CHAPTER SIX Balance of Payments and Foreign Exchange Mar ets

Tr!e"False
1. In the balance of payments accounts the sum of all debits is equal to the value transferred out of the economy in the given period. Ans: True Dif: M 2. A !"### computer shipped abroad from the $.%. is a credit entry in the $.%. capital account. Ans: &alse Dif: M '. If a domestic resident receives payment from abroad a credit entry is made in the balance of payments accounts. Ans: True Dif: M (. An import of foods )ould result in a debit in the goods category of the current account. Ans: True Dif: M !. The most accurately measured balance of payments category is the capital account. Ans: &alse Dif: * +. The cost to ship military equipment to Afghanistan to bring do)n the Taliban resulted in resulted in an entry in the services category of the current account. Ans: True Dif: M ,. -urchases of foreign securities by domestic residents results in a decrease to the capital account but the interest received from those securities results in an increase to the current account. Ans: True Dif: M .. A net capital inflo) means the net purchases of foreign assets by domestic residents e/ceed the net purchases of domestic assets by private foreign residents. Ans: &alse Dif: M

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Cha&ter $ ' Test Ban

0. A balance of payments deficit refers to a situation )here the official settlements balance is negative. Ans: &alse Dif: D 1#. If one includes the statistical discrepancy the overall balance of payments for a country is al)ays 1ero. Ans: True Dif: * 11. A country2s balance of payments account has a statistical discrepancy of 1ero" a current account surplus of !# billion and a capital account deficit of '! billion. The official settlements balance must be a net 1! billion credit. Ans: True Dif: D 12. The current price to buy a unit of foreign currency no) is called the spot e/change rate. Ans: True Dif: * 1'. &oreign e/change ris3 is eliminated for all parties to an import transaction if the purchase is denominated in the local currency. Ans: &alse Dif: M 1(. In most )holesale foreign e/change transactions hard currencies never cross national boundaries. Ans: True Dif: * 1!. 4an3s and foreign e/change bro3ers account for about 0#5 of all foreign e/change mar3et transactions. Ans: &alse Dif: M 1+. The foreign e/change mar3et is more than t)enty6five times larger than the combined volume of the )orld2s ten largest stoc3 mar3ets. Ans: True Dif: * 1,. The mar3et to buy or sell a currency for delivery )ithin 2 to ' days is called the for)ard mar3et. Ans: &alse Dif: * 1.. 7ou buy the 4ritish pound at 8#.+, per out ahead on the deal. Ans: True Dif: M and sell it at 1.!! per 8. Ignoring commissions" you came

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10. 7ou have *uros and you buy the dollar at 1.#' per 9 and sell it at 9 1.#! per . Ignoring commissions" you came out ahead on the deal. Ans: &alse Dif: M 2#. In a cross rate table" reading across the $.%. dollar ro) gives the $.%. dollar per unit of foreign currency for the various country columns. Ans: &alse Dif: D 21. The real e/change rate is al)ays less than the nominal e/change rate. Ans: &alse Dif: M 22. The effective e/change rate is an e/change rate that has been ad:usted for different price levels the t)o countries under consideration. Ans: &alse Dif: * 2'. A )eighted average measure of the value of a currency relative to t)o or more other currencies is termed an effective e/change rate. Ans: True Dif: * 2(. The ris3 that the revenues or costs associated )ith a transaction e/pressed in terms of the domestic currency may change due to variations in e/change rates is called translation e/posure. Ans: &alse Dif: * 2!. The ris3 that changes in e/change values might change today2s value of a firm2s future income streams is called economic e/posure. Ans: True Dif: * 2+. *ntering into a derivatives contract to offset the ris3 of another position is termed hedging. Ans: True Dif: * 2,. A firm sells the pound short in the spot mar3et in hopes of buying it bac3 at a lo)er price in the future. The firm is engaging in currency speculation. Ans: True Dif: * 2.. 7ou buy an option that you can e/ercise only on the e/piration date of the option. 7ou must have purchased a *uropean option. Ans: True Dif: *

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20. An American currency call option gives the holder the right" but not the obligation" to purchase the underlying currency at a preset price at any time until the option e/pires. Ans: True Dif: * '#. A $.%. firm has entered into a contract to buy te/tiles from ;ong <ong. -ayment )ill be in ;ong <ong dollars in + months. The $.%. importer could reduce its currency ris3 by selling the ;ong <ong dollar for)ard. Ans: &alse Dif: M

