Ch 9: International Financial Markets

CHAPTER 9
INTERNATIONAL FINANCIAL MARKETS

TRUE/FALSE QUESTIONS

1. Well-functioning financial markets funnel money from organizations and economies with
excess funds to those with shortages.
(True; Easy; p. 258; LO1)

2. International financial markets allow companies to exchange one currency for another.
(True; Easy; p. 260; LO1)

3. The international financial market is composed of two interrelated systems: the international
capital market and the foreign goods market.
(False; Easy; p. 258; LO1)

4. A capital market is a system that allocates financial resources in the form of debt and equity
according to their most efficient uses.
(True; Easy; p. 260; LO1)

5. The international capital market is a network of individuals, companies, financial institutions,

and governments that invest and borrow across national boundaries.
(True; Moderate; p. 259; LO1)

6. Through the international capital market, a company that is unable to obtain funds from
investors in its own nation can seek financing from investors elsewhere.
(True; Moderate; p. 259; LO1)

7. If the money supply increases, its price—in the form of interest rates—also increases.
(False; Easy; p. 260; LO1)

8. An excess money supply creates a borrower’s market, forcing down interest rates and the cost
of borrowing.
(True; Easy; p. 260; LO1)

9. Given the globalization trend, the international capital market reduces the available set of
investment opportunities.
(False; Moderate; p. 260; LO1)

10. Investors increase risk by holding international securities whose prices move independently.
(False; Moderate; p. 260; LO1)

11. When obtaining microcredit, small groups of low-income entrepreneurs can borrow money at
competitive rates without having to put up collateral.
(True; Easy; p. 260; LO1) {AACSB: Ethics}

12. The microcredit concept was pioneered in developed countries as a way for developing
countries to create the foundation for a market economy.
(True; Moderate; p. 260; LO1) {AACSB: Ethics}
Ch 9: International Financial Markets

13. The rapid growth of the international capital market can be traced to three main factors:
deregulation, innovative financial instruments, and information technology.
(True; Moderate; p. 261; LO1)
14. Deregulation of national capital markets has been instrumental in the expansion of the
international capital market.
(True; Easy; p. 261; LO1)

15. Increased regulation of national capital markets has been instrumental in the expansion of the
international capital market.
(False; Moderate; p. 261; LO1)

16. Securitization is the unbundling and repackaging of hard-to-trade financial assets into more
liquid, negotiable, and marketable financial instruments.
(True; Easy; p. 261; LO1)

17. The world’s three most important financial centers are New York, Chicago, and London.
(False; Moderate; p. 261; LO1)

18. Offshore financial centers tend to be characterized by economic and political instability and
poor telecommunications infrastructures.
(False; Moderate; p. 261; LO1)

19. An offshore financial center is a country or territory whose financial sector features very few
regulations and few, if any, taxes.
(True; Moderate; p. 261; LO1)

20. Booking centers are usually located on small island nations and territories with favorable tax
and/or secrecy laws.
(True; Moderate; p. 262; LO1)

21. The most important factor fueling growth in the international bond market is high interest
rates in developed nations.
(False; Difficult; p. 263; LO2)

22. High interest rates outside the developed nations have fueled increased activity in the
international bond market.
(True; Difficult;p. 263; LO2)

23. Typical buyers of international bonds include medium- and large-sized banks, pension funds,
mutual funds, and governments with excess financial reserves.
(True; Moderate; p. 263; LO2)

24. By issuing bonds in the international bond market, borrowers from newly industrialized and
developing countries can borrow money from other nations where interest rates are lower.
(True; Moderate; p. 263; LO2)

25. Samurai bonds are bonds issued in Japan by non-Japanese entities.

(True; Moderate; p. 263; LO2)
 Ch 9: International Financial Markets

26. A rise in a country’s currency forces borrowers to shell out more local currency to pay off the
interest owed on bonds denominated in an unaffected currency.
(False; Difficult; p. 263; LO2)

27. The international bond market consists of all stocks bought and sold outside the issuer’s
home country.
(False; Moderate; p. 264; LO2)

28. The speed of privatization is encouraging the growth of the international equity market.
(True; Moderate; p. 264; LO2)

29. Although historically more devoted to equity as a means of financing, Europe has more
recently discovered the value of debt.
(False; Moderate; p. 264; LO2)

30. All of Europe’s currencies combined are referred to as Eurocurrency.

(False; Moderate; p. 264; LO2)

