1250/FF, then the expected spot rate in two years is a. $.1299 b. $.1150 c. $.1203 d. $.1335 ANSWER: c: purchasing power parity 4.19 Suppose five-year deposit rates on Eurodollars and Euromarks are 12% and 8%, respectively. If the current spot rate for the mark is $0.50, then the spot rate for the mark five years from now implied by these interest rates is a. .5997 b. .4169 c. .5185 d. .4821 ANSWER: a: the international Fisher effect 4.20 The direct spot quote for the Canadian dollar is $.76 and the 180-day forward rate is $.74. The difference between the two rates is likely to mean that a. inflation in the U.S. during the past year was lower than in Canada b. interest rates are rising faster in Canada than in the U.S. c. prices in Canada are expected to rise more rapidly than in the U.S. d. the Canadian dollar's spot rate is expected to rise in terms of the U.S. dollar ANSWER: c: interest rate parity theory 4.21 The spot rate on the Dutch guilder is $0.39 and the 180-day forward rate is $0.40. The difference between the spot and forward rates means that a. interest rates are higher in the U.S. than in the Netherlands b. the guilder has risen in relation to the dollar c. the inflation rate in the Netherlands is declining d. the guilder is expected to fall in value relative to the dollar there is a high inflation rate in the U.S. ANSWER: a: interest rate parity theory 4.22 Suppose the price indexes in Mexico and the U.S., which both began the year at 100, are at 160 and 103, respectively, by the end of the year. If the exchange rate began the year at Mex$4.5 = $1 and ended the year at Mex$5.9 = $1, then the change in the real value of the peso (a "-" indicates a real devaluation) during the year is a. 0% b. -5.0% c. 18.5% d. -8.2% ANSWER: c: purchasing power parity 4.23 Suppose the spot rates for the pound, mark, and Swiss franc are $1.20, $.32, and $.40, respectively. The associated 90-day interest rates (annualized) are 16%, 8%, and 4%, while the U.S. 90-day interest rate is 12%. What is the 90-day forward rate (to the nearest cent) on a TCU (TCU 1 = £1 + DM1 + SFr1) if interest parity holds? a $1.92 b $1.98 c $1.94 d $1.87 ANSWER: a: interest rate parity theory 4.24 The current five-year Euroyen rate is 6% per annum (compounded annually). The five-year Eurodollar rate is 8.5%. What is the implied forward premium or discount of the yen (over the current spot rate) for a five-year forward contract? a. 4.17% premium b. 18.46% discount c. 11.00% discount d. 12.36% premium ANSWER: d: interest rate parity theory 4.25 Suppose the spot rates for the pound, mark, and Swiss franc are $1.50, $.42, and $.48, respectively. The associated 90-day interest rates (annualized) are 12%, 6%, and 4%, while the U.S. 90-day interest rate (annualized) is 8%. What is the 90-day forward rate on a DCU (DCU 1 = £1 + DM1 + SFr1) if interest parity holds? a. $2.4027 b. $2.3923 c. $2.4196 d. $2.3738 ANSWER: b: interest rate parity theory 4.26 Suppose that spot pounds are selling at $1.7342, while 90-day forward pounds are selling at $1.7156. At the same time, DM spot and 90-day forward rates are $0.6138 and $0.6014, respectively. According to these quotes the a. pound is selling at a 3.87% forward discount relative to the DM b. pound is selling at a 2.37% forward premium relative to the DM c. DM is selling at a 0.97% forward discount relative to the pound d. DM is selling at a 1.54% forward premium relative to the pound ANSWER: a: interest rate parity theory 4.27 If annualized interest rates in the U.S. and France are 9% and 13%, respectively, and the spot value of the franc is $.1109, then at what 180-day forward rate will interest rate parity hold? a. $.1070 b. $.1150 c. $.1088 d. $.1130 ANSWER: c: interest rate parity theory 4.28 If annualized interest rates in the U.S. and Switzerland are 10% and 4%, respectively, and the 90-day forward rate for the Swiss franc is $.3864, at what current spot rate will interest rate parity hold? a. $.3902 b. $.3874 c. $.3807 d. $.3792 ANSWER: c: interest rate parity theory 4.29 The spot rate on the euro is $1.40 and the 180-day forward rate is $1.50. The difference between the two rates means a. interest rates are higher in the U.S. than in the European Union b. the mark has risen in relation to the dollar c. the inflation rate in Germany is declining d. the euro is expected to fall in value relative to the dollar ANSWER: a: interest rate parity theory 4.30 Suppose the spot rates for the pound, mark, and Swiss franc are $1.30, $.35, and $.40, respectively. The associated 90-day interest