M!lti&le Choice
1. A $.%. tourist traveling in *urope spends money on a hotel room and food in -aris. These transactions result in a ========== to the ========== category of the $.%. balance of payments. A> debit? goods 4> credit? goods @> debit? services D> credit? services *> credit? income Ans: @ Dif: M 2. In the $.%. balance of payments accounts $.%. firms importing goods results in a ========== and $.%. residents purchasing foreign stoc3s and bonds results in a ==========. A> debit? credit 4> credit? debit @> credit? credit D> debit? debit Ans: D Dif: * '. Activities in the services category of the balance of payments accounts include I. international tourism A travel. II. royalties and fees received from overseas. III. military transactions. A> I only 4> II only @> I and II only D> II and III only *> I" II and III Ans: * Dif: *

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(. A Berman resident buys a long term $.%. Treasury bond and receives coupon interest in the same year. The purchase price of the Treasury bond is recorded in the Berman ========== account and the income is recorded in the Berman ========== account. A> capital? current 4> capital? capital @> current? capital D> current? official settlements *> official settlements? capital Ans: A Dif: M !. A %)iss resident buys a long term $.%. Treasury bond and receives coupon interest in the same year. The purchase of the Treasury bond is a ========== in the %)iss balance of payments and the income received is a ==========. A> debit? debit 4> credit? credit @> debit? credit D> credit? debit Ans: @ Dif: * +. %uppose that in a given month $.%. residents buy 1+ million of foreign stoc3s and bonds" at the same time foreigners buy 2! million of $.%. stoc3s and bonds and the official settlement account increases 1# million. The net effect of these three sets of transactions is to A> increase the capital account by !1 million. 4> decrease the capital account by (1 million. @> increase the capital account by 10 million. D> decrease the capital account by 1 million. *> none of the above Ans: @ Dif: D ,. @hanges in the financial assets and deposits of government agencies are recorded in the A> current account. 4> services account. @> capital account. D> official settlements account. *> income account. Ans: D Dif: *

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.. A country imports .## million )orth of goods and services and e/ports +## million. The country2s private agents purchase 2## million of foreign assets and foreigners buy '## million of domestic assets. If the statistical discrepancy is 6 1## million" )hat must be the net official settlements balance if there are no other transactionsC A> (## million credit 4> 2## million credit @> '## million debit D> 2## million debit *> (## million debit Ans: 4 Dif: D 0. A country has a current account surplus of '## million and a capital account deficit of (## million. If the statistical discrepancy is 1ero this situation must result in A> a balances of payment deficit. 4> a positive official settlements balance. @> a negative official settlements balance. D> both A> and 4> *> both A> and @> Ans: D Dif: M 1#. The current account includes )hich of the follo)ing categoriesC I. II. III. ID. goods services income unilateral transfers

A> I and II only 4> I and III only @> II and ID only D> I" II and ID only *> I" II" III and ID Ans: * Dif: * 11. A capital account surplus implies that a country2s domestic residents A> purchased more foreign assets than foreigners purchased domestic assets. 4> purchased less foreign assets than foreigners purchased domestic assets. @> imported more goods and services than they e/ported. D> e/ported more goods and services than they imported. *> received more income from foreign asset holdings than foreigners received on their domestic asset holdings. Ans: 4 Dif: M

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EAFF4*BIE: Table 1" 4alance of -ayment Data Hypothetical U.S. BOP Data Bill $ */ports of merchandise 12! Imports of merchandise */ports of services !! Imports of services $.%. foreign aid payments to Income received from domestic 1# Afghanistan holdings of foreign assets %tatistical discrepancy &oreign purchases of $.%. assets Gfficial %ettlements 4alance ! $.%. purchases of foreign assets Income paid to foreigners on their 0 domestic asset holdings EAFF*ED 12. Fefer to Table 1 to ans)er the follo)ing question: The current account must be equal to a A> 2, billion surplus. 4> 1, billion surplus. @> 1! billion surplus. D> 2, billion deficit. *> 1, billion deficit. Ans: A EAF: Table 1 4alance of -ayment Data Dif: M 1'. Fefer to Table 1 to ans)er the follo)ing question: The capital account must be equal to a A> 2. billion deficit. 4> '# billion deficit. @> 2. billion surplus. D> 1. billion surplus. *> '# billion surplus. Ans: 4 EAF: Table 1 4alance of -ayment Data Dif: M 1(. Fefer to Table 1 to ans)er the follo)ing question: The statistical discrepancy must be equal to ======== billion. A> H ' 4> 6 ' @> # D> H 2 *> 6 2 Ans: * EAF: Table 1 4alance of -ayment Data Dif: D Bill $ 12# (! 11 2! !!

