Multinational Business Finance, 16e (Eiteman/Stonehill/Moffett)

Chapter 5 The Foreign Exchange Market

5.1 Functions of the Foreign Exchange Market

1) Which of the following is NOT true regarding the market for foreign exchange?
A) The market provides the physical and institutional structure through which the money of one
country is exchanged for another.
B) The rate of exchange is determined in the market.
C) Foreign exchange transactions are physically completed in the foreign exchange market.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one
currency will be delivered at a specified rate for some other currency.
A) Eurodollar transaction
B) import/export exchange
C) foreign exchange transaction
D) interbank market transaction
Answer: C
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

3) The ________ is the mechanism by which participants transfer purchasing power between
countries, obtain or provide credit for international trade transactions, and minimize exposure to
the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR
Answer: C
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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4) Which of the following is NOT a motivation identified by the authors as a function of the
foreign exchange market?
A) the transfer of purchasing power between countries
B) obtaining or providing credit for international trade transactions
C) minimizing the risks of exchange rate changes
D) All of the above were identified as functions of the foreign exchange market.
Answer: D
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

5) Business firms in countries with exchange controls, for example, China (mainland), often
must surrender foreign exchange earned from exports to the central bank at the daily fixing price.
Answer: TRUE
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

6) The foreign exchange market provides the physical and institutional structure through which
three typical functions are accomplish. List and explain three functions of the foreign exchange
market.
Answer: The foreign exchange market is the mechanism by which participants transfer
purchasing power between countries by exchanging money, obtain or provide credit for
international trade transactions, and minimize exposure to the risks of exchange rate changes. 1)
The transfer of purchasing power is necessary because international trade and capital transactions
normally involve parties living in countries with different national currencies. Usually each party
wants to deal in its own currency, but the trade or capital transaction can be invoiced in only one
currency. Hence, one party must deal in a foreign currency. 2) Because the movement of goods
between countries takes time, inventory in transit must be financed. The foreign exchange
market provides a source of credit. Specialized instruments, such as bankers' acceptances and
letters of credit are available to finance international trade. 3) The foreign exchange market
provides "hedging" facilities for transferring foreign exchange risk to someone else more willing
to carry risk.
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

2
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5.2 Structure of the Foreign Exchange Market

1) While trading in foreign exchange takes place worldwide, the major currency trading centers
are located in:
A) London, New York, Singapore, Hong Kong, and Tokyo.
B) New York, Zurich, and Hong Kong.
C) Paris, Frankfurt, and London.
D) Los Angeles, New York, and London.
Answer: A
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

2) The authors describe the old two tiers of foreign exchange markets made of:
A) bank and nonbank foreign exchange.
B) commercial and investment transactions.
C) interbank and client markets.
D) client and retail market.
Answer: C
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

3) It is characteristic of foreign exchange dealers to:

A) bring buyers and sellers of currencies together but never to buy and hold an inventory of
currency for resale.
B) act as market makers, willing to buy and sell the currencies in which they specialize.
C) trade only with clients in the retail market and never operate in the wholesale market for
foreign exchange.
D) All of the above are characteristics of foreign exchange dealers.
Answer: B
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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4) Which of the following may be participants in the foreign exchange markets?
A) bank and nonbank foreign exchange dealers
B) central banks and treasuries
C) speculators and arbitrageurs
D) all of the above
Answer: D
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

5) ________ seek to profit from trading in the market itself rather than having the foreign
exchange transaction being incidental to the execution of a commercial or investment
transaction.
A) Speculators and arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries
Answer: A
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

6) In the foreign exchange market, ________ seek all of their profit from exchange rate changes
while ________ seek to profit from simultaneous exchange rate differences in different markets.
A) wholesalers; retailers
B) central banks; treasuries
C) speculators; arbitrageurs
D) dealers; brokers
Answer: C
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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7) Foreign exchange ________ earn a profit by a bid-ask spread on currencies they purchase and
sell. Foreign exchange ________, on the other hand, earn a profit by bringing together buyers
and sellers of foreign currencies and earning a commission on each sale and purchase.
A) central banks; treasuries
B) dealers; brokers
C) brokers; dealers
D) speculators; arbitrageurs
Answer: B
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