rates (annualized) are 16%, 8%, and 4%, while the U.S. 90-day interest rate (annualized) is 12%. What is the 90-day forward rate on an ACU (ACU 1 = £1 + DM1 + SFr1) if interest parity holds? a. $2.0512 b. c. d. ANSWER: $2.1134 $2.0397 $2.0489 d: interest rate parity theory 4.31 The current five-year Euroyen and Eurodollar rates are 8% and 12.5% per annum, respectively. What is the implied forward premium or discount of the yen (over the current spot rate for a five-year forward contract)? a. 4.17% premium b. 18.46% discount c. 17.74% discount d. 22.64% premium ANSWER: d: interest rate parity theory 4.32 The 90-day interest rates (annualized) in the U.S. and Japan are, respectively, 10% and 7%, while the direct spot quote for the yen in New York is $.004300. At what 90-day forward rate would interest rate parity hold? a. .004430 b. .004271 c. .004332 d. .004176 ANSWER: c: interest rate parity theory 4.33 If annualized interest rates in the U.S. and France are 9% and 13%, respectively, and the spot value of the franc is $.1109, then at what 180-day forward rate will interest rate parity hold? a. $.1070 b. $.1150 c. $.1088 d. $.1130 ANSWER: c: interest rate parity theory DIFFICULT 4.34 Suppose the pound devalues from $1.25 at the start of the year to $1.00 at the end of the year. Inflation during the year is 15% in England and 5% in the U.S. What is the real devaluation (-) or real revaluation (+) of the pound during the year? a. - 12.38% b. - 20.71% c. + 2.39% d. ANSWER: + 1.46% a: purchasing power parity 4.35 Suppose the price indexes in Spain and the U.S., which both began the year at 100, are at 117 and 105, respectively, by the end of the year. If the beginning and ending exchange rates, respectively, for the peseta are $.1320 and $.1125, then the change in the real value of the peseta (a "-" indicates a real devaluation) during the year is a. 0% b. -5.0% c. 2.4% d. -8.2% ANSWER: b: purchasing power parity 4.36 Suppose the Swiss franc revalues from $0.40 at the beginning of the year to $0.44 at the end of the year. U.S. inflation is 5% and Swiss inflation is 3% during the year. What is the real devaluation (-) or real revaluation (+) of the Swiss franc during the year? a. + 7.9% b. - 5.3% c. + 8.1% d. - 1.6% ANSWER: a: purchasing power parity 4.37 Suppose the value of the Polish zloty moves from Z 1000 = $1 at the start of the year to Z 1,800 at the end of the year. At the same time, the Polish price level changes from an index of 100 on January 1 to 134 on December 31. U.S. inflation during the year was 4.5%. If the one-year interest rate on the zloty is 44%, what was the real dollar cost of borrowing the zloty during the year? a. 17.53% b. 27.81% c. -23.44% d. -8.76% ANSWER: c: purchasing power parity 4.38 Suppose inflation rates in the U.S. and France are expected to be 4% and 9%, respectively, next year and 6% and 7%, respectively, in the following year. If the current spot rate is $.1050, then the expected spot value of the franc in two years is a. $.1111 b. $.1024 c. d. ANSWER: $.0992 $.1074 c: purchasing power parity 4.39 Suppose the Deutsche mark revalues from $.30 at the beginning of the year to $.33 at the end of the year. Inflation during the year is 5% in the U.S. and 3% in Germany. What is the real devaluation (-) or real revaluation (+) of the Deutsche mark during the year? a. + 7.9% b. - 5.3% c. + 8.1% d. - 1.6% ANSWER: a: purchasing power parity 4.40 If the U.S. trade balance with Japan is expected to go from a deficit this year to a surplus next year, the forward rate on yen would a. be less than the spot rate b. be higher than the spot rate c. equal the spot rate d. could be either above or below the spot rate ANSWER: d: the relationship between the forward rate and the future spot rate 4.41 The following exchange and interest rate quotations were recently observed: Eurocurrency rates Exchange rate per $ 90-days (% annum) (Discretely-compounded) 90-day forward Spot $ DM £ DM £ DM £ Bid: 15 5/8 7 7/8 12 1/4 1.881 .4961 1.801 .4937 Ask: 16 8 1/4 13 1.843 .4902 1.773 .4889 An arbitrage profit can be obtained by a. borrowing pounds and lending dollars b. borrowing dollars and lending DM c. borrowing DM and lending pounds d. there are no arbitrage opportunities ANSWER: a: interest rate and parity theory CHAPTER 5 The Balance of Payments and International Economic Linkages EASY 5.1 A balance of trade deficit results in a current account a. deficit b. surplus c. IMF intervention d. World Bank loan ANSWER: c: current account 5.2 The change in private domestic borrowing or lending