31. The main appeal of the Eurocurrency market is the complete absence of regulation.
(True; Moderate; p. 265; LO2)

32. The London Interbank Bid Rate (LIBID) is the interest rate that London banks charge other
large banks for borrowing Eurocurrency.
(False; Difficult; p. 265; LO2)

33. The rate at which one currency is exchanged for another depends on the size of the
transaction, the trader conducting it, and general economic conditions.
(True; Moderate; p. 265; LO3)

34. The practice of insuring against potential losses that result from adverse changes in exchange
rates is called currency arbitrage.
(False; Easy; p. 266; LO3)

35. Interest arbitrage is the profit-motivated purchase and sale of interest-paying securities
denominated in different currencies.
(True; Easy; p. 266; LO3)

36. There are two components of every quoted exchange rate: the debt and the equity rates.
(False; Moderate; p. 268; LO4)

37. If an exchange rate quotes the number of Indian rupees needed to buy one U.S. dollar, the
dollar is the quoted currency and the rupee is the base currency.
(False; Moderate; p. 268; LO4)

38. In any exchange rate, the quoted currency is always the numerator and the base currency is
always the denominator.
(True; Moderate; p. 268; LO4)

39. Exchange rate risk is the risk of adverse changes in exchange rates.
(True; Easy; p. 269; LO4)
Ch 9: International Financial Markets

40. International transactions between two currencies other than the U.S. dollar often use the
dollar as a vehicle currency.
(True; Moderate; p. 270; LO4)

41. Cross rates between two currencies can be calculated using either currency’s indirect or direct
exchange rates with another currency.
(True; Moderate; p. 270; LO4)

42. An exchange rate requiring delivery of the traded currency within two business days is called
a cross rate.
(False; Easy; p. 271; LO4)

43. If you are traveling to another country and want to exchange currencies at your bank before
departing, you will be quoted the spot rate since you are exchanging on the spot.
(False; Moderate; p. 271; LO4)

44. Forward rates represent the expectations of currency traders and bankers regarding a
currency’s future spot rate.
(True; Easy; p. 272; LO4)

45. Forward contracts belong to a family of financial instruments called arbitrage.

(False; Easy; p. 272; LO4)

46. If a currency’s forward rate is higher than its spot rate, the currency is trading at a discount.
(False; Moderate; p. 272; LO4)

47. A currency swap is the simultaneous purchase and sale of foreign exchange for two different
dates.
(True; Easy; p. 273; LO4)

48. Although London has a better location and the preferred time zone, New York dominates the
foreign exchange market because the majority of the trades involve the U.S. dollar.
(False; Difficult; p. 274; LO5)

49. The process of aggregating the currencies that one bank owes another and then carrying out
the transaction is called clearing.
(True; Easy; p. 275; LO5) {AACSB: Technology}

50. All foreign exchange transactions can be performed in the over-the-counter (OTC) market.
(True; Moderate; p. 276; LO5)

51. A convertible currency (or soft currency) is traded freely in the foreign exchange market with
its price determined by the London banks.
(False; Easy; p. 277; LO6)

52. One goal of currency restriction is to preserve hard currencies to pay for imports and to
finance trade deficits.
(True; Moderate; p. 277; LO6)

53. A way to get around national restrictions on currency convertibility is to use barter.
(True; Moderate; p. 278; LO6)
 Ch 9: International Financial Markets

MULTIPLE CHOICE QUESTIONS

1. The ease with which bondholders and shareholders may convert their investments into cash is
called ________.
a. barter
b. hedging
c. arbitrage
d. liquidity
(d; Moderate; p. 259; LO1)

2. Which of the following is NOT true?

a. The international capital market expands the available set of lending opportunities.
b. Investors reduce their overall risk by spreading their money over a greater number of
debt and equity instruments.
c. Investors increase risk by holding international securities whose prices move
independently.
d. Investing in international securities benefits investors because some economies are
growing while others are in decline.
(c; Moderate; p. 259-260; LO1)

3. An expanded money supply ________.

a. reduces the cost of borrowing
b. makes it difficult for financial institutions to lend money
c. increases the cost of borrowing
d. diminishes the entrepreneurial initiatives of a country
(a; Moderate; p. 259-260; LO1)

4. Which of the following is not a purpose of the international capital market?

a. Reducing investor risk
b. Expanding the money supply for borrowers
c. Reducing the cost of money to borrowers
d. Preserving hard currencies to finance trade deficits
(d; Moderate; p. 259-260; LO1)

