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Global Business International Edition 3rd Edition by Mike Peng – Test Bank

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  • ISBN-10 ‏ : ‎ 1133584500
  • ISBN-13 ‏ : ‎ 978-1133584506

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SKU:tb1001747

Global Business International Edition 3rd Edition by Mike Peng – Test Bank

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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 3. Basic economic theory suggests that the price of a commodity is most fundamentally determined by its supply and demand. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence 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. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension  7. The rise of a country’s productivity is usually accompanied by increased demand for its home currency. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension 8. A country highly productive in manufacturing typically generates a merchandise trade deficit. ANS: F PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension 9. A country’s current account deficit can only be financed using its savings. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 10. Governments adopting the floating exchange rate policy tend to set the exchange rate of a currency relative to other currencies. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Legal Responsibilities KEY: Bloom’s: Knowledge 11. Many countries with high inflation have pegged their currencies to the yuan in order to restrain domestic inflation. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 12. Balance of payments and exchange rate policies usually determine long-run movements of a currency. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension 13. The effect of investors moving in the same direction at the same time leads to a bandwagon effect. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 15. The Bretton Woods system was centered on the British pound as the new common denominator. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 16. The Bretton Woods system did not allow the United States to unilaterally change the exchange rate of the dollar. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 17. The Bretton Woods system had been built on the condition that the US inflation rate had to be continuously high. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 18. The International Monetary Fund offers free grants to countries depending on the stability and need of the borrower. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 19. The foreign exchange market has no central physical location and is the largest and most active market in the world. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies KEY: Bloom’s: Knowledge 20. Forward transactions allow participants to buy and sell currencies now for future delivery. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies KEY: Bloom’s: Knowledge 21. Currency hedging is a popular way to minimize the foreign exchange risk inherent in all nonspot transactions. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 22. Forward discount is a condition under which the forward rate of one currency relative to another currency is lower than the spot rate. ANS: F PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies KEY: Bloom’s: Comprehension 23. The primary participants of the foreign exchange market are IMF and World Bank. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies KEY: Bloom’s: Knowledge 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. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies KEY: Bloom’s: Knowledge 25. Strategic hedging focuses on using forward contracts and swaps to contain currency risks. ANS: F PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies KEY: Bloom’s: Comprehension 26. Proponents of fixed exchange rates argue that fixed exchange rates impose monetary discipline by preventing governments from engaging in inflationary monetary policies. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Comprehension 27. Proponents of fixed exchange rates believe that market forces should take care of supply, demand, and price of any currency. ANS: F PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Comprehension  28. A floating exchange rate allows each country to make its own monetary policy. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 29. Floating exchange rates are less volatile than fixed rates. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 30. The most extreme fixed rate policy is through a currency board. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 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. ANS: F PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 32. A weak dollar makes it more expensive for US tourists when traveling abroad. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 33. Majority of the largest US firms practice currency hedging. ANS: F PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 34. Hedging protects firms from spot market unpredictability. ANS: T PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-5 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 35. Risk analysis of any country must include its currency risks. ANS: T PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-5 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 ANS: D PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 ANS: D PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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. ANS: A PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Comprehension 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Knowledge 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 ANS: C PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Knowledge 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Strategy KEY: Bloom’s: Comprehension 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. ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Comprehension 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 ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Comprehension 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 ANS: B PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Knowledge 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 ANS: D PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Knowledge 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 ANS: C PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Knowledge 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. ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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. ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Comprehension 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 OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Comprehension 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 ANS: D PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Information Technologies KEY: Bloom’s: Comprehension 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 ANS: C PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 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 ANS: A PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Operations Management KEY: Bloom’s: Knowledge 25. _____ allow participants to buy and sell currencies now for future delivery. a. Currency Swaps b. Direct transactions c. Spot transactions d. Forward transactions ANS: D PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Strategy KEY: Bloom’s: Knowledge 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 ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 ANS: C PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 ANS: A PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Information Technologies | DISC: Environmental Influence KEY: Bloom’s: Knowledge 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. ANS: B PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 ANS: B PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Knowledge 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 ANS: C PTS: 1 DIF: Difficulty: Easy OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence KEY: Bloom’s: Knowledge 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 ANS: C PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Comprehension 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. ANS: B PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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. ANS: D PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 ANS: A PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence KEY: Bloom’s: Comprehension 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence 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 OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence 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). PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-1 NAT: BUSPROG: Analytic STA: DISC: Strategy| DISC: Environmental Influence KEY: Bloom’s: Comprehension 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. PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-2 NAT: BUSPROG: Analytic STA: DISC: Environmental Influence| DISC: Strategy KEY: Bloom’s: Comprehension 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. PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension  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. PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-3 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension 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. PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-4 NAT: BUSPROG: Analytic STA: DISC: Creation of Value KEY: Bloom’s: Comprehension 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. PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 7-5 NAT: BUSPROG: Analytic STA: DISC: Strategy KEY: Bloom’s: Comprehension

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