IBUS 401 FINAL EXAM BULLINGTON
CORRECT 100%
Government intervenes through their ________ (Ex: Federal Reserve) - ANSWER
Central Bank
Types of Exchange Rate Systems - ANSWER 1. Fixed
2. Free Floating
3. Managed (Controlled) Float
4. Pegged
Fixed Exchange Rate System - ANSWER Exchange rates are held at narrow
boundaries. Rates are held constant or allowed to fluctuate within narrow boundaries.
Free Floating Exchange Rate System - ANSWER Government lets the market do the
work. Most large currencies are somewhat free floating.
Managed (Controlled) (Dirty) Float Exchange Rate System - ANSWER Between fixed
and free floating. Announced or implied range that government will let rates change. If
outside the range the government will intervene.
Pegged Exchange Rate System - ANSWER Home currency is pegged to another
currency.
most famous pegged currency - ANSWER Hong Kong dollar
Dollarization - ANSWER Replacement of a foreign currency with the US dollar.
Indirect Government Intervention - ANSWER interest, income, expectations, inflation
Direct Government Intervention - ANSWER buying and selling a currency
Two types of reserves (in US) - ANSWER 1. dollars
2. foreign currency
Want dollar to get stronger - ANSWER buy dollars with foreign currency (demand for
dollar goes up, supply for other currency goes up - other currency gets weaker)
Want to make dollar weaker - ANSWER Use dollars to buy foreign currency (supply of
dollars goes up, demand of other currencies goes up - other currencies get stronger)
Non Sterile Intervention - ANSWER leave it alone, let dollar quantity increase
,Sterile Intervention - ANSWER 1. dollar stronger -> bought dollars -> dollar supply goes
up, so use excess dollars to pay off some debt (buy T-bills)
2. dollar weaker -> used dollars -> dollar supply goes down, so issue T-bills to get
dollars back
Types of Direct Government Intervention - ANSWER 1. Weaken Currency
2. Strengthen Currency
3. Sterile vs. Non Sterile Intervention
Bad Economy - ANSWER - high unemployment
- low exports and low imports
Want to make dollar weaker so increase exports and decrease imports -> heats up the
economy
Too Good Economy - ANSWER - need for additional people
- wages increase rapidly
- Inflation
Want to make dollar stronger so decrease exports and increase imports - > cools the
economy
The threat of ______ is what makes the market work. - ANSWER arbitrage
Types of Arbitrage - ANSWER 1. Locational Arbitrage
2. Triangular Arbitrage
3.Covered Interest Arbitrage
Locational Arbitrage - ANSWER keeps the bid/ask honest
Triangular Arbitrage - ANSWER takes advantage of a problem in the cross exchange
rate. Makes cross exchange rates in the market work.
Covered Interest Arbitrage - ANSWER taking advantage of differences in interest.
Threat of interest arbitrage makes quotes on forward market correct. Takes advantage
where interest rate parity does not exist in the forward market.
Interest Rate Parity - ANSWER drives the prices on the forward market. 99% of the
time, in the forward rate, interest rate parity exists.
Interest Rate Parity Formula - ANSWER Premium in Market P(d) = (1+
ihome)/(1+iforeign) -1
Absolute Form of Purchase Power Parity - ANSWER prices of same basket of products
in two different countries should be equal when measured in common currency
Relative Form of Purchase Power Parity - ANSWER Due to market imperfections,
prices of the same basket of products in different countries will not necessarily be the
,same, but the rate of change in prices should be similar when measured in common
currency
Purchasing Power Parity Formula - ANSWER Exchange Rate ef = (1 + Ihome)/(1 +
Iforeign) -1
International Fischer Effect - ANSWER no such thing as a difference in interest rates.
the difference is in inflation.
Why do we forecast Exchange Rates? - ANSWER 1. Hedging
2. Short-term Investments
3. Capital Budgeting
4. Earnings Assessments
5. Long-term Financing
Hedging - ANSWER guarding company against a problem on a receivable or a payable.
_______ to decide whether to hedge or not. - ANSWER forecast
Short-term investments - ANSWER if have excess money, where do you want to put it
(or where do you want to borrow it)
Capital Budgeting - ANSWER forecasting about most important thing you can do.
Assess whether to invest funds in a foreign project
Earnings Assessment - ANSWER very important to MNC, and earnings forecast
Long-term Financing - ANSWER to issue bonds to secure long-term funds
How we forecast exchange rates - ANSWER 1. Technical forecasting
2. Fundamental forecasting
3. Market-Based forecasting
4. Mixed forecasting
Technical forecasting - ANSWER looking at history to forecast a future exchange rate.
