International Business

Chapter 9 Global Foreign-Exchange Markets

1) Western Union's role in foreign exchange trading is best described as ________.

B) transferring currency from one country to another
Answer: B

2) A major challenge faced by Western Union in wiring money between the United States and Mexico is
that ________.
B) it is facing competition from some commercial banks
Answer: B

3) In 2010, what was the top remittance-receiving country in the world?

C) India
Answer: C

4) Which of the following is the largest source of foreign-exchange income in Mexico?

D) remittance income
Answer: D

5) Which term refers to money denominated in the currency of another nation or group of nations?
A) foreign exchange
Answer: A

6) A(n) ________ is the price of a currency.

C) exchange rate
Answer: C

7) If Toranaga-san, who works for a Japanese trading company that operates in Japanese yen, wanted to
purchase Spanish castanets from a company in Barcelona and needed euros to complete the transaction,
he would use the ________ to gain access to spot euros.
B) foreign-exchange market
Answer: B

8) The relationship between the value of the Brazilian and Chinese currencies is known as the
________.
B) exchange rate
Answer: B

9) In foreign exchange markets, reporting dealers are ________.

A) financial institutions that actively participate in local and global foreign exchange markets
Answer: A

10) Which of the following would have the LEAST influence on price setting in the foreign exchange
market?
C) Western Union
Answer: C

11) In foreign-exchange markets, reporting dealers ________.

B) trade more foreign exchange with other financial institutions than with any other category of users
Answer: B

12) The interbank market in foreign exchange is where ________.

B) banks trade currency with each other
Answer: B
13) An example of an electronic brokerage system used to trade foreign exchange is ________.
A) Reuters
Answer: A

14) ________ involve the exchange of currency the second day after the date on which the two foreign
exchange traders agree to the transaction.
A) Spot transactions
Answer: A

15) Outright forward transactions involve the exchange of currency on a future date beyond two
business days at a fixed exchange rate, known as the ________.
B) forward rate
Answer: B

16) In which of the following transactions is one currency swapped for another on one date and then
swapped back on a future date?
C) FX swap
Answer: C

17) A foreign exchange contract that is an agreement between two parties to buy or sell a particular
currency at a particular price at a particular date in the future as specified in a standardized contract to
all participants in the specified market is known as a(n) ________.
C) futures contract
Answer: C

18) Which of the following best explains the increase in trading activity in recent years?
A) growing emphasis on hedge funds
Answer: A

19) The ________ is the most widely traded currency in the world.
D) U.S. dollar
Answer: D

20) The U.S. dollar is most likely traded widely because it is ________.
A) a reserve currency held by many central banks
Answer: A
21) Albert, an employee at Morgan Stanley, has been given the task of handling the foreign exchange
for a customer who is moving from Brazil to Switzerland in one week. Which of the following should
Albert most likely use when exchanging the client's Brazilian real for Swiss francs?
B) cross rate
Answer: B

22) As a trading currency, the euro is _______

D) gaining ground against the U.S. dollar in Eastern European countries
Answer: D

23) Why is London most likely the top market for trading foreign exchange?
C) London is uniquely positioned geographically in terms of time zones.
Answer: C

24) As a center for foreign exchange trading, London ________.

A) actually trades more U.S. dollars than are traded in the United States
Answer: A
25) The top location for trading foreign exchange is ________.
A) London
Answer: A

26) Which of the following is NOT one of the top four locations for trading foreign exchange?
A) London
B) New York
C) Tokyo
D) Hong Kong
Answer: D

27) In the spot market, the ________ is the difference between the bid and offer rates and is the trader's
profit margin.
D) spread
Answer: D

28) Which of the following is the price at which the trader is willing to sell foreign currency?
A) offer
Answer: A

29) Melissa, a foreign exchange trader, wants to buy euros from Stephanie. Which of the following is
the price at which Melissa is willing to buy euros?
C) bid
Answer: C

30) In the foreign exchange market, the bid is the rate at which ________.
C) the trader is willing to buy foreign exchange
Answer: C

31) If a foreign currency is quoted in American terms (the direct quote) and the forward rate for a
foreign currency is less than the spot rate, the foreign currency is selling at a ________.
D) forward discount
Answer: D
32) If a foreign currency is quoted in American terms (the direct quote) and the forward rate is greater
than the spot rate, the foreign currency is selling at a ________.
A) forward premium
Answer: A

33) The pound-dollar forward rate for pounds is $1.9068, and the spot rate is $1.9059. Pounds are
selling at a ________.
C) forward premium
Answer: C

34) The pound-dollar forward rate for pounds is $1.9068, and the spot rate is $1.9100. Pounds are
selling at a ________
C) forward discount
Answer: C

35) A(n) ________ is the right but not the obligation to buy or sell a foreign currency within a certain
time period or on a specific date at a specific exchange rate.
D) option
Answer: D

36) Which of the following is most likely true regarding options?