required to keep payments in balance without adjusting official reserves is called a. the net liquidity balance b. the balance of payments c. the balance on current account d. the balance on capital account ANSWER: a: balance-of-payment measures 5.3 Tourism shows up on the a. merchandise account b. current account c. capital account d. a and c above ANSWER: b: current account 5.4 The accounting statement that summarizes all the economic transactions between residents of the home country and residents of all other countries is called the a. balance of trade b. current account balance c. balance of payments d. capital account balance ANSWER: c: balance-of-payment categories 5.5 The balance on current account includes the net flow of good, services, income and a. portfolio investments b. changes in reserve assets c. direct investment d. unilateral transfers ANSWER: d: balance of payment categories 5.6 The sale of American computers to the Spanish government shows up as a. a debit on the official reserves account b. a credit on the official reserves account c. a credit on the trade account d. ANSWER: a debit on the current account c: current account 5.7 An overvalued currency acts as a(n) ____ on exports and a(n) _____ to imports. a. subsidy, tax b. increase, reduction c. increase, increase d. tax, subsidy ANSWER: d: coping with the current-account deficit 5.8 The US savings deficit can be attributed, in part, to a. the growing US budget deficit b. high real interest rates abroad c. low American investment in plant and equipment d. rising US taxes on capital accumulation ANSWER: a: the international flow of goods MODERATE 5.9 In a freely floating exchange rate system, if the capital account surplus for the U.S. rises, what will most likely happen to the real value of the dollar? a. it will decline b. it will rise c. there is no impact on the dollar d. the IMF will step in to adjust rising exchange rates ANSWER: b: the link between the current and the capital accounts 5.10 If a real value of a nation's freely floating currency increases, and the nation's current account is initially zero, its capital account will most likely be a. in deficit b. in surplus c. adjusted for the rate of inflation d. decreased by the amount of increase in the current account ANSWER: b: the link between the current and the capital accounts 5.11 In a freely floating exchange rate system, if the capital account is running a deficit a. the balance of payments must run a deficit b. the balance of payments must be zero c. the current account must run a surplus d. b and c above ANSWER: d: the link between the current and the capital accounts 5.12 As the real value of the dollar rises, the balance on current account is likely to a. increase b. decrease c. stay the same d. move with the capital account adjustments factor ANSWER: b: the link between the current and the capital goods 5.13 In a freely floating exchange rate system, if the current account is running a deficit a. the balance of payments must run a deficit b. the balance of payments must be zero c. the capital account must run a surplus d. b and c above ANSWER: d: the link between the current and the capital goods 5.14 In a freely-floating exchange rate system, the sale of Japanese cars to the United States will be offset by which item on the US balance of payments? a. a credit on the current account b. a credit on the capital account c. a debit on the trade account d. a or b ANSWER: d: the link between the current and the capital goods 5.15 The Japanese current account surplus can best be attributed to a. the high rate of Japanese domestic investment b. Japanese protectionism c. the high rate of Japanese savings d. government budget deficits ANSWER: c: the link between the current and the capital goods According to the J-curve theory, a country’s trade deficit a. decreases just after its currency depreciates b. increases just after its currency appreciates c. increases just after its currency is pegged to the dollar d. worsens just after its currency depreciatees ANSWER: d: coping with the current-account deficit 5.16 DIFFICULT 5.17 Suppose Lufthansa buys 10 Boeing 747s for $150 million in 1991, financed by a five-year loan from the US Export-Import Bank There is a one year grace period on principal and interest payments The net impact of this sale in 1991 is a. a $150 million reduction in the U.S. trade deficit b. a $150 million increase in the U.S. capital account surplus c. d. ANSWER: positive change in the U.S. balance of payments in 1991 a $500 million reduction