5. The international capital market ________.

a. limits the available set of lending opportunities
b. increases overall portfolio risk for investors
c. is easily accessible to everyone
d. allows investors to reduce risk by holding international securities whose prices move
independently
(d; Moderate; p. 259-260; LO1)

6. A small group of low-income entrepreneurs from less-developed countries borrowing money

at competitive rates with little or no collateral is called ________.
a. microdebit
b. microcredit
c. capital loans
d. capital credit
(b; Moderate; p. 260; LO1) {AACSB: Ethics}

7. Microcredit loans in developing countries typically average ________.

Ch 9: International Financial Markets

a. more than $100

b. less than $100
c. more than $500
d. less than $500
(b; Moderate; p. 260; LO1) {AACSB: Ethics}

8. The international capital market’s rapid growth rate is traced to all these EXCEPT ________.
a. innovative financial instruments
b. information technology
c. foreign exchange rates
d. deregulation
(c; Moderate; p. 261; LO1) {AACSB: Ethics}

9. Deregulation of capital markets resulted in all of the following EXCEPT ________.

a. increased competition
b. lowered the cost of financial transactions
c. opened many national markets to global investing and borrowing
d. reduced the use of microcredit
(d; Moderate; p. 261; LO1)

10. The international bond market consists of all bonds sold by issuing companies, governments,
or other organizations ________.
a. within their own countries
b. to London banks
c. outside their own countries
d. to developing nations only
(c; Easy; p. 262; LO2)

11. The most important factor fueling growth in the international bond market is ________.
a. former communist countries’ transformation to capitalist
b. technology deregulation
c. rising stock markets worldwide
d. low interest rates
(d; Moderate; p. 263; LO2)

12. Typical buyers of bonds include all of the following EXCEPT ________.
a. medium- to large-sized banks
b. pension funds
c. mutual funds
d. governments in need of funds
(d; Moderate; p. 263; LO2)

13. Eurobonds account for ________ percent of all international bonds.

a. 20 to 25
b. 30 to 40
c. 50 to 65
d. 75 to 80
(d; Difficult; p. 263; LO2)

14. A bond issued by a Venezuelan company, denominated in U.S. dollars, and sold in Britain,
France, and Germany is called a(n) ________.
 Ch 9: International Financial Markets

a. Venobond
b. Forobond
c. Eurobond
d. Latinobond
(c; Moderate; p. 263; LO2)

15. Eurobonds are popular because ________.

a. they are less risky than traditional bonds
b. they are always denominated in euros
c. of the absence of government regulation
d. European companies are considered very stable
(c; Moderate; p. 263; LO2)

16. The absence of government regulation in the Eurobond market ________.

a. substantially reduces the cost of issuing a bond
b. lowers the risk level of the bond
c. makes Eurobonds less popular than foreign bonds
d. exists because of the difficulty of regulating a multi-country market
(a; Moderate; p. 263; LO2)

17. Bonds sold outside the borrower’s country and denominated in the currency of the country in
which they are sold are called ________.
a. international bonds
b. foreign bonds
c. Eurobonds
d. local bonds
(b; Easy; p. 263; LO2)

18. Foreign bonds account for about ________ percent of all international bonds.
a. 20 to 25
b. 25 to 40
c. 50 to 70
d. more than 90
(a; Difficult; p. 263; LO2)

19. Foreign bonds issued in Japan are called ________.

a. bulldog bonds
b. yankee bonds
c. samurai bonds
d. dragon bonds
(c; Moderate; p. 263; LO2)

20. The most commonly quoted rate in the Eurocurrency market is the ________.
a. London Interbank Offer Rate (LIBOR)
b. London Interbank Bid Rate (LIBID)
c. spot rate
d. cross rate
(a; Moderate; p. 265; LO2)

21. Rates that the world’s largest banks charge one another for loans are called ________.
a. interbank interest rates
Ch 9: International Financial Markets

b. standardized interest rates

c. exchange rates
d. none of the above
(a; Easy; p. 265; LO2)

22. The market in which currencies are bought and sold and their prices determined is called the
________.
a. Eurocurrency market
b. international capital market
c. international bond market
d. foreign exchange market
(d; Easy; p. 265; LO3)