A) An option can only be purchased from a commercial bank.
B) Options are never used with foreign currency.
C) An option is a right to sell foreign currency.
D) Options do not provide firms with flexibility.
Answer: C

37) Why are options most likely so attractive to companies?

B) Options provide companies with more flexibility than a forward contract.
Answer: B

38) Compared with a forward contract, a futures contract ________.

D) is only traded on an exchange
Answer: D
39) Stella, who works and lives in San Diego, wants to send money to her mother who lives in a small
village south of Puerto Vallarta, Mexico. Stella typically uses Western Union to handle the transaction.
Which of the following is the most likely reason that Stella uses Western Union?
B) convenience
Answer: B

40) Which of the following handles the majority of all foreign exchange activities
C) commercial banks
Answer: C

41) Which of the following is NOT one of the top exchanges that trade in foreign currency futures and
options?
A) CME
B) UBS
C) NYSE Liffe
D) NASDAQ OMX
Answer: B

42) When selecting a commercial and/or investment bank to deal in foreign exchange, corporations are
most likely to use ________.
B) more than one bank to meet different needs
Answer: B

43) Companies most likely use the foreign exchange market to ________.
B) convert money for use in financial transactions
Answer: B

44) Companies most likely use the foreign exchange market to ________.
B) facilitate regular business transactions
Answer: B
45) If a company from Country A decides to sell merchandise to a company from Country B, then the
company from Country A ________.
C) can denominate the sale in either currency and use the foreign exchange market to convert currency
Answer: C

46) Which of the following is NOT a reason a company would deal in foreign exchange?
A) to pay or receive dividends in a foreign currency
B) to speculate on possible future movements in a currency
C) to buy and sell merchandise denominated in a foreign currency
D) to import merchandise denominated in its currency rather than the currency of the exporter
Answer: D

47) In a ________, one party directs another party to make payment.

B) commercial bill of exchange
Answer: B

48) Gomez Enterprises, a firm based in Mexico City, exported 1,000 circuit boards to Taylor Industries,
a firm based in Chicago. Taylor received a document from Gomez that requests immediate payment for
the goods. Gomez has most likely sent a ________.
B) sight draft
Answer: B

49) A document requesting payment 30 days after delivery is known as a ________.

A) time draft
Answer: A

50) An irrevocable letter of credit ________.

C) can be amended only if all parties involved agree
Answer: C

51) A letter of credit that provides an exporter with the guarantee of another bank in addition to the
importer's bank is called ________.
A) a confirmed letter of credit
Answer: A
52) A speculator is someone who ________.
C) takes positions in foreign exchange markets to earn a profit
Answer: C

53) Anita, an employee at ABX Partners, a hedge fund firm, has purchased euros because she believes
that the euro will strengthen against other currencies. Which term best describes Anita's activities?
B) speculation
Answer: B

54) Which of the following best describes arbitrage?

D) purchasing foreign currency on one market for immediate resale on another market
Answer: D

55) Ryan, a foreign exchange dealer, sold U.S. dollars for Swiss francs in the U.S., then sold Swiss
francs for Japanese yen in Switzerland, and then sold the Japanese yen for U.S. dollars in the U.S. Ryan
hopes that he will end up with more U.S. dollars than when he began. Which term best describes Ryan's
actions?
A) arbitrage
Answer: A

56) Which of the following is an example of interest arbitrage?

