Chapter #8

There are various forms of purchasing power parity (PPP) theory. Which form of PPP is also known as the "law of one price"? a. numerical form b. relative form c. accounting form d. absolute form e. none of the above 2. Inflation in the U.S. is 3% and the inflation rate in Europe is 5%. From the perspective of the U.S., what should the euro adjustment be if purchasing power parity (PPP) applies? a. 1.94% appreciation b. -1.9% depreciation c. -1.94% depreciation d. 1.9% appreciation e. none of the above 3. Which of the following is not a reason for deviations in PPP? a. relative income levels b. trade barriers c. interest rate differentials d. several substitutes for traded goods e. all of the above are reasons for deviations 4. Assume Switzerland has a one-year interest rate of 3% and the U.S. has a 4%, one-year interest rate. If the International Fisher effect (IFE) holds, what would your forecast for the Swiss franc exchange rate with respect to the dollar be? a. 9.7% appreciation b. 9.7% depreciation c. 0.97% appreciation d. 0.97% depreciation e. none of the above 5. Assume the United Kingdom has a one-year interest rate of 6% and the U.S. has a 4%, one-year interest rate. If the spot rate is $1.50 per British pound and the international Fisher effect (IFE) holds, what would you forecast for the future spot rate of the pound in one year (using the simplified method)? a. $1.5288 b. $1.5300

c. $1.4700 d. $1.4717 e. none of the above 6. Which of the following statements is false? a. the international Fisher effect (IFE) uses interest rates to predict forward rates. b. the international Fisher effect (IFE) uses interest rates to predict future spot rates. c. interest rate parity (IRP) uses interest rates to predict forward rates. d. purchasing power parity (PPP) uses inflation rates to predict future spot rates. e. all of the above are true statements. 7. The absolute form of purchasing power parity (PPP) accounts for the possibilities of market imperfections such as transportation costs, tariffs, and quotas. a. True b. False 8. While the relationship between inflation differentials and exchange rates is not perfect even in the long run, recent research supports the use of inflation differentials to forecast long-run movements in exchange rates. a. True b. False 9. The International Fisher effect (IFE) uses interest rates rather than inflation rate differentials to explain exchange rate changes over time. It is closely related to the PPP theory because interest rates are often not correlated with inflation rates. a. True b. False 10. It is possible for purchasing power parity (PPP) to hold but for the international Fisher effect (IFE) to not hold over the same time period. a. True b. False 11. Unlike purchasing power parity (PPP), the international Fisher effect (IFE) consistently holds over the short run. a. True b. False 12. The international Fisher effect (IFE) and interest rate parity (IRP) use interest rate differentials to predict expected future spot rates. a. True b. False 13. A somewhat simplified statistical test of purchasing power parity (PPP) could be developed by applying regression analysis to historical exchange rates and inflation differentials.

a. True b. False

The one-year U.S. nominal interest rate is 4%. The one-year UK nominal interest rate is 4%. The spot rate of the Pound is currently $1.53. Assume that interest rate parity holds. The spot rate that we should anticipate in one year based on the International Fisher Effect is:

a. $1.53 b. $1.50 c. $1.48 d. $1.46 status: incorrect (0.0) correct: a your answer: b feedback: Incorrect. 2 The International Fisher Effect and the interest rate parity theorem are linked together through the unbiased hypothesis. True False status: correct (1.0) correct: true your answer: true feedback: Correct. 3 Purchasing power parity and the International Fisher Effect provide a framework for forming expectations regarding future exchange rates; they most likely will not predict the future exchange rate with perfect accuracy. True False

status: correct (1.0) correct: true your answer: true feedback: Correct. 4 Anecdotally, high inflation countries tend to have high nominal interest rates, and their currencies do tend to weaken over time. True False status: correct (1.0) correct: true your answer: true feedback: Correct. 5 The one-year forward rate of the Euro is $1.16. The spot rate is $1.21. The U.S. interest rate is 6%. We could estimate the interest rate on Euros based on:

a. the International Fisher Effect. b. purchasing power parity. c. interest rate parity. d. None of the answers are correct. status: incorrect (0.0) correct: c your answer: a feedback: Incorrect. 6 If one felt higher nominal interest rates in a foreign country more than offset the depreciation on the currency, one could use uncovered interest arbitrage to make a profit. True False status: correct (1.0) correct: true your answer: true

feedback: Correct. 7 If the home country nominal interest rate is 6% and the one-year foreign interest rate is 3%, we should expect the home country currency to appreciate by 2.91%. True False status: correct (1.0) correct: false your answer: false feedback: Correct. 8 The relationship between inflation rates and the change in the spot rate is specified by the International Fisher Effect. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 9 The one-year U.S. nominal interest rate is 4%. The one-year UK nominal interest rate is 2%. The indirect spot rate is currently 0.5350 Pounds per dollar. The one-year indirect forward rate in the market today based on the interest rate parity theorem is ________ Pounds per dollar.

a. 0.5247 b. 0.2632 c. 1.906 d. 0.5455 status: correct (1.0) correct: a your answer: a feedback: Correct.

10 Which of the following is not true regarding IRP, PPP, and the IFE? IRP suggests that a currency's spot rate will change according to interest rate a. differentials. PPP suggests that a currency's spot rate will change according to inflation b. differentials. The IFE suggests that a currency's spot rate will change according to interest rate c. differentials. d. All of the above answers are correct. status: incorrect (0.0) correct: a your answer: b feedback: Incorrect. 11 The relation between interest rate differentials and expected changes in the spot rate is called:

a. forward parity. b. interest rate parity. c. relative purchasing power parity. d. the international fisher effect. status: incorrect (0.0) correct: d your answer: b feedback: Incorrect. 12 Purchasing power parity is also referred to as arbitrage parity. True False status: incorrect (0.0) correct: false

your answer: true feedback: Incorrect. 13 According to the International Fisher Effect, if the one-year Eurozone interest rate is 5% and the one-year U.S. interest rate is 7%, Americans should expect the Euro to:

a. depreciate as compared to the dollar by 1.90%. b. appreciate as compared to the dollar by 1.87%. c. appreciate as compared to the dollar by 1.90%. d. depreciate as compared to the dollar by 1.87%. status: incorrect (0.0) correct: c your answer: a feedback: Incorrect. 14 If the nominal UK interest rate is 5%, and the Pound is expected to appreciate as compared to the dollar by 4% over the same time period, the effective return from the UK investment would be exactly 9%. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 15 A trader in the currency markets sees a news announcement that oil prices are going to cause inflationary price movements in the U.S. but not in the UK. He or she should expect the value of the dollar to fall in international trading. True False status: correct (1.0) correct: true your answer: true

feedback: Correct. 16 To the extent that the U.S. economy is comprised of goods that are not arbitrageable and services, purchasing power parity does not provide a good description of exchange rates. True False status: incorrect (0.0) correct: true your answer: false feedback: Incorrect. 17 If the price of a pen is E1.95 and the price of the pen in the U.S. is $3.00, the exchange rate that will prevent arbitrage of pens (assuming no transaction costs) is one euro = ________.

a. $1.00 b. $1.54 c. $0.65 d. $0.82 status: correct (1.0) correct: b your answer: b feedback: Correct. 18 Which of the following parity conditions specifies the relationship between the forward rate and nominal interest rate differentials?

a. international Fisher Effect b. interest rate parity theorem c. purchasing power parity

d. None of the answers are correct. status: correct (1.0) correct: b your answer: b feedback: Correct. 19 The one-year U.S. nominal interest rate is 2.3%. The one-year UK inflation rate is 1.4%. The indirect spot rate is currently Pound 0.5350/$. The indirect spot rate we should anticipate in one year based on purchasing power parity is:

a. 0.2630 b. 0.5302 c. 0.5389 d. None of the answers are correct. status: correct (1.0) correct: b your answer: b feedback: Correct. 20 If the purchasing power parity is true, countries with lower inflation rates should have weak currencies. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 21 The current spot rate is Ringett2.5/SF. The expected spot rate in one year is Ringett2.8/SF. The current Swiss interest rate is 8%. What Malaysian interest rate will cause IFE to hold?