23. The rate at which one currency is exchanged for another is called the ________.
a. exchange rate
b. LIBOR
c. LICU rate
d. Federal funds rate
(a; Easy; p. 265; LO3)

24. The bid-ask spread in the foreign exchange market is the ________.
a. price at which a bank will buy a currency
b. price of currency in the foreign exchange market
c. difference between the bid and ask quotes for a currency
d. price a bank will pay for a currency
(c; Easy; p. 265; LO3)

25. For which of the following reasons do investors use the foreign exchange market?
a. Currency hedging
b. Currency speculation
c. Currency arbitrage
d. Currency conversion
e. All of the above
(e; Moderate; p. 265; LO3)

26. The exchange rate between two currencies depends on ________.

a. the size of the transaction
b. the trader conducting the transaction
c. general economic conditions
d. all of the above
(d; Moderate; p. 265; LO3)

27. The practice of insuring against potential losses that result from adverse changes in exchange
rates is called currency ________.
a. hedging
b. arbitrage
c. speculation
d. conversion
(a; Easy; p. 266; LO3)

28. ________ is the instantaneous purchase and sale of a currency in different markets for profit.
 Ch 9: International Financial Markets

a. Currency hedging
b. Currency arbitrage
c. Currency speculation
d. Currency conversion
(b; Easy; p. 266; LO3)

29. The profit-motivated purchase and sale of interest-paying securities denominated in different
currencies is called ________.
a. currency arbitrage
b. currency hedging
c. interest arbitrage
d. interest hedging
(c; Moderate; p. 266; LO3)

30. The exchange rate between the euro (€) and the dollar is €0.8461/$. Which of the following is
the correct direct quote on the dollar?
a. $2.20/€
b. $1.1819/€
c. $5.50/€
d. $0.8461/€
(b; Difficult; p. 269; LO4)

31. An exchange rate calculated using two other exchange rates is called a ________.
a. arbitrage rate
b. hedge rate
c. forward rate
d. cross rate
(d; Easy; p. 270; LO4)

32. Which of the following is an exchange rate that requires delivery of the traded currency
within two business days?
a. Derivative rate
b. Spot rate
c. Discount rate
d. Forward rate
(b; Easy; p. 271; LO4)

33. The exchange rate at which two parties agree to exchange currencies on a specified future
date is called a ________.
a. forward rate
b. bid-ask rate
c. spot rate
d. arbitrage rate
(a; Easy; p. 272; LO4)

34. If a currency’s forward rate is higher than its spot rate, the currency is trading at a ________.
a. discount
b. swap rate
c. derivative rate
d. premium
(d; Moderate; p. 272; LO4)
Ch 9: International Financial Markets

35. If the spot for the British pound (GBP) is $1.6950/GBP and the 30-day forward rate is
$1.6921/GBP, then the pound is trading at a ________ in the 30-day market.
a. premium
b. discount
c. neither a premium nor a discount
d. none of the above
(b; Moderate; p. 272; LO4)

36. Which of these is the simultaneous purchase and sale of foreign exchange for two different
dates?
a. Forward swap
b. Bid-ask swap
c. Currency swap
d. Security swap
(c; Moderate; p. 273; LO4) {AACSB: Technology}

37. A currency used as an intermediary to convert funds between two other currencies is called
a(n) ________.
a. spot currency
b. vehicle currency
c. forward currency
d. interbank currency
(b; Easy; p. 274; LO5)

38. The world’s largest banks exchange currencies at spot and forward rates in the ________.
a. securities exchanges
b. Eurocurrency market
c. interbank market
d. over-the-counter market
(c; Easy; p. 275; LO5)

39. A ________ currency is traded freely in the foreign exchange market.

a. barter
b. convertible
c. vehicular
d. soft
(b; Moderate; p. 277; LO6)

40. Governments impose currency restrictions to ________.

a. protect a currency from speculators
b. preserve hard currencies to finance trade deficits or repay debts
c. keep resident individuals and businesses from investing in other nations
d. all of the above
(d; Moderate; p. 277; LO6)

SHORT-ANSWER QUESTIONS

1. An ________ is a country or territory whose financial sector features very few regulations
and few, if any, taxes.
 Ch 9: International Financial Markets

(offshore financial center; Moderate; p. 261; LO1)

2. Prominent operational centers include ________ and ________.

(London, Switzerland; Difficult; p. 261; LO1)

3. ________ are usually located on small island nations or territories with favorable tax and/or
secrecy laws.
(Booking centers; Moderate; p. 262; LO1)