A) investing in debt instruments in different currencies or different countries
Answer: A
57) How does arbitrage differ from speculation?
B) A speculator buys or sells foreign currency with the hope that that currency will either weaken or
strengthen in the future, resulting in a profit.
Answer: B

58) Which of the following best explains why migrant workers in Dubai send money back home?
A) Non-citizens cannot purchase property.
Answer: A

59) An investor sells Japanese yen which is yielding a low interest rate and uses the proceeds to buy
Swiss francs that yield a higher interest rate. Which term best describes the investor's actions?
D) carry trade
Answer: D

60) Which of the following is LEAST relevant to being designated by Euromoney magazine as a top
foreign-exchange dealer?
A) capability of handling specific currencies
B) capability of assessing cultural risk
C) capability of handling derivatives
D) capability of engaging in analytics
Answer: B
61) An exchange rate is the number of units that buys one unit of another currency.
Answer: TRUE

62) A tariff is the price of a currency.

Answer: FALSE

63) In foreign exchange markets, reporting dealers trade more foreign exchange with other reporting
dealers than with any other category of users.
Answer: TRUE

64) Most foreign exchange is handled through voice brokers.

Answer: FALSE

65) In an FX swap, one currency is swapped for another on one date and then swapped back on a future
date.
Answer: TRUE

66) Outright forward transactions involve the exchange of currency the second day after the date on
which the two foreign exchange traders agree to the transaction.
Answer: FALSE

67) The U.S. dollar is important as a vehicle for foreign exchange transactions between two countries
other than the United States.
Answer: TRUE
68) The U.S. dollar is so widely traded partially because the New York Stock Exchange is the biggest
foreign exchange center in the world.
Answer: FALSE

69) The largest market in foreign exchange is in London.

Answer: FALSE

70) Hong Kong is one of the top four largest markets in the world in foreign exchange trades and the
largest in Asia.
Answer: FALSE

71) The bid is the price at which the trader is willing to sell foreign currency.
Answer: FALSE

72) In the spot market, the spread is the difference between the bid and offer rates and is the trader's
profit margin.
Answer: TRUE

73) If the forward rate for a foreign currency is less than the spot rate, the foreign currency is selling at a
forward premium.
Answer: FALSE

74) A currency sells at a forward premium when the forward rate is greater than the spot rate.
Answer: TRUE
75) Options are more flexible than forward contracts.
Answer: TRUE

76) An offer is the right but not the obligation to buy or sell foreign currency.
Answer: FALSE

77) Commercial banks look at foreign-exchange trading as a service extended primarily to important
customers, not as a major business activity of its own.
Answer: FALSE

Learning Outcome: Describe the functions of the foreign exchange market

78) Although most foreign exchange activity takes place through big money center banks, the use of
electronic trading has allowed even regional banks to deal directly in foreign exchange markets.
Answer: TRUE

Learning Outcome: Describe the functions of the foreign exchange market

79) One reason that companies use the foreign exchange market is to diversify their expenses from other
sources.
Answer: FALSE

Learning Outcome: Describe the functions of the foreign exchange market

80) Companies use the foreign exchange market to convert money for use in financial transactions.
Answer: TRUE

Learning Outcome: Describe the functions of the foreign exchange market

81) An irrevocable letter of credit is the basis for multilateral netting.

Answer: FALSE
82) A confirmed letter of credit may obligate the exporter's bank to honor a draft presented to it.
Answer: TRUE

83) Arbitrage is the purchase of foreign currency on one market for immediate resale on a foreign
market in order to profit from a price discrepancy.
Answer: TRUE

84) An American investing in a London-based company is an example of interest arbitrage.

Answer: FALSE

85) EBS and Reuters provide customers with electronic foreign exchange services as well as current
market data.
Answer: TRUE

AACSB: Use of information technology

86) The Chicago Mercantile Exchange and NASDAQ are part of the OTC market.
Answer: FALSE

87) Trading activity has increased in recent years due to the growing importance of foreign exchange as
an alternative asset and the expanded emphasis on hedge funds.
Answer: TRUE

Learning Outcome: Describe the functions of the foreign exchange market

88) The U.S. dollar is widely traded because it is a transaction currency in many international
commodity markets.
Answer: TRUE

89) A major challenge faced by Western Union in transferring money between the United States and
Mexico is that Mexican citizens trust the banks but do not trust Western Union due to its reliance on
global banks.
Answer: FALSE

90) According to 2010 surveys, the most frequently traded currency pair is the U.S. dollar and Japanese
yen.
Answer: FALSE

