Fundamentals of Multinational Finance, 4e (Moffett)

Chapter 9 Foreign Exchange Rate Determination and Forecasting

Multiple Choice and True/False Questions

9.1 Exchange Rate Determination: The Theoretical Thread

1) The important thing to remember about foreign exchange rate determination is that parity conditions,
asset approach, and balance of payments approaches are ________ theories rather than ________
theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing
Answer: D
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets in the
1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.
Answer: D
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

3) It is safe to say that most determinants of the spot exchange rate are also affected by changes in the
spot rate. i.e., they are linked AND mutually determined.
Answer: TRUE
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual

4) The ________ approach states that the exchange rate is determined by the supply and demand for
national currency stocks, as well as the expected future levels and rates of growth of monetary stock
A) balance of payments
B) monetary
C) asset market
D) law of one price
Answer: B
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

1
Copyright © 2012 Pearson Education, Inc.
5) The ________ approach argues that exchange rates are determined by the supply and demand for a
wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price
Answer: C
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

6) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of
fundamental exchange rate theories.
Answer: TRUE
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual

7) The ________ approach to the determination of spot exchange rates hypothesizes that the most
important factors are the relative real interest rate and a country's outlook for economic growth and
profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market
Answer: D
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

8) The authors compromise as to the key factors for exchange rate determination. They conclude that
________ are important in the short run, but that ________ determines long run exchange rates.
A) Fisher effect; PPP
B) asset markets, interest rates, and expectations; PPP
C) PPP; Fisher effect
D) Fisher effect; asset prices, interest rates, and expectations
Answer: B
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual

2
Copyright © 2012 Pearson Education, Inc.
9) ________, traditionally referred to as chartists, focus on price and volume data to determine past
trends that are expected to continue into the future.
A) Mappists
B) Trappist Monks
C) Filibusters
D) Technical analysts
Answer: D
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

10) The longer the time horizon of the technical analyst the more accurate the prediction of foreign
exchange rates is likely to be.
Answer: FALSE
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual

11) Short-term foreign exchange forecasts are often motivated by such activities as ________ whereas
long-term forecasts are more likely motivated by ________.
A) long-term investment; long-term capital appreciation
B) long-term capital appreciation; desire to hedge a receivable
C) the desire to hedge a payable; the desire for long-term investment
D) the desire for long-term investment; the desire to hedge a payable
Answer: C
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition

12) The more efficient the foreign exchange market is, the more likely it is that exchange rate
movements are random walks.
Answer: TRUE
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual

13) A major U.S. multinational firm has forecast the euro/dollar rate to be euro1.10/$ one year hence,
and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this imply
the company's expected rate for the euro per pound to be in one year?
A) euro 1.40/£
B) £1.40/euro
C) £1.54/euro
D) euro 1.54/£
Answer: D
Diff: 1
Topic: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Analytical

3
Copyright © 2012 Pearson Education, Inc.
9.2 Currency Market Intervention

1) The Chinese government announces that on December 31, 2006 the value of the Yuan will officially
change from 6.40 Yuan/$ to 6.00 Yuan/$. This would be an official ________ of the Chinese currency
of ________.
A) revaluation; 6.25%
B) revaluation; 6.679%
C) devaluation; 6.25%
D) devaluation; 6.67%
Answer: B
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Analytical

2) "Overshooting" exchange rate changes in response to an action of the Federal Reserve would be an
example of
A) a market inefficiency.
B) a market efficiency.
C) the Fisher Effect.
D) none of the above.
Answer: A
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

3) A currency board is
A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the
economy.
B) a recipe for conservative and prudent financial management.
C) designed to eliminate the power of politicians to exercise judgment by relying on an automatic and
unbendable rule.
D) all of the above.
Answer: D
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

4) The fall in the value of the domestic currency will sharply reduce the purchasing power of its people.
Answer: TRUE
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Conceptual

5) There is a long-standing saying that "what worries bankers is unemployment, but what worries
elected officials is inflation."
Answer: FALSE
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition
4
Copyright © 2012 Pearson Education, Inc.
6) A country's Central Bank may have the policy to ________.
A) fight inflation
B) fight slow economic growth
C) either A or B
D) none of the above
Answer: A
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

7) The Central Bank practice of the active buying and selling of the domestic currency against foreign
currencies is the process of ________.
A) direct intervention
B) indirect intervention
C) coordinated intervention
D) capital controls
Answer: A
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

8) If the Central Bank's goal was to decrease the value of its currency, or to fight an appreciation of its
currency’s value on the foreign exchange market, the bank could ________.
A) buy its own currency with foreign currency
B) sell its own currency in exchange for foreign currency
C) sell foreign currency
D) do all of the above
Answer: B
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

9) When country Central banks work together to intervene and push a particular currency’s value in
a desired direction, this is known as coordinated intervention.