a. 4.92%

b. 7.35% c. 12.32% d. None of the answers are correct. status: incorrect (0.0) correct: c your answer: b feedback: Incorrect. 22 The evidence from empirical tests suggest that both the International Fisher Effect and purchasing power parity hold. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 23 If U.S. nominal interest rates are lower than Canadian nominal interest rates, and the dollar does not rise as compared to the Canadian dollar enough for the International Fisher Effect to hold, who has benefited?

a. people who borrowed in the U.S. b. people who invested in Canada c. people who both borrowed in the U.S. and invested in Canada d. All of the answers are correct. status: incorrect (0.0) correct: d your answer: a feedback: Incorrect.

24 The International Fisher Effect and purchasing power parity are linked together through:

a. the domestic Fisher Effect. b. the forward rate. c. interest rate parity theorem. d. None of the answers are correct. status: incorrect (0.0) correct: a your answer: b feedback: Incorrect. 25 The relation between expected future changes in the spot rate and expected inflation differentials is called:

a. forward parity. b. interest rate parity. c. relative purchasing power parity. d. the international fisher effect. status: incorrect (0.0) correct: c your answer: a feedback: Incorrect. 26 If the U.S. nominal interest rate rises above the Canadian nominal interest rate, and the reason for the interest rate increase is that the real interest rate has risen while inflation has not, what should happen to the U.S. dollar as compared to the Canadian nominal interest rate in the short term?

a. The dollar will rise as compared to the Canadian dollar. b. The dollar will fall as compared to the Canadian dollar.

c. The dollar will remain the same as compared to the Canadian dollar. d. None of the answers are correct. status: correct (1.0) correct: a your answer: a feedback: Correct. 27 Relative purchasing power parity states that countries with higher inflation rates will have currencies that depreciate as compared to countries with low inflation rates. True False status: correct (1.0) correct: true your answer: true feedback: Correct. 28 Inflation is the only variable that is important in determining future exchange rates. True False status: correct (1.0) correct: false your answer: false feedback: Correct. 29 If the International Fisher Effect does not hold, which of the following could be true? Managers could borrow at abnormally low interest rates in foreign markets, given that currencies with lower interest rates do not appreciate by the same a. magnitude as the interest rate differentials. Investors could invest at abnormally high interest rates in foreign markets, given that currencies with lower interest rates do not depreciate by the same magnitude b. as the interest rate differentials. The borrowing and lending rates will be exactly the same everywhere in the c. world that has a comparable level of default risk.

d. a and b status: incorrect (0.0) correct: d your answer: b feedback: Incorrect. 30 The International Fisher Effect implies that a home country investment and an uncovered foreign investment should provide the same rate of return, if default risk is the same. True False status: correct (1.0) correct: true your answer: true feedback: Correct.

Chapter #10
Some have argued the exchange rate risk is irrelevant. Which of the following is not an argument for exchange rate risk irrelevance? a. purchasing power parity argument b. investor hedge argument c. interest rate parity argument d. currency diversification argument e. all of the above are arguments for irrelevance 2. One of the arguments for exchange rate risk irrelevance is that if a U.S.-based MNC is well diversified across numerous countries, its value will not be affected by exchange rate movements because of offsetting affects. This identifies which argument? a. purchasing power parity argument b. investor hedge argument c. interest rate parity argument d. currency diversification argument e. none of the above 3. The exposure of the MNC's consolidated financial statements to exchange rate fluctuations is what type of exposure?