91) What are the two major segments of the foreign exchange market? What types of foreign exchange
instruments are traded within these markets?
Answer: The foreign exchange market has two major segments: the over-the-counter market (OTC) and
the exchange-traded market. The OTC market is comprised of banks, both commercial banks and
investment banks, as well as other financial institutions, and is where most of the foreign exchange
activity takes place. The exchange-traded market is composed of securities exchanges, such as the
Philadelphia Stock Exchange and the Chicago Mercantile Exchange, where certain types of foreign
exchange instruments, such as exchange-traded options and futures, are traded. Several different types of
foreign exchange instruments are traded in these markets, but the traditional foreign exchange
instruments that comprise the bulk of foreign exchange trading are spot transactions, outright forwards,
and FX swaps. Spot transactions involve the exchange of currency the second day after the date on
which the two foreign exchange traders agree to the transaction. The rate at which the transaction is
settled is the spot rate. Outright forward transactions involve the exchange of currency three or more
days after the date on which the traders agree to the transaction. It is the single purchase or sale of a
currency for future delivery. The rate at which the transaction is settled is the forward rate and is a
contract rate between the two parties. In an FX swap, one currency is swapped for another on one date
and then swapped back on a future date. Although an FX swap is both a spot and a forward transaction,
it is accounted for as a single transaction.

Learning Outcome: Describe the functions of the foreign exchange market

92) What are the characteristics of the spot market? What institutions handle spot exchanges?
Answer: Most foreign currency transactions take place between foreign exchange traders, so the traders,
who work for foreign exchange brokerage houses or commercial banks, quote the rates. The traders
always quote a bid and offer rate. The bid is the price at which the trader is willing to sell foreign
currency. In the spot market, the spread is the difference between the bid and offer rates and is the
trader's profit margin. The method of quoting exchange rates is called the direct quote, also known in the
foreign exchange industry as "American terms." It represents a quote from the point of view of someone
in the United States. The other convention for quoting foreign exchange is "European terms," which
means a direct quote from the perspective of someone in Europe. From a U.S. point of view, this means
the number of units of the foreign currency per U.S. dollar. This is also sometimes called the indirect
quote in the United States, although American terms and European terms are the most accurate way to
describe the quotes.

Learning Outcome: Describe the functions of the foreign exchange market

Skill: Synthesis
,4

93) What are the characteristics of the forward market? Why do companies participate in the forward
market? Provide an example to illustrate your answer.
Answer: The spot market is for foreign exchange transactions that occur within two business days, but
in some transactions a seller extends credit to the buyer for a period that is longer than two days. The
forward rate is the rate quoted today for future delivery. The most widely traded currencies in the
forward market are the British pound, Canadian dollar, Japanese yen, and Swiss franc. Many currencies
do not have a forward market due to the small size and volume of transactions in that currency. The
difference between the spot and forward rates is either the forward discount or the forward premium. If
the forward rate for a foreign currency is less than the spot rate, the foreign currency is selling at a
forward discount. If the forward rate is greater than the spot rate, the foreign currency is selling at a
forward premium. For example, a Japanese exporter of consumer electronics might sell television sets to
a U.S. importer with immediate delivery but payment due in 30 days. The U.S. importer is obligated to
pay in yen in 30 days and may enter into a contract with a currency dealer to deliver the yen at a forward
rate-the rate quoted today for future delivery.

Learning Outcome: Describe the functions of the foreign exchange market

Skill: Synthesis
,5

94) What is a futures contract? What institutions handle futures contracts?

Answer: A foreign currency futures contract resembles a forward contract insofar as it specifies an
exchange rate some time in advance of the actual exchange of currency. However, a future is traded on
an exchange, not OTC. Instead of working with a bank or other financial institution, companies work
with exchange brokers when purchasing futures contracts.

Learning Outcome: Describe the functions of the foreign exchange market

Skill: Synthesis
,4
95) In a short essay, discuss how companies use foreign exchange.
Answer: There are a number of reasons why companies use the foreign exchange market. The most
obvious is for import and export transactions. Companies also use the foreign exchange market for
financial transactions, such as those in FDI. Sometimes companies, but mostly traders and investors,
deal in foreign exchange solely for profit. One type of profit-seeking activity is arbitrage, which is the
purchase of foreign currency on one market for immediate resale on another market (in a different
country) to profit from a price discrepancy.