Fundamental forecasting - ANSWER based on fundamental relationships between
economic variables and exchange rates (inflation, income, interest rates, government
intervention)
Market-based forecasting - ANSWER look at the market (spot rate today, forward rate
today and what is is telling you). Looking at forward rate works until the interest rate
changes)
Mixed forecasting - ANSWER best way to go. Use mix of forecasting techniques
, What they do to forecast exchange rates - ANSWER 1. put together a forecasting team
that meets quarterly
2. forecasts for each currency what they expect to happen and document why they
forecasted something
3. Corporate governance: everyone has to use it and it is updated every quarter
4. same group in next quarter reforests and looks back at what they forecasted and why
(analysis of forecast to the actual)
Corporate governance concerning forecasts - ANSWER everyone has to use it and it is
updated every quarter
Are exchange rates important? - ANSWER YES. Need to manage the exchange
exposure in your company. The larger the proportion of business is outside of the US
the more important it gets.
Measuring Transaction Exposure - ANSWER 1. Exchange Volatility
2. Exchange Correlation
Exchange volatility - ANSWER exchange rates are very volatile, expect all of them to be
volatile
Exchange correlation - ANSWER some currencies are closely correlated to other
currencies, some are not correlated at all
Economic exposure - ANSWER selling in one currency and costing in another currency
(also called operating exposure). Not easily hedgable, takes a long time to fix.
Translation exposure - ANSWER translating financial statements into the currency of
your corporation.
Receivable hedging with a forward contract - ANSWER contract to sell foreign currency
for dollars on receivable due date (or later)
Receivable hedging with an option - ANSWER put option to sell foreign currency for
dollars at strike price on recorded due date (or later). Exercise if strike price higher than
spot rate. Always pay for option.
Receivable hedging with a money market hedge - ANSWER on day 1: borrow foreign
funds so that the receivable will pay money market debt on recorded due date and
convert borrowed foreign funds to dollars at today's spot rate, and deposit in dollar
money market
on day receivable is due: get dollars plus accrued interest out of money market
Payable Hedging with a forward contract - ANSWER contract to buy foreign currency on
day payable due. Buy foreign currency with dollars, pay off payable
CORRECT 100%
Government intervenes through their ________ (Ex: Federal Reserve) - ANSWER
Central Bank
Types of Exchange Rate Systems - ANSWER 1. Fixed
2. Free Floating
3. Managed (Controlled) Float
4. Pegged
Fixed Exchange Rate System - ANSWER Exchange rates are held at narrow
boundaries. Rates are held constant or allowed to fluctuate within narrow boundaries.
Free Floating Exchange Rate System - ANSWER Government lets the market do the
work. Most large currencies are somewhat free floating.
Managed (Controlled) (Dirty) Float Exchange Rate System - ANSWER Between fixed
and free floating. Announced or implied range that government will let rates change. If
outside the range the government will intervene.
Pegged Exchange Rate System - ANSWER Home currency is pegged to another
currency.
most famous pegged currency - ANSWER Hong Kong dollar
Dollarization - ANSWER Replacement of a foreign currency with the US dollar.
Indirect Government Intervention - ANSWER interest, income, expectations, inflation
Direct Government Intervention - ANSWER buying and selling a currency
Two types of reserves (in US) - ANSWER 1. dollars
2. foreign currency
Want dollar to get stronger - ANSWER buy dollars with foreign currency (demand for
dollar goes up, supply for other currency goes up - other currency gets weaker)
Want to make dollar weaker - ANSWER Use dollars to buy foreign currency (supply of
dollars goes up, demand of other currencies goes up - other currencies get stronger)
Non Sterile Intervention - ANSWER leave it alone, let dollar quantity increase
,Sterile Intervention - ANSWER 1. dollar stronger -> bought dollars -> dollar supply goes
up, so use excess dollars to pay off some debt (buy T-bills)
2. dollar weaker -> used dollars -> dollar supply goes down, so issue T-bills to get
dollars back
Types of Direct Government Intervention - ANSWER 1. Weaken Currency
2. Strengthen Currency
3. Sterile vs. Non Sterile Intervention
Bad Economy - ANSWER - high unemployment
- low exports and low imports
Want to make dollar weaker so increase exports and decrease imports -> heats up the
economy
Too Good Economy - ANSWER - need for additional people
- wages increase rapidly
- Inflation
Want to make dollar stronger so decrease exports and increase imports - > cools the
economy
The threat of ______ is what makes the market work. - ANSWER arbitrage
Types of Arbitrage - ANSWER 1. Locational Arbitrage
2. Triangular Arbitrage
3.Covered Interest Arbitrage
Locational Arbitrage - ANSWER keeps the bid/ask honest
Triangular Arbitrage - ANSWER takes advantage of a problem in the cross exchange
rate. Makes cross exchange rates in the market work.