in the U.S. trade deficit a: the link between the current and the capital goods 5.18 If a nation's income exceeds its spending, then a. savings will be less than domestic investment b. the nation must run a current-account deficit c. the balance of payments will have deficits for the next two years d. the nation must run a capital-account deficit ANSWER: d: the link between the current and the capital goods 5.19 A nation that is running a savings deficit a. must spend more than it produces b. will invest domestically more than it saves c. must have a net capital outflow d. a and b only ANSWER: d: the link between the current and the capital goods 5.20 In order to reduce its current-account deficit, the United States must do which of the following? a. reduce the federal budget deficit b. lower national product relative to national spending c. reduce savings relative to domestic investment d. reduce the federal budget surplus ANSWER: a: the link between the current and the capital goods CHAPTER 6 THE FOREIGN EXCHANGE MARKET EASY 6.1 Exports of goods and services by the United States now total more than _________ of gross domestic product. a. 10% d. 20% d. 50% d. 75% ANSWER: a: introduction 6.2 What is the name of the international bank communications network for foreign exchange transactions that connects more than 7,000 banks and broker-dealers? a. FedWire b. CHIPS c. SWIFT d. UBS ANSWER: c: organization of the foreign exchange market 6.3 The overwhelming majority of foreign exchange transactions involve a. multinational corporations buying and selling foreign exchange b. importers and exporters buying and selling foreign exchange c. banks buying and selling foreign exchange d. governments buying and selling foreign exchange ANSWER: c: the participants 6.4 The world's largest currency trading market is located in the city of a. New York b. Frankfurt c. Tokyo d. London ANSWER: d: size 6.5 American terms refers to the a. number of U.S. dollars per unit of foreign currency b. number of foreign-currency units per U.S. dollar c. quotation system found in the United States d. bid-ask spread on the U.S. dollar ANSWER: d: spot quotations 6.6 Trading on the foreign exchange market is a. located in a physical headquarters in London b. takes place within an organized exchange c. conducted by licensed brokers from the London stock exchange d. an electronically linked network of banks, brokers, and dealers ANSWER: d: organization 6.7 Traders on the foreign exchange market use ___________ to eliminate or cover the risk of loss on export or import orders denominated in foreign currencies. a. currency options b. forward contracts c. money-market hedges d. currency futures contracts ANSWER: b: the participants 6.8 Hedgers, mostly _____________, engage in forward contracts on the foreign exchange markets to protect the home currency value of various foreign currencydenominated assets and liabilities on their balance sheets. a. commercial banks b. public utilities c. multinational corporations d. speculators ANSWER: c: the participants 6.9 A ___________ between a bank and a customer calls for a fixed delivery date, at a fixed exchange rate for a specified amount of one currency against another currency payment. a. spot quotation b. currency option c. currency swap d. forward contract ANSWER: d: the forward market 6.10 Risk that a central bank will not make the necessary transfer of foreign currency to complete a currency settlement is known as ________ risk. a. exchange rate b. Herstatt c. Interest-rate d. settlement ANSWER: b: the mechanics of spot transactions MODERATE 6.11 The spot and 30-day forward rates for the Dutch guilder are $.3075 and $.3120, respectively. The guilder is said to be selling at a forward a. premium of 16.83% b. premium of 17.56% c. discount of 6.39% d. discount of 15.10% ANSWER: b: forward quotations 6.12 Suppose the spot direct quotes for the pound sterling and French franc are $1.3981-89 and $.1130-33, respectively. What is the direct quote for the pound in Paris? a. 12.3398-3796 b. 12.3469-3726 c. .0808-12 d. .0976-87 ANSWER: a: spot quotations 6.13 Suppose the following direct quotes are received for spot and one- month French francs in New York: .1160-684-6. Then the outright 30- day forward quote for the French franc is: a. .1156-62 b. .1164-74 c. .1166-72 d. .1154-64 ANSWER: b: forward quotations 6.14 Suppose the spot direct quotes for the Swedish krona and French franc are $.1395-99 and $.1130-33, respectively. What is the direct quote for the krona in Paris? a. 1.2312-81 b. 