Answer: TRUE
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

5
Copyright © 2012 Pearson Education, Inc.
10) ________ is the alteration of economic or financial fundamentals which are thought to be drivers of
capital to flow in and out of specific currencies.
A) Proportional intervention
B) Direct intervention
C) Indirect intervention
D) Hopeless intervention
Answer: C
Diff: 1
Topic: 9.2 Currency Market Intervention
Skill: Recognition

9.3 Disequilibrium: Exchange Rates in Emerging Markets

1) Which of the following was NOT an international currency crisis in the 1990s and early 2000s?
A) The Asian Crisis
B) The Russian Crisis
C) The Argentine Crisis
D) All of the above were currency crises in the 1990s and 2000s.
Answer: D
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

2) The Asian Currency crisis appeared to begin in ________.

A) South Korea
B) Taiwan
C) Thailand
D) Japan
Answer: C
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

3) Prior to July 2, 1997, the Thai government

A) allowed the Thai Bhat to float against major currencies.
B) fixed the Bhat's value against the Korean won only.
C) fixed the Bhat's value against major currencies especially the U.S. dollar.
D) None of the above.
Answer: C
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

6
Copyright © 2012 Pearson Education, Inc.
4) The "tequila effect" is a slang term used to describe a form of financial panic called ________.
A) run on the market
B) speculation
C) contrary investing
D) contagion
Answer: D
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

5) The authors did not identify which of the following as a root of the Asian currency crisis?
A) the collapse of some Asian currencies
B) the rate of inflation in the United States
C) corporate socialism
D) banking stability and management
Answer: B
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual

6) Corporate socialism in the Asian markets could be contributed in part

A) to the relatively short and stable post-WWII history of capitalism in their markets.
B) a belief by the owners of Asian companies that their governments would not allow them to fail.
C) the practice of lifetime employment at many corporations.
D) all of the above.
Answer: D
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

7) The authors refer to the practice of many Asian firms being largely controlled by families of groups
related to the governing body of the country as ________.
A) illegal
B) insider trading
C) cronyism
D) not in my backyard
Answer: C
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

7
Copyright © 2012 Pearson Education, Inc.
8) The principle focus of the IMF bailout efforts during the Asian financial crisis was ________.
A) banking liquidity
B) shareholder's wealth
C) reestablishing fixed currency exchange rates in Asia
D) dollarization of Asian currencies
Answer: A
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

9) In the years immediately preceding 1998 the Russian Ruble operated under a ________ type of
exchange rate regime.
A) fixed
B) free floating (market determined)
C) managed floating
D) pegged (to the U.S. dollar)
Answer: C
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

10) ________ is the official Chinese currency.

A) Baht
B) Won
C) Ringgit
D) Renminbi
Answer: D
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

11) The stability of the Russian Ruble in the 1990s (until the Russian debt crisis) was considered an
observable success of the Yeltsin administration.
Answer: TRUE
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

8
Copyright © 2012 Pearson Education, Inc.
12) When the Russian Ruble reached the limits of the bands about its managed float targets (Ru5.70/$ to
Ru6.35/$) in 1997, the Russian government would intervene in the markets to stabilize the Ruble. If the
exchange rate approached Ru5.70/$ the government would ________ Rubles using foreign exchange
and gold, or if the exchange rate approached Ru6.35/$ they would ________ Rubles.
A) buy; sell
B) sell; buy
C) buy; buy
D) sell; sell
Answer: B
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual

13) After the Russian government (in August 1998) allowed the Ruble to move outside its official
trading range of between Ru5.70/$-Ru6.35/$, the value of the Ruble eventually ________ to around
________ by May 1999.
A) increased; Ru13/$
B) increased; Ru4.50/$
C) decreased; Ru13/$
D) decreased; Ru25/$
Answer: D
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

14) It is safe to say that the Russian transition from a communist economy to a capitalist economy has
been smooth for the Russian people
Answer: FALSE
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

15) The ________ is the Argentine currency unit.

A) peso
B) dollar
C) real
D) peseta
Answer: A
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

9
Copyright © 2012 Pearson Education, Inc.
16) The Asian currency crisis was primarily a
A) parity conditions problem.
B) an asset markets problem.
C) balance of payments problem.
D) PPP problem.
Answer: C
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

17) The Russian Ruble crisis of 1998 was a complex combination of speculative pressures best
explained by ________ to exchange rate determination.
A) parity conditions approach
B) asset approach
C) balance of payments approach
D) PPP approach
Answer: B
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

18) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.
Answer: TRUE
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

19) Argentina's economic performance in the 1990s while their peso was pegged to the U.S. dollar can
be characterized as ________ rates of inflation and ________ rates of unemployment.
A) high; high
B) low; low
C) low; high
D) high; low
Answer: C
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual

20) During the 1990s Argentina's exports became some of the least expensive in all of South America
thanks in part to the pegging of the Argentine peso to the U.S. dollar.
Answer: FALSE
Diff: 1
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition

10
Copyright © 2012 Pearson Education, Inc.
9.4 Forecasting in Practice

1) Which of the following is a driver in the determination of foreign exchange rates under the Asset
Market Approach to forecasting?
A) relative inflation rates
B) relative real interest rates
C) forward exchange rates
D) the current account balance
Answer: B
Diff: 1
Topic: 9.4 Forecasting in Practice
Skill: Recognition