Covered Interest Arbitrage - ANSWER taking advantage of differences in interest.
Threat of interest arbitrage makes quotes on forward market correct. Takes advantage
where interest rate parity does not exist in the forward market.
Interest Rate Parity - ANSWER drives the prices on the forward market. 99% of the
time, in the forward rate, interest rate parity exists.
Interest Rate Parity Formula - ANSWER Premium in Market P(d) = (1+
ihome)/(1+iforeign) -1
Absolute Form of Purchase Power Parity - ANSWER prices of same basket of products
in two different countries should be equal when measured in common currency
Relative Form of Purchase Power Parity - ANSWER Due to market imperfections,
prices of the same basket of products in different countries will not necessarily be the
,same, but the rate of change in prices should be similar when measured in common
currency
Purchasing Power Parity Formula - ANSWER Exchange Rate ef = (1 + Ihome)/(1 +
Iforeign) -1
International Fischer Effect - ANSWER no such thing as a difference in interest rates.
the difference is in inflation.
Why do we forecast Exchange Rates? - ANSWER 1. Hedging
2. Short-term Investments
3. Capital Budgeting
4. Earnings Assessments
5. Long-term Financing
Hedging - ANSWER guarding company against a problem on a receivable or a payable.
_______ to decide whether to hedge or not. - ANSWER forecast
Short-term investments - ANSWER if have excess money, where do you want to put it
(or where do you want to borrow it)
Capital Budgeting - ANSWER forecasting about most important thing you can do.
Assess whether to invest funds in a foreign project
Earnings Assessment - ANSWER very important to MNC, and earnings forecast
Long-term Financing - ANSWER to issue bonds to secure long-term funds
How we forecast exchange rates - ANSWER 1. Technical forecasting
2. Fundamental forecasting
3. Market-Based forecasting
4. Mixed forecasting
Technical forecasting - ANSWER looking at history to forecast a future exchange rate.
Fundamental forecasting - ANSWER based on fundamental relationships between
economic variables and exchange rates (inflation, income, interest rates, government
intervention)
Market-based forecasting - ANSWER look at the market (spot rate today, forward rate
today and what is is telling you). Looking at forward rate works until the interest rate
changes)
Mixed forecasting - ANSWER best way to go. Use mix of forecasting techniques
, What they do to forecast exchange rates - ANSWER 1. put together a forecasting team
that meets quarterly
2. forecasts for each currency what they expect to happen and document why they
forecasted something
3. Corporate governance: everyone has to use it and it is updated every quarter
4. same group in next quarter reforests and looks back at what they forecasted and why
(analysis of forecast to the actual)
Corporate governance concerning forecasts - ANSWER everyone has to use it and it is
updated every quarter
Are exchange rates important? - ANSWER YES. Need to manage the exchange
exposure in your company. The larger the proportion of business is outside of the US
the more important it gets.
Measuring Transaction Exposure - ANSWER 1. Exchange Volatility
2. Exchange Correlation
Exchange volatility - ANSWER exchange rates are very volatile, expect all of them to be
volatile
Exchange correlation - ANSWER some currencies are closely correlated to other
currencies, some are not correlated at all
Economic exposure - ANSWER selling in one currency and costing in another currency
(also called operating exposure). Not easily hedgable, takes a long time to fix.
Translation exposure - ANSWER translating financial statements into the currency of
your corporation.
Receivable hedging with a forward contract - ANSWER contract to sell foreign currency
for dollars on receivable due date (or later)
Receivable hedging with an option - ANSWER put option to sell foreign currency for
dollars at strike price on recorded due date (or later). Exercise if strike price higher than
spot rate. Always pay for option.
Receivable hedging with a money market hedge - ANSWER on day 1: borrow foreign
funds so that the receivable will pay money market debt on recorded due date and
convert borrowed foreign funds to dollars at today's spot rate, and deposit in dollar
money market
on day receivable is due: get dollars plus accrued interest out of money market
Payable Hedging with a forward contract - ANSWER contract to buy foreign currency on
day payable due. Buy foreign currency with dollars, pay off payable