4. The ________ consists of all bonds sold by issuing companies, governments, or other
organizations outside their own countries.
(international bond market; Moderate; p. 262; LO2)

5. A bond issued outside the country in whose currency it is denominated is called a(n)
________.
(Eurobond; Moderate; p. 263; LO2)

6. Bonds sold outside the borrower’s country and denominated in the currency of the country in
which they are sold are called ________.
(foreign bonds; Moderate; p. 263; LO2)

7. Today, the most important factor fueling growth in the international bond market is
________.
(low interest rates; Moderate; p. 263; LO2)

8. By issuing bonds in the international bond market, borrowers from newly industrialized and
developing nations can borrow money from other nations where interest rates are ________.
(lower; Easy; p. 263; LO2)

9. The ________ consists of all stocks bought and sold outside the issuer’s home country.
(international equity market; Easy; p. 264; LO2)

10. In a quoted exchange rate, the currency that is to be purchased with another currency is called
the ________.
(base currency; Difficult; p. 268; LO4)

11. The exchange rate calculated using two other exchange rates is called the ________.
(cross rate; Easy; p. 270; LO4)

12. The exchange rate requiring delivery of the traded currency within two business days is
called the ________.
(spot rate; Easy; p. 271; LO4)

13. The exchange rate at which two parties agree to exchange currencies on a specified future
date is called the ________.
(forward rate; Moderate; p. 272; LO4)

14. A ________ is a contract requiring the exchange of an agreed-upon amount of a currency on

an agreed-upon date at a specific exchange rate.
(forward contract; Moderate; p. 272; LO4)
Ch 9: International Financial Markets

15. If a currency’s forward rate is higher than its spot rate, the currency is trading at a ________.
(premium; Moderate; p. 272; LO4)

16. If a currency’s forward rate is lower than its spot rate, the currency is trading at a ________.
(discount; Moderate; p. 272; LO4)

17. A ________ is the simultaneous purchase and sale of foreign exchange for two different
dates.
(currency swap; Easy; p. 273; LO4) {AACSB: Technology}

18. A ________ is a right to exchange a specific amount of a currency on a specific date at a

specific rate.
(currency option; Easy; p. 273; LO4)

19. A ________ is a currency used as an intermediary to convert funds between two other
currencies.
(vehicle currency; Easy; p. 274; LO5)

20. The world’s largest banks exchange currencies at spot and forward rates in the ________.
(interbank market; Moderate; p. 275; LO5)

21. The process of aggregating the currencies that one bank owes another and then carrying out
that transaction is called ________.
(clearing; Easy; p. 275; LO5) {AACSB: Technology}

22. Currency that trades freely in the foreign exchange market, with its price determined by the
forces of supply and demand, is called a ________.
(convertible currency (or hard currency); Moderate; p. 277; LO6)

23. Exchange of goods and services between two parties without money is called ________.
(countertrade; Easy; p. 278; LO6)

ESSAY QUESTIONS

1. Describe the purposes of the international capital market, and the factors accounting for its
rapid growth.
(Difficult; p. 259-261; LO1)

2. What is an offshore financial center? Differentiate between an operational and a booking

center, providing country examples of each.
(Moderate; p. 261; LO1)

3. Briefly describe any two of the three main components of the international capital market.
(Moderate; p. 262-265; LO2)

4. Identify and explain factors responsible for the growth of the international equity market.
(Moderate; p. 264; LO2)

5. What is the foreign exchange market? Explain why investors use this market.
(Moderate; p. 265-266; LO3)
 Ch 9: International Financial Markets

6. Differentiate between currency speculation and currency arbitrage. Which is riskier?

(Difficult; p. 266; LO3)

7. Differentiate between a quoted exchange rate and a cross rate providing an example.
(Difficult; p. 268-270; LO4)

8. Identify and explain the types of currency instruments used in the forward market.
(Moderate; p. 272; LO4)

9. Explain what a vehicle currency is and the role it plays in the foreign exchange market.
(Easy; p. 274-275; LO5)

10. Briefly describe the three main institutions of the foreign exchange market.
(Moderate; p. 275-276; LO5)

11. Identify and discuss strategies for effective foreign exchange management.
(Difficult; p. 276; LO5)

12. Why do governments impose currency restrictions and how can companies get around such
restrictions?
(Moderate; p. 277-278; LO6)