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Cha&ter $ ' Test Ban

1!. Ihich one of the follo)ing does not belong in the current accountC A> humanitarian foreign aid payments 4> income earned on foreign assets @> purchases of domestic financial assets by foreigners D> payments for military services abroad *> e/ports and imports of services Ans: @ Dif: * 1+. The foreign e/change mar3et is a mar3et for the e/change of A> currency. 4> goods. @> services. D> income streams. *> none of the above Ans: A Dif: * 1,. The $.%. had a capital account surplus in 2##1. This means that the $.%. A> either net sold assets to foreigners andJor net increased its indebtedness to foreigners. 4> e/ported more than goods than services. @> e/ported more goods and services than it imported. D> imported more goods and services than it e/ported. *> must have had a positive official settlements balance. Ans: A Dif: M 1.. The bul3 of foreign e/change trading activity is A> hard currency transfers across borders. 4> due to tourism" travel and illegal activities. @> in the for)ard mar3et. D> done )ith currency futures. *> electronic or phone originated trades of foreign currency denominated financial instruments. Ans: * Dif: * 10. @itigroup has a 81# million deposit in the $.<. that they )ish to convert to %)iss francs K%fr>. $4% is )illing to s)itch the pounds to francs at a rate of 2.'2 %frs per pound. Deutsche 4an3 )ill accept 8#.(' per franc. 4ased on these quotes" )hat is the greatest amount of francs that @itigroup can get for its 81# millionC A> 2'"2!!".1' 4> 2'"2##"### @> ("'1#"'(! D> 2!"(''"''+ *> ("'##"### Ans: A Dif: *

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2#. Fan3 the follo)ing foreign e/change participants from largest to smallest in trading activity: I. ban3s II. foreign e/change trading )ebsites III. foreign e/change bro3ers A> I" II" III 4> I" III" II @> II" III" I D> III" II" I *> III" I" II Ans: 4 Dif: M 21. The currency per $.%. dollar quote for the 4ritish pound is 1.!!. If you )ish to buy 1"### )orth of pounds" ho) many pounds could you getC A> 1"!!# 4> +(! @> (!# D> 1### *> !!# Ans: 4 Dif: * 22. The e/change rate for the euro changed from #.00+. on December 2" 2##2 to #.00++ K$.%. dollar equivalent> on December '" 2##2. If you used 1 million to buy euros on December 2 and sold them on December third you made A> H 2##.+.. 4> 6 1((.(!. @> 6 2##.+(. D> H 1((.,0. *> none of the above Ans: @ Dif: M 2'. The @anadian dollar is )orth +( cents $.%. If the @anadian dollar drops in value by 25 the @anadian dollar )ill be )orth ========== cents $.%. A> +2.,2 4> +!.2. @> ++.## D> +2.## *> none of the above Ans: A Dif: *

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2(. The @anadian dollar is )orth +( cents $.%. If the $.%. dollar drops in value by '5 the @anadian dollar )ill be )orth ========== cents $.%. A> +!.2. 4> +!.02 @> +!.'1 D> +2.#. *> none of the above Ans: @ Dif: D 2!. The currency per $.%. for the %outh <orean )on is 121,. The similar quote for the Lapanese yen against the dollar is 12(.!''. Ihat is the implied )on per yen cross e/change rateC A> 1!1"!!+.++ 4> #.#####, @> 0.00.+ D> #.1#2'2. *> none of the above Ans: * Dif: M 2+. The 4ritish pound is )orth 2.'10. %)iss francs and the Me/ican peso is )orth #.1(!12 %)iss francs. ;o) many pesos is the 4ritish pound )orthC A> #.#+2+ 4> #.''!( @> 2.0.1. D> 1!.0.! *> none of the above Ans: D Dif: M 2,. The @-I is no) at 1.1 and last year it )as at 1,#. Inflation over the year )as A> 0.##5. 4> 1.#+!5. @> 11.##5. D> +.(,5. *> '.2'5. Ans: D Dif: * 2.. %uppose that the @-I in 4ritain is at 12! and the @-I in the $.%. is at 12#. If the nominal e/change rate is 1.!+2! to the pound" )hat is the real e/change rate for the dollarC A> 1.+2,+ 4> 1.!### @> 8#.+++, D> 8#.+1(( *> none of the above Ans: D Dif: M