a. economic b. translation c. transaction d. none of the above 4. Over the next year, an MNC expects British pound () inflows of 10,000, outflows of 15,000, and a British pound exchange rate of $1.50. It expects Swiss franc (Sf) inflows of Sf30,000, outflows of Sf20,000, and a Swiss franc exchange rate of $0.75. The company expects Mexican peso (p) inflows of p1,000,000, outflows of p1,500,000, and a Mexican peso exchange rate of $0.20. What is this MNC's transaction exposure? a. -5,000, +Sf10,000, -p500,000 b. +5,000, -Sf10,000, +p500,000 c. -$7,500 on pounds, +$7,500 on francs, +$100,000 on pesos d. -$7,500 on pounds, +$7,500 on francs, -$100,000 on pesos e. none of the above 5. Using the information in question 4, the MNC expects the Swiss franc and the British pound to be perfectly negatively correlated over this year and the peso to have 0 correlation to the pound and the franc. What will be the MNC's transaction exposure? a. The pound and franc exposures will offset, leaving just peso exposure. b. The MNC will still have pound, franc, and peso exposure. c. The MNC will have no exposure because it converts the currencies to dollars. d. None of the above. 6. Translation exposure is not dependent on which of the following? a. accounting methods used b. locations of foreign subsidiaries c. proportion of business conducted by foreign subsidiaries d. translation exposure is dependent on all of the above e. translation exposure is dependent on none of the above 7. The degree to which a firm's present value of future long-term cash flows can be influenced by exchange rate fluctuations is referred to as transaction exposure to exchange rates. a. True b. False 8. If a local currency appreciates and the firm's exports are denominated in the local currency, the firm should expect net cash flows from transactions to decrease. a. True b. False 9. A firm without any foreign inflows or outflows (a purely domestic company) is still vulnerable to economic exposure.

a. True b. False 10. One method of measuring an MNC's transaction exposure is to classify the cash flows into different income statement items and subjectively predict each income statement item based on a forecast of exchange rates. a. True b. False 11. Under Financial Accounting Standards Board No. 52 (FASB-52), revenues, expenses, and gains and losses of a foreign entity from its functional into the reporting currency is done using the weighted average exchange rate. a. True b. False 12. Most analysts agree that translation exposure is the most relevant form of exposure. a. True b. False

Value at risk tells managers how much they can expect to lose, with a certain percent of confidence, over a specified time period. True False status: incorrect (0.0) correct: true your answer: false feedback: Incorrect. 2 Which of the following transactions are negatively affected by local currency appreciation?

a. exports denominated in foreign currency b. interest received from foreign investments c. local sales d. All of the answers are correct. status: incorrect (0.0) correct: d your answer: c

feedback: Incorrect. 3 Translation exposure refers to:

a. loss of value due to rules on the consolidation of foreign financial statements. b. potential loss of value on future cash transactions due to exchange rate changes. loss of value from changes in the competitive environment due to exchange rate c. changes. d. All of the answers are correct. status: correct (1.0) correct: a your answer: a feedback: Correct. 4 Techniques for measuring different kinds of economic exposure include: using sensitivity or scenario analysis to identify how income changes under a. various exchange rate scenarios. using regression to examine the sensitivity of the firm's cash flows to changes in b. exchange rates. c. value at risk. d. All of the answers are correct. status: incorrect (0.0) correct: d your answer: a feedback: Incorrect. 5 Which of the following exposures can result in a loss of cash flows?

a. transaction exposure b. translation exposure

c. economic exposure d. More than one of these. status: incorrect (0.0) correct: d your answer: b feedback: Incorrect. 6 Translation exposure matters if:

a. investors care about earnings stability or ratios like the P/E ratio. b. investors care about only cash flows. c. the subsidiary plans to remit cash flows to the parent. d. More than one of these. status: incorrect (0.0) correct: d your answer: a feedback: Incorrect. 7 Which of the following increase when the local currency depreciates?

a. interest owed on foreign funds borrowed b. the firm's imported supplies denominated in local currency c. revenue on accounts receivable d. All of the answers are correct. status: incorrect (0.0) correct: c your answer: a feedback: Incorrect.

8 Which of the following is false about FASB 52? Firms translate using FASB 52 to convert functional currency items to reporting a. currency items. Firms use a weighted average exchange rate to translate revenue, expenses, and b. gains and losses from functional currency into reporting currency. Historic exchange rates at the reporting date are used to translate the assets and liabilities of the foreign unit from the functional currency into the reporting c. currency. d. All of the answers are correct. status: incorrect (0.0) correct: c your answer: b feedback: Incorrect. 9 The primary purpose of hedging is to reduce uncertainty. True False status: correct (1.0) correct: true your answer: true feedback: Correct. 10 Which of the following are true about value at risk?