8) ________ are agents who facilitate trading between dealers without themselves becoming
principals in the transaction.
A) Central banks
B) Foreign exchange brokers
C) Arbitrageurs
D) Foreign exchange dealers
Answer: B
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

9) Among the types of trades or traders that remain outside the core foreign exchange market
today are:
A) central banks.
B) small banks.
C) large banks.
D) speculators.
Answer: B
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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10) Following the discovery of significant market manipulation and coordinated malfeasance in
2013 and 2014 in the foreign exchange market, the Bank for International Settlements (BIS)
proposed a set of global principles (Global Code) made of the following leading principles
EXCEPT:
A) Ethics.
B) Information sharing.
C) Confirmation and settlement processes.
D) Capital.
Answer: D
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

11) Because the market for foreign exchange is worldwide, the volume of foreign exchange
currency transactions is level throughout the 24-hour day.
Answer: FALSE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

12) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement
at Bretton Woods.
Answer: FALSE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

13) Dealers in foreign exchange departments at large international banks act as market makers
and maintain inventories of the securities in which they specialize.
Answer: TRUE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

14) Currency trading lacks profitability for large commercial and investment banks but is
maintained as a service for corporate and institutional customers.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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15) The primary motive of foreign exchange activities by most central banks is profit.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

16) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank
markets.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

17) Dealers in the foreign exchange departments of large international banks often function as
"market makers." Such dealers stand willing at all times to buy and sell those currencies in which
they specialize and thus maintain an "inventory" position in those currencies.
Answer: TRUE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

18) Currency trading is a service center rather than a profit center for commercial and investment
banks.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

19) For individuals and firms involved in the import and export of goods and services, using the
foreign exchange market is necessary, but incidental, to their underlying commercial or
investment purpose.
Answer: TRUE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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20) Most transactions in the interbank foreign exchange trading are primarily conducted via
telecommunication techniques and little is conducted face-to-face.
Answer: TRUE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

21) What are some of the reasons central banks and treasuries enter the foreign exchange
markets, and in what important ways are they different from other foreign exchange participants?
Answer: Central banks and treasuries enter the foreign exchange market to acquire/spend their
own foreign exchange reserves and to influence the price at which their own currency is traded.
Unlike other market participants, they are not profit oriented. Instead, they may willingly take a
loss if they think it is in their best national interest.
Diff: 3
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

5.3 Transactions in the Foreign Exchange Market

1) ________ is NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Forward transactions
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

2) A ________ transaction in the foreign exchange market requires an almost immediate delivery
(typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above
Answer: A
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

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3) A ________ transaction in the foreign exchange market requires delivery of foreign exchange
at some future date.
A) spot
B) forward
C) swap
D) currency
Answer: B
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

4) A forward contract to deliver British pounds for U.S. dollars could be described either as
________ or ________.
A) buying dollars forward; buying pounds forward
B) selling pounds forward; selling dollars forward
C) selling pounds forward; buying dollars forward
D) selling dollars forward; buying pounds forward
Answer: C
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

5) A common type of swap transaction in the foreign exchange market is the ________ where
the dealer buys the currency in the spot market and sells the same amount back to the same bank
in the forward market.
A) "forward against spot"
B) "forspot"
C) "repurchase agreement"
D) "spot against forward"
Answer: D
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

9
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6) The ________ is a derivative forward contract that was created in the 1990s. It has the same
characteristics and documentation requirements as traditional forward contracts except that they
are only settled in U.S. dollars and the foreign currency involved in the transaction is not
delivered.
A) nondeliverable forward
B) dollar only forward
C) virtual forward
D) internet forward
Answer: A
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

7) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts?
A) NDFs are used primarily for emerging market currencies.
B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged
for dollar settlement.
C) NDFs can only be traded by central banks.
D) NDFs are contracted offshore.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

8) A ________ transaction in the interbank market is the simultaneous purchase and sale of a
given amount of foreign exchange for two different value dates.
A) spot
B) forward
C) swap
D) futures
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

