ECON 3050: Fall 2013

The Foreign Exchange Market

Sample Questions


1. How do international businesses use foreign exchange markets for currency
conversion?
2. What is meant by carry trade? Why is it risky? Explain with an example.
3. What is hedging? What are the costs of hedging?
4. Differentiate between spot exchange rates and forward exchange rates.
5. Describe different features of the foreign exchange market.
6. What does the Law of One Price state?
7. How do the purchasing power parity theory and the law of one price relate the
prices of commodities to exchange rate movements?
8. How does an increase in money supply in an economy lead to inflation?
[Hint: A government increasing the money supply is analogous to giving people more money. An increase in the
money supply makes it easier for banks to borrow from the government and for individuals and companies to
borrow from banks. The resulting increase in credit causes increases in demand for goods and services. Unless
the output of goods and services is growing at a rate similar to that of the money supply, the result will be
inflation.]
9. What is the Fisher effect? What is the international Fisher effect?
10. Explain how investor psychology and bandwagon effects impact the movement
in exchange rates.