2) Short-term forecasts are typically motivated by a desire to hedge a receivable, payable, or dividend
for perhaps a period of three months.
Answer: TRUE
Diff: 1
Topic: 9.4 Forecasting in Practice
Skill: Conceptual

3) The more INEFFICIENT the market is, the more likely it is that exchange rates are "random walks,"
with past price behavior providing no clues to the future.
Answer: FALSE
Diff: 1
Topic: 9.4 Forecasting in Practice
Skill: Conceptual

4) The authors claim that the theories of international currency values hold better for less liquid and
poorly capitalized markets.
Answer: FALSE
Diff: 1
Topic: 9.4 Forecasting in Practice
Skill: Conceptual

5) The authors claim that random events, institutional frictions, and technical factors may cause currency
values to deviate significantly from their long-term fundamental path.
Answer: TRUE
Diff: 1
Topic: 9.4 Forecasting in Practice
Skill: Conceptual

6) The authors claim that theoretical and empirical studies appear to show that fundamentals do apply to
the long-term for foreign exchange.
Answer: TRUE
Diff: 1
Topic: 9.4 Forecasting in Practice
Skill: Conceptual

11
Copyright © 2012 Pearson Education, Inc.
Essay Questions

9.1 Exchange Rate Determination: The Theoretical Thread

1) Describe the asset market approach to exchange rate determination. How is this consistent with
economic theory of (say, security) prices in general?
Answer: The asset market approach to exchange rate determination looks at relative interest rates and
prospects for economic growth and profitability. This is consistent with the pricing of equity securities
in that the price of a share of stock should reflect expectations about the timing, magnitude, and risk of
future cash flows. In other words, expectations about what is to come is more important to the price of
an asset, including currency prices, than what has occurred in the past.
Diff: 3
Topic: 8.9 The Security Market Line

9.2 Currency Market Intervention

1) Assume your country has a balance of payments surplus. How would the government and markets
react to "correct" this imbalance under a fixed exchange rate regime? Under a floating exchange rate
regime?
Answer: A BOP surplus means there is a surplus demand for the country's currency most likely due to a
surplus of exports of goods and services. Under a fixed exchange regime, the government is obligated to
attempt to keep the BOP at or near zero. This surplus demand for currency means the government must
supply it to the international markets by using currency to buy gold or foreign currencies in the
international market place.

Under a floating exchange rate regime, the excess demand for the home currency would result in an
appreciating currency on the foreign exchange markets. Demand for the currency would in theory push
the value up, thus reducing exports, increasing imports, and moving the balance of payments toward
equilibrium.
Diff: 3
Topic: 9.1 Short-term and Long-term Decisions

12
Copyright © 2012 Pearson Education, Inc.
9.3 Disequilibrium: Exchange Rates in Emerging Markets

1) Describe the Russian ruble collapse through August of 1998.

Answer: The crisis of August 1998 was the culmination of a continuing deterioration in general
economic
conditions in Russia. During the period from 1995 to 1998, Russian borrowers—both governmental and
nongovernmental—had borrowed heavily on the international capital markets. Servicing this debt soon
became a growing problem, as servicing dollar debt requires earning dollars.The Russian current
account, a surprisingly healthy surplus, was not finding its way into internal investment and external
debt service. Capital flight accelerated, as hard-currency earnings flowed out as fast as they found their
way in. Finally, in the spring of 1998, even Russian export earnings began to decline. Russian exports
were predominantly commodity-based, and global commodity prices had been falling since the start of
the Asian crisis in 1997.

The Russian currency, the ruble (RUB), operated under a managed float.This meant that the Central
Bank of Russia allowed the ruble to trade within a band.The exchange rate band had been adjusted
continually throughout 1996, 1997, and the first half of 1998.Theoretically, the Central Bank allowed
the exchange rate and associated band to slide daily at a 1.5% per month rate.

On August 7, 1998, the Russian Central Bank announced that its currency reserves had fallen by $800
million in the last week of July. Russia said it would issue an additional $3 billion in foreign bonds to
help pay its rising debt, a full $1 billion more than had been previously scheduled.

On fears of a Chinese devaluation, the Russian stock market fell 5% on August 10. Eventually, the
government announced a 34% devaluation of the ruble. Overall, in less than one month the ruble fell
from RUB6.3/USD to over RUB13/USD.
Diff: 3
Topic: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

9.4 Forecasting in Practice

1) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and
contrast the motivation for and the techniques a forecaster might use for each of the time periods.
Answer: Short-run forecasts are usually more tactical in nature as a firm may desire to reduce exchange
rate risk associated with foreign receivable or payables. Technical factors and short-term market
expectations are often more important for short-run forecasters than long-run parity or fundamental
economic conditions.

Long-run forecasts are more strategic in nature as firms make key decisions about entering new foreign
markets. Longer time horizons tend to be less accurate but also require less accuracy. What forecasters
typically desire is a general long-run understanding of the relationships between markets. Fundamental
analysis and parity conditions tend to be more important than technical factors in this type of
forecasting.
Diff: 3
Topic: 9.4 Forecasting in Practice

13
Copyright © 2012 Pearson Education, Inc.