10
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9) Daily trading volume in the foreign exchange market was about ________ per ________ in
2019.
A) $6,600 billion; month
B) $3,100 billion; month
C) $6,600 billion; day
D) $3,100 billion; day
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

10) The greatest volume of daily foreign exchange transactions are:

A) spot transactions.
B) forward transactions.
C) swap transactions.
D) This question is inappropriate because the volume of transactions are approximately equal
across the three categories above.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

11) The United Kingdom and United States together make up nearly ________ of daily currency
trading.
A) 30%
B) 40%
C) 50%
D) 60%
Answer: D
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

12) The top three currency pairs traded with the U.S. dollar are:
A) U.K. pound, Chinese Yuan, Japanese yen.
B) Swiss franc, euro, Japanese yen.
C) U.K. pound, euro, Japanese yen.
D) euro, Chinese Yuan, Japanese yen.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

11
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13) The greatest amount of foreign exchange trading takes place in the following two cities:
A) New York and Tokyo.
B) New York and London.
C) London and Frankfurt.
D) London and Tokyo.
Answer: B
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

14) The four currencies that constitute about 50% of all foreign exchange trading are:
A) U.K pound, Chinese yuan, euro, and Japanese yen.
B) U.S. dollar, euro, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, euro, and U.K. pound.
D) U.S. dollar, U.K. pound, yen, and Chinese yuan.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

15) A spot transaction in the interbank market for foreign exchange would typically involve a
two-day delay in the actual delivery of the currencies, while such a transaction between a bank
and its commercial customer would not necessarily involve a two-day wait.
Answer: TRUE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

16) Nondeliverable Forwards were originally envisioned as a method of currency speculation,

but it is now estimated that 70% of NDFs are trading for hedging purposes.
Answer: FALSE
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

17) In general, NDF markets normally develop for country currencies having large cross-border
capital movements, but still subject to convertibility restrictions.
Answer: TRUE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

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18) NDFs are traded and settled inside the country of the subject currency, and therefore are
within the control of the country's government.
Answer: FALSE
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

19) A contract to deliver dollars for euros in six months is both "buying euros forward for
dollars" and "selling dollars forward for euros."
Answer: TRUE
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

20) As you might expect, the foreign exchange daily trading volume in in New York City is
roughly twice as large as the daily trading volume in London.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

21) The low level of interest rates around the globe in recent years, combined with slowing
economic growth and new debt issuances, has had a dampening impact on the swap market.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

22) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the
most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar
trading pairs.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

13
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23) Swap and forward transactions account for an insignificant portion of the foreign exchange
market.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge

24) Define spot, forward, and swap transactions in the foreign exchange market and give an
example of how each could be used.
Answer: Spot transactions are exchanging one currency for another right now. Spot transactions
are typically entered into because the parties need to exchange foreign currencies that they have
received into their domestic currency, or because they have an obligation that requires them to
obtain foreign currency.
Forward foreign exchange transactions are agreements entered into today to exchange currencies
at a particular price at some point in the future. Forwards may be speculative or a hedge against
unexpected changes in the price of the other currency.
Swaps are the simultaneous purchase and sale of a given amount of a foreign exchange for two
different dates. Both transactions are conducted with the same counterparty. A swap may be
considered a technique for borrowing another currency on a fully collateralized basis.
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge

5.4 Foreign Exchange Rates and Quotations

1) A foreign exchange ________ is the price of one currency expressed in terms of another
currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.
A) quote; rate
B) quote; quote
C) rate; quote
D) rate; rate
Answer: C
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

14
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2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed
as the foreign currency per dollar this known as ________ whereas ________ are expressed as
dollars per foreign unit.
A) European terms; indirect
B) American terms; direct
C) American terms; European terms
D) European terms; American terms
Answer: D
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

3) The following is an example of an American term foreign exchange quote:

A) $20/£
B) €0.85/$
C) ¥100/€
D) none of the above
Answer: A
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

4) From the viewpoint of a British investor, which of the following would be a direct quote in the
foreign exchange market?
A) SF2.40/£
B) $1.50/£
C) £0.55/€
D) $0.90/€
Answer: C
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