1.2435-37 c. .0806-11 d. .0973-81 ANSWER: a: spot quotations 6.15 Suppose sterling is quoted at $1.4419-36, and the Swiss franc is quoted at $0.6250-67. What is the direct quote for the pound in Zurich? a. 2.3035-70 b. 2.3018- 88 c. 2.3008-98 d. 2.3020-50 ANSWER: c: spot quotations 6.16 Suppose the Brazilian Real is quoted at $0.9455-9510, and the Thai baht is quoted at $25.2513-3986. What is the direct quote for the Real in Bangkok? a. 27.1267-5673 b. 26.7801-9801 c. 25.2597-2700 d. 26.5524-8626 ANSWER: d: spot quotations 6.17 If the direct price of the dollar is 2.5 in Frankfurt and transaction costs are .4% of the amount transacted, then the minimum- maximum direct quotes for the DM in New York are: a. .3968-4032 b. 2.4800-2.5200 c. .3984-.4016 d. 2.4900-2.5100 ANSWER: a: spot quotations 6.18 Suppose the 90-day forward quotes on the DM and the French franc are $.4002-10 and $.1180-90, respectively. What is the direct 90-day forward quote for the franc in Frankfurt? a. 3.3625-54 b. 3.3631-92 c. .2943-74 d. .2949-68 ANSWER: c: forward quotations 6.19 The spot and 180-day forward rates for the DM are $.3310 and $.3402, respectively. The DM is said to be selling at a forward a. discount of 2.8% b. premium of 2.8% c. discount of 5.6% d. premium of 5.6% ANSWER: d: forward quotations 6.20 Suppose the spot direct quotes for the Italian lira and Swedish krone are $.00050-51 and $.1201-10, respectively. What is the direct quote for the Swedish krone in Milan? a. .00413-25 b. .00422-31 c. 235.49-242.00 d. 237.81-245.03 ANSWER: c: forward quotations 6.21 Suppose the direct quote for sterling in New York is 1.3110-5. Then the direct quote for dollars in London is: a. .7110-5 b. 2.6220-30 c. .7625-8 d. 1.3110-5 ANSWER: c: spot quotations 6.22 An American company that imports leather goods from England is most likely to be a. long pounds b. short pounds c. can't tell ANSWER: b: spot quotations DIFFICULT 6.23 On December 3,2001, spot Japanese yen were sold at $0.008058. Suppose the 180-day forward Japanese yen was selling at a 1.91% annualized premium, what is the 180-day forward rate of the yen? a. 0.008245 b. 0.008135 c. 0.008457 d. can’t tell ANSWER: b: forward quotations 6.24 Suppose the spot rate and forward rate for the British pound are 1.4248 and 1.4179 respectively. Assume the forward pound is selling at a 1.94% annualized discount, what is the number of days of the forward contract? a. 180 days b. 120 days c. 90 days d. 60 days ANSWER: c: forward quotations 6.25 Suppose one observed the following direct spot quotations in New York and London, respectively: 1.2500-60 and .8000-50. Arbitrage profits per $1 million equal a. $637 b. $0 c. $1,268 d. $4,492 ANSWER: b: currency arbitrage 6.26 The $/DM exchange rate is DM1 = $.35 and the DM/FF exchange rate is FF1 = DM.31. What is the FF/$ exchange rate? a. 3.226 French francs per dollar b. 1.129 French francs per dollar c. .886 French francs per dollar d. 9.217 French francs per dollar ANSWER: d: cross rates 6.27 Suppose the following direct quotes are received for spot and one-month French francs in New York: .1260-684-6. Then the outright 30-day forward quote for the French is: a. .1256-62 b. .1264-74 c. .1266-72 d. .1254-64 ANSWER: b: forward quotations 6.28 If the direct price of the dollar is 5 in Copenhagen and transaction costs are .5%, then the minimum-maximum direct quotes for the Danish krone in New York are a. 4.9750-5.0250 b. 4.9500-5.0500 c. .1980-.2020 d. .1990-.2010 ANSWER: c: the spot quotations 6.29 Suppose the pound sterling is selling for $1.62 and the buying rate for the Swiss franc is $0.71. Then the £/SFr cross rate is a. £1 = SFr 0.4383 b. SFr 1 = £2.2817 c. £1 = SFr 2.2817 d. a or b ANSWER: c: cross rates 6.30 Suppose the quote for DM is DM 2.9865-92. Then the percent spread is a. 2.31% b. 0.97% c. 0.62% d. 0.09% ANSWER: d: transaction costs
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Outline
Title: International Finance
1. Introduction
2. Theory of Purchasing Power Parity (PPP)
3. Limitations of the theory
4. Conclusion
5. References


Running Head: INTERNATIONAL FINANCE

International Finance
Name:
Institution:
Date:

1

INTERNATIONAL FINANCE

2
Introduction

It is apparent that there are different City-States in the world. These City-States have
different currencies with different values. In economics, international finance relates to all the
interactions such as the exchange of money that occurs among City-States in the world. As such,
the rates of currency exchan...


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