Test Bank For Global Business 3rd Edition Peng

Test Bank for Global Business, 3rd Edition : Peng
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Chapter 7—Dealing with Foreign Exchange
TRUE/FALSE
1. A foreign exchange rate refers to the price of buying and selling commodities for future delivery.
ANS: F PTS: 1 DIF: Difficulty: Easy

REF: p. 68 OBJ: LO: 7-1 NAT: BUSPROG: Analytic
KEY: Bloom's: Knowledge
2. An appreciation is an increase in the value of the currency whereas a depreciation is a loss in the value
of the currency.
ANS: T PTS: 1 DIF: Difficulty: Easy

3. Basic economic theory suggests that the price of a commodity is most fundamentally determined by its
supply and demand.

4. The foreign exchange markets are influenced only by economic factors and free from the effect of
social or political pressures.
ANS: F PTS: 1 DIF: Difficulty: Moderate

KEY: Bloom's: Comprehension
5. The theory of purchasing power parity suggests that in the absence of trade barriers, the price for
identical products sold in different countries will be different.

6. If one country’s interest rate is high relative to other countries, the country will attract foreign funds.
ANS: T PTS: 1 DIF: Difficulty: Moderate

7. The rise of a country's productivity is usually accompanied by increased demand for its home
currency.

8. A country highly productive in manufacturing typically generates a merchandise trade deficit.

9. A country’s current account deficit can only be financed using its savings.

10. Governments adopting the floating exchange rate policy tend to set the exchange rate of a currency
relative to other currencies.

11. Many countries with high inflation have pegged their currencies to the yuan in order to restrain
domestic inflation.

12. Balance of payments and exchange rate policies usually determine long-run movements of a currency.

13. The effect of investors moving in the same direction at the same time leads to a bandwagon effect.

14. Under the gold standard, to be able to redeem its currency in gold at a fixed price, every central bank
needed to maintain gold reserves.

15. The Bretton Woods system was centered on the British pound as the new common denominator.

16. The Bretton Woods system did not allow the United States to unilaterally change the exchange rate of
the dollar.

17. The Bretton Woods system had been built on the condition that the US inflation rate had to be
continuously high.

18. The International Monetary Fund offers free grants to countries depending on the stability and need of
the borrower.

19. The foreign exchange market has no central physical location and is the largest and most active market
in the world.

20. Forward transactions allow participants to buy and sell currencies now for future delivery.

21. Currency hedging is a popular way to minimize the foreign exchange risk inherent in all nonspot
transactions.

22. Forward discount is a condition under which the forward rate of one currency relative to another
currency is lower than the spot rate.

23. The primary participants of the foreign exchange market are IMF and World Bank.

24. Strategic hedging means spreading out activities in a number of countries in different currency zones
to offset the currency losses in certain regions through gains in other regions.

25. Strategic hedging focuses on using forward contracts and swaps to contain currency risks.

26. Proponents of fixed exchange rates argue that fixed exchange rates impose monetary discipline by
preventing governments from engaging in inflationary monetary policies.

27. Proponents of fixed exchange rates believe that market forces should take care of supply, demand, and
price of any currency.

28. A floating exchange rate allows each country to make its own monetary policy.

29. Floating exchange rates are less volatile than fixed rates.

30. The most extreme fixed rate policy is through a currency board.

31. In terms of international trade competitiveness, a strong dollar makes it easier for US firms to export
and to compete on price when combating imports.

32. A weak dollar makes it more expensive for US tourists when traveling abroad.

33. Majority of the largest US firms practice currency hedging.

34. Hedging protects firms from spot market unpredictability.

35. Risk analysis of any country must include its currency risks.

MULTIPLE CHOICE
1. A _____ is the price of one currency, such as the dollar, in terms of another, such as the euro.
a. stock exchange index
b. securities market rate
c. commodities exchange rate
d. foreign exchange rate
ANS: D PTS: 1 DIF: Difficulty: Easy
2. The _____ suggests the price for identical products in different countries would be the same, if trade
barriers are absent.
a. theory of purchasing power parity
b. fixed exchange rate policy
c. Penn effect
d. Bretton Woods system
ANS: A PTS: 1 DIF: Difficulty: Easy
3. Which of the following methods is directly derived from the theory of purchasing power parity (PPP)?
a. The floating exchange rate
b. The fixed exchange rate
c. The stock market index
d. The Big Mac index
4. Which of the following conditions will attract foreign funds into a country?
a. If the country has high trade deficits
b. If the country’s interest rate is relatively high compared to other countries
c. If the country’s currency is depreciated
d. If the country is experiencing high levels of inflation
ANS: B PTS: 1 DIF: Difficulty: Moderate
5. Which of the following will cause a country’s currency to depreciate?