5) A/An ________ quote in the United States would be foreign units per dollar, while a/an
________ quote would be in dollars per foreign currency unit.
A) direct; direct
B) direct; indirect
C) indirect; indirect
D) indirect; direct
Answer: D
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge
15
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6) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for
the U.S. investor would be ________ and the direct quote for the British investor would be
________.
A) £0.699/$; £0.699/$
B) $0.699/£; £0.699/$
C) £1.43/£; £0.699/$
D) £0.699/$; $1.43/£
Answer: A
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

7) ________ make money on currency exchanges by the difference between the ________ price,
or the price they offer to pay, and the ________ price, or the price at which they offer to sell the
currency.
A) Dealers; ask; bid
B) Dealers; bid; ask
C) Brokers; ask; bid
D) Brokers; bid; ask
Answer: B
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

16
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TABLE 5.1
Use the table to answer following question(s).

8) Refer to Table 5.1. The current spot rate of dollars per pound as quoted in a newspaper is
________ or ________.
A) £1.4484/$; $0.6904/£
B) $1.4481/£; £0.6906/$
C) $1.4484/£; £0.6904/$
D) £1.4487/$; $0.6903/£
Answer: C
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

9) Refer to Table 5.1. The one-month forward bid price for dollars as denominated in Japanese
yen is:
A) -¥20.
B) -¥18.
C) ¥129.74/$.
D) ¥129.62/$.
Answer: D
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

10) Refer to Table 5.1. The ask price for the two-year swap for a British pound is:
A) $1.4250/£.
B) $1.4257/£.
C) -$230.
D) -$238.
Answer: B
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

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11) Refer to Table 5.1. According to the information provided in the table, the 6-month yen is
selling at a forward ________ of approximately ________ per annum. (Use the mid rates to
make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%
Answer: C
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

12) Given the following exchange rates, which of the multiple-choice choices represents a
potentially profitable intermarket arbitrage opportunity?
¥129.87/$
€1.1226/$
€0.00864/¥
A) ¥115.69/€
B) ¥114.96/€
C) $0.8908/€
D) $0.0077/¥
Answer: B
Diff: 3
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

13) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of
$0.8909/€ to $0.8709/€. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%
Answer: A
Diff: 3
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

18
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14) A German firm is attempting to determine the euro/pound exchange rate and has the
following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate =
$1.2194/€. Therefore, the euro/pound rate must be:
A) £1.2719/€.
B) €1.2719/£.
C) €0.7316/£.
D) €0.7863/£.
Answer: B
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking

15) The European and American terms for foreign currency exchange are square roots of one
another.
Answer: FALSE
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge

16) When the cross rate for currencies offered by two banks differs from the exchange rate
offered by a third bank, a triangular arbitrage opportunity exists.
Answer: TRUE
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge

17) A confusing "quirk" of international exchange rates occurs when calculating the percentage
change in spot rates from one period to another. The percent change in the foreign currency from
one period to another when quoted using foreign currency terms is always greater than the
percent changes quoted when using home currency terms.
Answer: FALSE
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

18) The most commonly quoted currency exchange is that between the U.S. dollar and the
European euro, for example, a quotation of EUR/USD 1.2174. The euro is the base currency and
the dollar the price currency.
Answer: TRUE
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge
19
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19) Since in the U.S. the home currency is the dollar and the foreign currency is the euro, in New
York, USD 1.2174 = EUR 1.00 would be a direct quote on the euro and an indirect quote on the
dollar.
Answer: TRUE
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

20) A bid is the price in one currency at which a dealer will buy another currency. An ask is the
price at which a dealer will sell the other currency. Dealers bid (buy) at one price and ask (sell) at
a slightly higher price, making their profit from the spread between the prices. List and explain
three reasons/factors that could make the spread small.
Answer: The bid-ask spread may be quite large for currencies that are traded infrequently, in
small volumes, or both. The spread in wholesale transactions between banks and large
corporations is normally smaller than in the retail market. Competition among dealers worldwide
narrows the spread between bids and offers and so contributes to making the foreign exchange
market "efficient" in the same sense as are securities markets. Other factors that affect the spread
are the cost of processing orders, the cost of maintaining an inventory of a particular currency,
and the volatility in the value of a currency.
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge

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