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20. A $.%. firm has contracted to purchase &rench )ines and has agreed to pay 9 ! million in + months. Ihich of the follo)ing methods could be used to reduce the $.%. firm2s e/change rate ris3 that results from the dealC I. 4uy the euro for)ard. II. 4uy a call option on the euro. III. %)ap euros for dollars no). A> I only 4> II only @> I and II only D> II and III only *> I" II and III Ans: @ Dif: M '#. In foreign e/change" the *uropean demand for the dollar also represents the A> *uropean demand for dollar denominated goods and services. 4> supply of the euro made available for foreign e/change. @> *uropean supply of euro denominated goods and services. D> supply of the dollar made available for foreign e/change. *> both A> A 4> Ans: * Dif: D '1. The Thai baht is currently trading at (2 baht to the dollar in the spot mar3et. The ' month for)ard rate is #.#2! dollars per baht. Ihat is the standard for)ard premium or discount for the bahtC A> !5 premium 4> 10.#(5 premium @> 2#5 premium D> (.,+5 discount *> 10.#(5 discount Ans: @ Dif: D '2. The ruble is currently trading at '1 rubles to the dollar in the spot mar3et. The ( month for)ard rate is '! rubles to the dollar. Ihat is the standard for)ard premium or discount for the rubleC A> 12.0#5 premium 4> 11.('5 discount @> 2#5 premium D> '(.205 discount *> 11.('5 premium Ans: D Dif: D

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Cha&ter $ ' Test Ban

''. The yen has a one year for)ard discount of '5 against the dollar. If the spot e/change rate is 12( yen to the dollar )hat is the e/pected future spot rate in one year given that there is no bias in the for)ard rateC A> 12#.2.# yenJ 4> 12#.'.. yenJ @> 12,.,2# yenJ D> 12+.+'2 yenJ *> 12,..2, yenJ Ans: * Dif: D '(. 7ou believe the yen )ill increase in value by (5 against the dollar in one year. If you thin3 the spot e/change rate in one year )ill be 12# yen to the dollar" )hat must the spot rate be right no)C A> 12(..# yenJ 4> 12!.,+ yenJ @> 11!.2# yenJ D> 110..1 yenJ *> 12!.## yenJ Ans: A Dif: M '!. If the spot e/change rate is 1.!, $.%. to the pound and the pound is e/pected to depreciate by '5 over the ne/t year" )hat is the dollar e/pected to do against the poundC A> appreciate '5 4> depreciate '5 @> appreciate '.#05 D> depreciate '.#!5 *> appreciate '.#!5 Ans: @ Dif: D '+. Ihich one of the follo)ing statements about differences in currency futures and for)ards is not correctC A> &utures contracts are more standardi1ed than for)ard contracts. 4> &utures contracts may require the holder to pay out cash before contract maturity and for)ards do not. @> &or)ard contracts are generally for smaller amounts of currency than futures contracts. D> &utures contracts are more liquid than for)ard contracts. *> &utures contracts are traded on organi1ed e/changes and for)ards are GT@ contracts negotiated bet)een t)o parties. Ans: @ Dif: D

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',. A contract that grants the holder the right to buy a given amount of a foreign currency at a predetermined e/change rate until or on a specified date is a currency A> for)ard contract. 4> futures contract. @> call option. D> put option. *> s)ap agreement. Ans: @ Dif: * '.. A contract that grants the holder the right to sell a given amount of a foreign currency at a predetermined e/change rate until or on a specified date is a currency A> for)ard contract. 4> futures contract. @> call option. D> put option. *> s)ap agreement. Ans: D Dif: * '0. A contract that allo)s the holder to buy a given amount of a foreign currency at a predetermined e/change rate only on a specified date is aJan A> American put option. 4> *uropean put option. @> American call option. D> *uropean call option. *> s)ap agreement. Ans: D Dif: *