a. High interest rates on the currency
b. High inflation rates
c. High account surplus
d. High in-flow of foreign funds
6. Which of the following is true of quantitative easing?

a. It depreciates the currency that is being printed.
b. It appreciates the currency that is being printed.
c. It increases the inflation rate in the country.
d. It increases the exchange value of the currency.
ANS: A PTS: 1 DIF: Difficulty: Moderate
7. _____ is a country’s international transaction statement, which includes merchandise trade, service
trade, and capital movement.
a. Capital flight
b. Currency hedging
c. Purchasing power parity
d. Balance of payments
8. Which of the following characterizes a country's current account?

a. A country’s current account deficit has to be financed by both purchases and sales of
assets.
b. A country experiencing a current account deficit will see its currency appreciate.
c. A country’s current account balance consists of exports plus imports of merchandise and
services minus income on the country’s assets abroad.
d. A country experiencing a current account surplus will see its currency depreciate.
9. A clean floating exchange rate policy is a government policy to _____.

a. set exchange rates purely on the basis of supply and demand
b. allow a currency’s value to fluctuate according to the foreign exchange rate
c. allow selective government intervention in determining the exchange rate
d. link the exchange rate of a currency to the gold standard
10. Which of the following types of exchange rate policies is apt for a pure free market economy?
a. Dirty float
b. Flexible float
c. Clean float
d. Target exchange rate
ANS: C PTS: 1 DIF: Difficulty: Easy
11. Which of the following best describes a rate where selective government intervention works
hand-in-hand, allowing markets the freedom to work themselves out?
a. Free float rate
b. Fixed rate
c. Dirty float rate
d. Target exchange rate
12. _____ have specified upper or lower bounds within which the exchange rate is allowed to fluctuate.
a. Fixed exchange rates
b. Target exchange rates
c. Free float exchange rates
d. Dirty float exchange rates
ANS: B PTS: 1 DIF: Difficulty: Easy
13. The fixing of East and West Germany's currencies at a 1:1 ratio to each other during the German
unification in 1990 is an example of a _____.
a. managed float rate policy
b. floating rate policy
c. target exchange rate policy
d. fixed exchange rate policy
ANS: D PTS: 1 DIF: Difficulty: Moderate
14. Which of the following characterizes the peg policy in foreign exchange rates?
a. It links a developed country’s currency to the gold standard.
b. It stabilizes the import and export prices for developing countries.
c. It is a type of floating exchange rate policy.
d. It is primarily used by developed countries to control inflation.
15. The bandwagon effect is an example of the way _____ directly affects foreign exchange rates.
a. exchange rate policy
b. investor psychology
c. purchasing power parity
d. balance of payments
16. In foreign exchange, a(n) _____ is said to have occurred when investors move in the same direction at
the same time, like a herd.
a. placebo effect
b. bandwagon effect
c. edge effect
d. positive correlation
17. Capital flight is a phenomenon in which a large number of individuals and companies exchange
_____.
a. domestic goods for gold
b. gold for domestic goods
c. foreign currency for a domestic currency
d. domestic currency for a foreign currency
18. Between 1870 and 1914, the value of most major currencies was maintained by fixing their prices in
terms of _____.
a. dollar
b. yuan
c. gold
d. diamonds