Learning Outcome: Describe the functions of the foreign exchange market

96) What is currency speculation? Why is it risky?

Answer: Speculation is the buying or selling of a commodity that has both an element of risk and the
chance of great profit. For example, an investor could buy euros in anticipation of the euro's
strengthening against other currencies. If it strengthens, the investor earns a profit; if it weakens, the
investor incurs a loss. Speculators are important in the foreign exchange market because they spot trends
and try to take advantage of them. They create demand for a currency by purchasing it in the market, or
they can create a supply of the currency by selling it in the market. Speculation is a very risky business.
In recent years, the advent of e-trading has attracted a lot of day traders in foreign exchange. The
problem is that day traders rarely make money speculating in exchange rates because forecasting
currency movements is a risky business.

Learning Outcome: Describe the functions of the foreign exchange market

97) Why would companies become involved in arbitrage? What is the difference between arbitrage and
interest arbitrage?
Answer: As with most types of foreign exchange activities, companies attempt to earn money through
arbitrage and interest arbitrage. One type of profit-seeking activity is arbitrage, which is the purchase of
foreign currency on one market for immediate resale on another market (in a different country) to profit
from a price discrepancy. Interest arbitrage is the investing in debt instruments, such as bonds, in
different countries.

Learning Outcome: Describe the functions of the foreign exchange market

Skill: Synthesis
,5
98) What is remittance income? What institutions in Mexico can handle remittance accounts? Why are
some institutions used more frequently than others?
Answer: Remittance income refers to money that an individual makes in one country and sends back to
friends and family members in another country in a different currency. Wells Fargo and other U.S.
banks, including Citi and Bank of America, have established alliances with Mexican banks to offer
remittance accounts to the immigrant workers in the United States. Although immigrant workers
complain about the high transfer fees and exchange-rate spread associated with Western Union, many
continue to use this service instead of the lower-cost method of remitting money through banks. Mexico
has a history of unstable currencies and widespread inflation, resulting in a traditional mistrust of banks.
Other immigrants base their choice on word of mouth or convenience and location. Many are simply
unaware of the variety of choices available for sending money and do not know how to get the best deal.
Others need the convenience offered by Western Union.

Learning Outcome: Describe the functions of the foreign exchange market

Skill: Synthesis
,4

99) What is the Bank for International Settlements? What three categories does the BIS designate in the
foreign exchange market? Briefly describe each category.
Answer: The foreign-exchange market is made up of many different players. The Bank for International
Settlements (BIS), a central banking institution in Basel, Switzerland, owned and controlled by 56
member central banks, divides the market into three major categories: reporting dealers, other financial
institutions, and nonfinancial institutions. Reporting dealers, also known as money center banks, are
financial institutions that actively participate in local and global foreign exchange and derivative
markets. They are mainly the large commercial and investment banks and are widely assumed to include
the 10 largest banks and financial institutions in terms of overall market share in foreign-exchange
trading: Deutsche Bank, Barclays Capital, UBS, Citi, JP Morgan, HSBC, RBS, Credit Suisse, Goldman
Sachs, and Morgan Stanley. The other financial institutions are financial institutions not classified as
reporting dealers. They include smaller commercial banks, investment banks and securities houses,
hedge funds, pension funds, money market funds, currency funds, mutual funds, specialized foreign-
exchange trading companies, and so forth. Nonfinancial customers are any counterparty other than those
described above and include any non-financial end user, such governments and companies (MNEs as
well as small- and medium-size corporations and firms).

Learning Outcome: Describe the functions of the foreign exchange market

100) How is foreign exchange traded? What methods are available?
Answer: Foreign exchange is traded using electronic methods, customer direct, interbank direct, or
voice broker. There are different kinds of electronic methods. One is an electronic broking system where
trades are matched up for foreign exchange dealers using electronic systems such as EBS, Reuters, and
Bloomberg. Another is an electronic trading system that is executed on a single-bank proprietary system
or a multibank dealing system. Customer direct refers to trades between a reporting dealer and either a
non-reporting dealer or customer, without a third party being involved. Usually trades are executed by
telephone or direct electronic trading. Interbank direct refers to trades between dealer banks via
telephone or direct electronic trading. Voice broker is a trade via telephone communication with a
foreign exchange voice broker.