a. It is a probabilistic measure of exposure. b. It tells firms how much they can lose on the positions the MNC is exposed to. It tells firms what the impact of translation exposure on earnings per share will c. be. d. All of the answers are correct. status: incorrect (0.0) correct: c

your answer: b feedback: Incorrect. 11 Economic exposure is the degree to which a firm's future cash flows can be affected by exchange rates. True False status: correct (1.0) correct: true your answer: true feedback: Correct. 12 Transaction exposure is the loss of value due to changes in international accounting regulation. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 13 Exposure refers to the potential for loss of value due to changes in exchange rates. True False status: correct (1.0) correct: true your answer: true feedback: Correct. 14 Purely domestic firms cannot be exposed to exchange rate risk. True False status: incorrect (0.0) correct: false

your answer: true feedback: Incorrect. 15 Which of the following are examples of economic exposure?

a. Losses in book value of equity because of consolidation of financial statements. An account payable that will become more expensive if the foreign currency b. increases in value. Potentially greater competition in your export market if your home currency c. appreciates. d. More than one of these. status: incorrect (0.0) correct: d your answer: a feedback: Incorrect. 16 An example of leading is to stall payments until they net with an anticipated currency inflow. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 17 A firm anticipates receiving C$10M in two months and is required to pay a bill of C$12M in two months. Since the exchange rate could change in an unfavorable manner over the next two months, the firm should hedge both exposures. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect.

18 Which of the following is true? If a firm has exposures to accounts payable in two currencies that are perfectly a. negatively correlated, their net exposure will be zero. Firms should take into account the variability of the currencies they are exposed b. to rather than the correlations between currencies. Firms can reasonably assume that currency variability and the correlations c. between currencies will remain the same over time. d. All of the answers are correct. status: incorrect (0.0) correct: a your answer: b feedback: Incorrect. 19 Which of the following affect the degree of translation exposure faced by a firm?

a. The number of contracts it gets from foreign governments. b. The proportion of business conducted by foreign subsidiaries. c. The value of inputs it buys from abroad. d. All of the answers are correct. status: incorrect (0.0) correct: b your answer: a feedback: Incorrect. 20 Transaction exposure differs from translation exposure because transaction exposure does not affect cash flows. True False status: incorrect (0.0) correct: false your answer: true

feedback: Incorrect. 21 To measure currency variability, firms can use:

a. the standard deviation of the currency over some time period. b. value at risk. c. correlations between currencies. d. All of the answers are correct. status: incorrect (0.0) correct: a your answer: b feedback: Incorrect. 22 If markets are perfect, then there is no reason for managers to hedge. True False 23 Which of the following is not true about economic exposure?

a. Domestic firms cannot be affected by economic exposure. Appreciation in a firm's local currency causes a reduction in both cash inflows b. and outflows. All transactions that cause transaction exposure are also exposed to economic c. exposure. d. All of the answers are false. status: incorrect (0.0) correct: a your answer: b feedback: Incorrect.

24 The stakeholder diversification argument says that:

a. shareholders are diversified, so they do not need managers to hedge for them. if inflation rates cause exchange rates to change in accordance with purchasing b. power parity, managers do not need to hedge. since investors have perfect information, they are better able to hedge than c. managers. d. None of the answers are correct. 25 If purchasing power parity holds, firms have no reason to hedge against exchange rate risk. True False 26 There is no reason to hedge economic exposure, since it does not affect cash flows. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 27 The currency diversification argument implies that firms need to hedge on behalf of individual investors. True False 28 Which of the following is true about exchange rate exposure?

a. Financing costs can be affected by volatility caused by exchange rate changes.

Economic exposure is any direct or indirect exposure of cash flows to exchange b. rates. Translation exposure is irrelevant if shareholders only care about the market c. value of cash flows. d. All of the answers are correct. status: incorrect (0.0) correct: d your answer: b feedback: Incorrect. 29 Economic exposure refers to the loss of value on contracts already signed due to changes in exchange rates. True False status: incorrect (0.0) correct: false your answer: true feedback: Incorrect. 30 If the currencies in which firms generate revenues have a low correlation with one another, the firm will be less exposed to exchange rate risk. True