19. Which of the following is one of the major reasons the gold standard was abandoned?
a. The increased flow of gold from the U.S. into foreign central banks.
b. The competitive devaluation of currencies during the Great Depression.
c. The strengthening of the U.S. dollar due to the rise in productivity levels in the United
States.
d. The United States unilaterally announced that the dollar would not be convertible to gold.
20. Which of the following was true of the Bretton Woods system?
a. All currencies in the system had floating exchange rates.
b. All currencies were pegged at a fixed rate to the dollar.
c. All currencies were maintained by fixing their prices in terms of gold.
d. All currencies in the system were required to be gold convertible.
21. Which of the following resulted in the abandoning of the Bretton Woods system in the 1970s?
a. The inflation rates in the United States and other developed counties were low.
b. The United States was not running a trade deficit.
c. The dollar became inconvertible into gold.
d. Most countries wanted to return to the gold standard system.
ANS: C PTS: 1 DIF: Difficulty: Moderate
22. The post-Bretton Woods system is a system of flexible exchange rate regimes with _____.
a. the Japanese yen as its common denominator
b. the American dollar as its common denominator
c. gold as its common denominator
d. no official common denominator
23. The weight a member country carries within the IMF, which determines the amount of its financial
contribution, its capacity to borrow from the IMF, and its voting power is referred to as a(n) _____.
a. grant
b. accommodation
c. quota
d. balance of payment
24. Which of the following is the funding source for the International Monetary Fund?
a. Member-country quota
b. Foreign direct investment
c. Subsidiary investing
d. Currency trading
25. _____ allow participants to buy and sell currencies now for future delivery.
a. Currency Swaps
b. Direct transactions
c. Spot transactions
d. Forward transactions
26. Which of the following foreign exchange transactions provide protection to traders and investors from
being exposed to fluctuations of the spot rate?
a. Spot transactions
b. Forward transactions
c. Direct transactions
d. Currency swaps
27. If the forward rate of the euro per dollar is higher than the spot rate, the euro has a _____.
a. high spread
b. low spread
c. forward discount
d. forward premium
28. _____ is defined as the conversion of one currency into another at Time 1, with an agreement to revert
it back to the original currency at a specific Time 2 in the future.
a. Currency swap
b. Currency hedging
c. Spot transaction
d. Forward transaction
29. Which of the following is true of the bid rate in foreign exchange markets?
a. It is always higher than the offer rate.
b. It is always lower than the offer rate.
c. It is always equal to the offer rate.
d. It does not affect the spread of the exchange.
30. The ____ is defined as the difference between the offer price and the bid price in a foreign exchange.
a. cost to serve
b. spread
c. forward discount
d. forward premium
31. _____ refers to non-financial companies spreading out its activities in different currency zones in order
to offset the currency losses in certain regions through gains in other regions.
a. Currency hedging
b. Currency pegging
c. Strategic hedging
d. Currency swapping
32. A currency board is a monetary authority that issues notes and coins convertible into a key foreign
currency at a _____ exchange rate.
a. clean floating
b. dirty floating
c. fixed
d. target
33. Which of the following is an advantage of a strong US dollar?

a. US importers will find it easier to compete with low-cost imports.
b. US exporters will find it easier to compete on price abroad.
c. US firms will experience less competitive pressure to keep prices low.
d. US tourists will find it more expensive when traveling abroad.
34. Which of the following is an advantage of a weak US dollar?

a. US consumers benefit from low prices on imports.
b. US tourists enjoy lower prices abroad.
c. Foreign firms find it harder to acquire US targets.
d. Foreign tourists enjoy lower prices in the US.
35. A manager arguing against currency hedging would most likely argue that _____.
a. currency hedging eats into company profits
b. currency hedging leaves firms at the mercy of the spot market
c. currency hedging decreases stability of cash flows and earnings
d. currency hedging is mainly a practice of very large MNEs
ESSAY
1. List the five underlying building blocks that determine the supply and demand of foreign exchange.
ANS:
Foreign exchange is a unique commodity and its markets are influenced not only by economic factors,
but also a lot of political and psychological factors. The five underlying building blocks in foreign
exchange: (1) relative price differences, (2) interest rates and monetary apply, (3) productivity and
balance of payments, (4) exchange rate policies, (5) investor psychology.
PTS: 1 DIF: Difficulty: Easy REF: p. 70

OBJ: LO: 7-1 NAT: BUSPROG: Analytic KEY: Bloom's: Knowledge
2. Identify the difference between fixed and floating exchange rates. Provide an example of a situation
where the fixed and floating exchange rates were used.
ANS:
A fixed exchange rate involves a country that "fixes" its currency to another currency. The floating (or
flexible) exchange rate rests on the idea that the supply and the demand for the currency will
accurately maintain the currencies exchange rate. This policy is often promoted by free market
advocates. Few countries can adopt a truly clean (or free) float. Most countries that use the floating
exchange rate adapt a variation of a dirty (or managed) float, where the government can selectively
intervene in a time of crisis or unexpected market movement.
The US has been on a dirty float since the collapse of the Bretton Woods System. This has allowed the
American government to intervene during times of great inflation or when other appreciating
currencies force the dollar down.
An example of the fixed exchange rate is when East and West Germany's marks were fixed to each
other on a 1:1 ratio. This helped East Germany's economy act stronger than it really was, thus boosting
the morale and support of the East German citizens. West Germany ended up paying more for their
goods, but this additional income helped East Germany rebuild and reunite faster.
PTS: 1 DIF: Difficulty: Moderate REF: p. 75

OBJ: LO: 7-1 NAT: BUSPROG: Analytic KEY: Bloom's: Comprehension
3. Describe what it means for a country to peg its currency to another, and give two benefits to adopting
this policy.
ANS:
Pegging is a stabilizing policy of linking a developing country’s currency to a key currency. When a
country pegs its currency to another, the value of the currency strengthens or weakens according to the
currency it is pegged to. Most countries that choose to peg their currency choose the US dollar.
A country that pegs its currency takes advantage of two benefits. First, a peg stabilizes the import and
export prices for developing countries. Second, many countries with high inflation have pegged their
currencies to the US dollar to restrain domestic inflation (given the fact that the US has relatively low
inflation).

4. Briefly explain the cause for the fall of the Bretton Woods System.
ANS:
The Bretton Woods System was at its peak during the late 1950s and early 1960s, and it helped bring
the dollar into dominance in the global economy. However, in the late 1960s and early 1970s, the rise
of productivity outside of the US and the US inflationary policies brought the Bretton Woods into
question. Other countries such as West Germany exported more, and the US ran its first post-1945
trade deficit in 1971. The US also greatly increased the money supply to support more government
spending of the Vietnam War and the Great Society welfare programs. The US government under
President Lyndon increased the money supply but not additional taxation. A country cannot increase
government spending without additional taxation. As the dollar faced greater inflation, it depreciated
in the global exchange markets.
These actions led to rising inflation and strong pressure for the dollar to depreciate. Currency traders
speculated on the fall of the US dollar resulting in purchasing more German marks. The central bank
of Germany had to buy billions of dollars to maintain the dollar/mark ratio.
The Bretton Woods system was structured so the US unilaterally could not adjust the exchange rate of
the dollar. Therefore, as the US traded gold at a standard $35 an ounce, too much gold was going out
at an undervalued price. In 1971, President Nixon declared that the dollar was no longer convertible
into gold.

5. Explain, with the help of examples, the three primary types of foreign exchange transactions.
ANS:
There are three primary types of foreign exchange transactions: (1) spot transactions,
(2) forward transactions, and (3) swaps.
Spot transactions are the classic single-shot exchange of one currency for another. For example,
Canadian tourists buying several thousand euros in Italy with Canadian dollars will get their euros
from a bank right away.
Forward transactions allow participants to buy and sell currencies now for future delivery, typically in
30, 90, or 180 days, after the date of the transaction. The primary benefit of forward transactions is to
protect traders and investors from being exposed to the fluctuations of the spot rate, an act known as
currency hedging. Currency hedging is essentially a way to minimize the foreign exchange risk
inherent in all non-spot transactions, which characterize most trade and FDI deals. Traders and
investors expecting to make or receive payments in a foreign currency in the future are concerned
whether they will have to make a greater payment or receive less in terms of the domestic currency,
should the spot rate change. For example, if the forward rate of the euro is exactly the same as the spot
rate, the euro is “flat.” If the forward rate of the euro per dollar is higher than the spot rate, the euro has
a forward discount. If the forward rate of the euro per dollar is lower than the spot rate, the euro then
has a forward premium.
A third major type of foreign exchange transactions is swap. A currency swap is the conversion of one
currency into another in Time 1, with an agreement to revert it back to the original currency at a
specific Time 2 in the future. Deutsche Bank may have an excess balance of pounds but needs dollars.
At the same time, Union Bank of Switzerland (UBS) may have more dollars than it needs at the
moment, but it is looking for more pounds. They can negotiate a swap agreement in which Deutsche
Bank agrees to exchange with UBS pounds for dollars today and dollars for pounds at a specific point
in the future.

6. Compare and contrast the two primary strategies companies use to cope with the currency risks.
ANS:
There are two primary strategies companies use to cope with the currency risks: currency hedging and
strategic hedging.
Currency hedging focuses on using forward contracts and swaps to contain currency risks, a financial
management activity that can be performed by in-house financial specialists or outside experts (such as
currency traders). Strategic hedging is conceptually different from currency hedging. Strategic hedging
means spreading out activities in a number of countries in different currency zones in order to offset
any currency losses in one region with gains in other regions.
Therefore, strategic hedging can be considered as currency diversification. It reduces exposure to
unfavorable foreign exchange movements. Strategic hedging refers to geographically dispersing
operations⎯through sourcing or FDI⎯in multiple currency zones. By definition, this is more strategic
because it involves managers from many functional areas such as production, marketing, and sourcing
in addition to those from finance.

7. Compare and contrast the advantages and disadvantages of a strong and a weak dollar.
ANS:
A strong (appreciating) dollar:
Advantages:
• US consumers benefit from low prices on imports.
• Lower prices on foreign goods help keep US price level and inflation level low.
• US tourists enjoy lower prices abroad.
• US firms find it easier to acquire foreign targets.
Disadvantages:
• US exporters have a hard time to compete on price abroad.
• US firms in import-competing industries have a hard time competing with low-cost imports.
• Foreign tourists find it more expensive when visiting the US.
A weak (depreciating) dollar:
Advantages:
• US exporters find it easier to compete on price abroad.
• US firms face less competitive pressure to keep prices low.
• Foreign tourists enjoy lower prices in the US.
• Foreign firms find it easier to acquire US targets.
• The US can print more dollars to export its problems to the rest of the world.
Disadvantages:
• US consumers face higher prices on imports.
• Higher prices on imports contribute to higher price level and inflation level in the US.
• US tourists find it more expensive when traveling abroad.
• Governments, firms, and individuals outside the US holding dollar-denominated assets suffer from
value loss of their assets.

8. What determines the success and failure of currency management around the globe?
ANS:
From an institution-based standpoint, the “rules of the game”—economic, political, and
psychological—enable or constrain firms. From a resource-based perspective, how firms develop
valuable, unique, and hard-to-imitate capabilities in currency management may make or break them.
As a result, three implications for action emerge. First, foreign exchange literacy must be fostered.
Savvy managers need to not only pay attention to the broad long-run movements informed by PPP,
productivity changes, and balance of payments, but also to the fickle short-run fluctuations triggered
by interest rate changes and investor mood swings. Second, risk analysis of any country must include
its currency risks. Finally, a country’s high currency risks do not necessarily suggest that this country
needs to be totally avoided. Instead, they call for a prudent currency risk management strategy—via
currency hedging, strategic hedging, or both.

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Visit TestBankBell.com to get complete for all chapters

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

8. A country highly productive in manufacturing typically generates a merchandise trade deficit.

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Easy

34. Hedging protects firms from spot market unpredictability.

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Easy

5. Which of the following will cause a country’s currency to depreciate?

6. Which of the following is true of quantitative easing?

8. Which of the following characterizes a country's current account?

9. A clean floating exchange rate policy is a government policy to _____.

33. Which of the following is an advantage of a strong US dollar?

34. Which of the following is an advantage of a weak US dollar?

PTS: 1 DIF: Difficulty: Easy REF: p. 70

PTS: 1 DIF: Difficulty: Moderate REF: p. 75

PTS: 1 DIF: Difficulty: Moderate REF: p. 75

PTS: 1 DIF: Difficulty: Moderate REF: p. 77

PTS: 1 DIF: Difficulty: Moderate REF: p. 81

PTS: 1 DIF: Difficulty: Moderate REF: p. 82

A weak (depreciating) dollar:

PTS: 1 DIF: Difficulty: Moderate REF: p. 84

PTS: 1 DIF: Difficulty: Moderate REF: p. 87

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