Chapter 3 International Financial Markets




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Answers to Definitional Problems


  1. imperfect markets

  2. exchange rate expectations

  3. interest rates

  4. foreign exchange market

  5. spot

  6. forward

  7. Bretton Woods

  8. devalue

  9. interbank

  10. bid/ask spread

  11. bid; ask

  12. forward rate

  13. international money market

  14. Basel II

  15. Yankee

  16. American Depository Receipts (ADRs)

  17. direct; indirect

  18. cross exchange rate

  19. futures; forward

  20. call

  21. sell

  22. exercise

  23. Eurodollars

  24. Eurocredit loans

  25. London Interbank Offer Rate (LIBOR)

  26. foreign; Eurobond

  27. floating rate notes (FRNs)

  28. Euro-clear

  29. International mutual funds


True/False Problems


  1. The existence of imperfect markets has prevented the internationalization of financial markets.




  1. Economic conditions, exchange rate expectations, and international diversification are all motives for investing in foreign markets.




  1. It can be argued that a country’s currency may depreciate with high inflationary expectations, but the relationship between expected inflation and currency movements is not precise.




  1. When lending in foreign markets, international diversification increases the probability of simultaneous bankruptcy across borrowers.




  1. International diversification is a good risk-reduction technique for investment, but it may be less effective if the countries of concern tend to experience somewhat similar business cycles.




  1. When extending credit in foreign markets, investors probably anticipate that the local currency will depreciate against their own; when borrowing in foreign markets, borrowers probably anticipate that the local currency will appreciate against their own currency.

  2. In 1914, when World War I began, the gold standard was implemented; it lasted until 1944, when exchange rates were fixed under the Bretton Woods Agreement.




  1. Under the gold standard, each currency was convertible into gold at a specified rate, and the exchange rate between two currencies was determined by their relative convertibility rates per ounce of gold.




  1. From 1944 until 1971, the Bretton Woods agreement called for exchange rates to remain within 1% of their previously established levels. However, the Smithsonian Agreement of 1973 allowed exchange rates to fluctuate within 5% of their previously established levels.




  1. An investor engaging in a transaction whereby he or she contracts to purchase British pounds one year from now is an example of a spot market transaction.




  1. The immediate exchange of currencies takes place in the spot market.




  1. Besides considering the competitiveness of a bank’s quote, an investor frequently engaging in currency conversions and international trade will also consider the bank’s advice regarding foreign market conditions and exchange rate forecasts.




  1. At any given point in time, a bank’s bid quote will be greater than its ask quote.




  1. A forward contract is an agreement between a firm and a bank to exchange currencies at a specified rate (the forward rate) in a specified number of days.




  1. An MNC with receivables in Japanese Yen purchases yen forward to hedge its exposure to exchange rate fluctuations. This is an example of how MNCs can use forward contracts to hedge their exposure.




  1. Many MNCs use forward contracts.




  1. If the forward rate were the same as the spot rate, and interest rates between two countries differed, it would be possible for astute investors to engage in arbitrage to earn virtually riskless profits.




  1. An advantage of a forward contract for an MNC is that it can be tailored to accommodate the needs of the MNC.




  1. The value of the IMF’s special drawing right (SDR) is based on the value of MNCs’ stock.




  1. A cross exchange rate between two foreign currencies can easily be obtained with the two currencies’ exchange rates relative to the dollar.




  1. An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign receivables. To do so, the MNC can either sell the foreign currency forward or sell futures contracts.




  1. A currency put option provides the right, but not the obligation, to buy a specific currency at a specific price within a specific period of time.




  1. The price at which a currency may be bought or sold according to an option is known as the strike (or exercise) price.




  1. U.S. dollar deposits in Europe are known as Eurodollars; U.S. dollar deposits in Latin America are known as Latinodollars.




  1. The Asian money market is centered in Hong Kong and Singapore and consists of banks that accept deposits and make loans in various foreign currencies.




  1. All loans in the international credit market are so large that they require the use of bank syndicates.




  1. The Single European Act, which allowed banks established in an EEC country to expand into any other EEC country, and the Basel Accord, which called for risk-weighted bank capital ratios, prevented a trend toward increased globalization in the banking industry.




  1. The LIBOR varies among currencies because the market supply of and demand for funds vary among currencies.




  1. To avoid interest rate risk resulting from a mismatch of assets and liabilities, a bank may float its Eurocredit loan rate in accordance with the London Interbank Offer Rate (LIBOR).




  1. Some institutional investors prefer to invest in international bond markets rather than their respective local markets when they can earn a higher return on bonds denominated in foreign currencies.




  1. A foreign bond is a bond sold in countries other than the country represented by the currency denominating it; a Eurobond is issued by a borrower foreign to the country where the bond is placed.




  1. If an MNC issues a variety of foreign bonds in various countries, these foreign bonds are specifically called parallel bonds.




  1. Eurobond ratings are available for most issues, but there has been a tendency of the purchasers to ignore ratings in favor of a well-known name.




  1. An American Depository Receipt (ADR) is a drawing right, and it is available only for U.S. stocks.




  1. Foreign firms that issue stock in the U.S. through a Yankee stock offering are generally required to satisfy more stringent disclosure rules on their financial condition than domestic firms.




  1. Most of the largest firms based in Europe have listed their stock on the Euronext market, which was created by the Amsterdam, Brussels, and Paris stock exchanges in 2000.




  1. The international money market is frequently accessed by MNCs for short-term investment and financing decisions, while longer term financing decisions are made in the international credit market or the international bond market and in international stock markets.




  1. With an ECN, investors can place orders on their computers that are then executed by the computer system and confirmed through the Internet to the investor.




  1. Alliances between stock exchanges have resulted in monopolies and have resulted in market segmentation.




  1. Since stock market correlations become more pronounced during favorable market conditions, international diversification will be more effective during a downturn.




  1. When using the price-earnings method to value foreign stocks, investors should still consider exchange rate effects.




  1. ADRs in the U.S. are primarily traded on the over-the-counter (OTC) market.




  1. One limitations of hedging exchange rate risk is that investors may decide to retain the foreign stock beyond the initially planned investment horizon.




  1. Typically, a given stock will appear undervalued to investors from all countries at the same time.




  1. Other things being equal, investors based in low-tax countries should value stocks lower.


Answers to True/False Problems


  1. F

  2. T

  3. T

  4. F

  5. T

  6. F

  7. F

  8. T

  9. F

  10. F

  11. T

  12. T

  13. F

  14. T

  15. F

  16. T

  17. T

  18. T

  19. F

  20. T

  21. T

  22. F

  23. T

  24. F

  25. T

  26. F

  27. F

  28. T

  29. T

  30. T

  31. F

  32. T

  33. T

  34. F

  35. T

  36. T

  37. T

  38. T

  39. F

  40. F

  41. T

  42. T

  43. T

  44. F

  45. F



Multiple Choice Problems


  1. Which of the following is not mentioned in the text as a motive for investing in foreign markets?

  1. Economic conditions

  2. Interest rate levels

  3. International diversification

  4. Exchange rate expectations

  5. All of the above are mentioned in the text as motives.




  1. Which of the following is not true regarding the decision to provide credit in foreign markets?

  1. Creditors may consider supplying capital to countries whose currencies are expected to depreciate against their own.

  2. Creditors may consider supplying capital to countries whose interest rates are expected to rise above their own (everything else constant).

  3. Creditors can benefit from international diversification, which may reduce the probability of simultaneous bankruptcy across borrowers.

  4. If the foreign countries targeted for the provision of credit tend to experience somewhat similar business cycles, diversification across countries will be less effective.

  5. To the extent that inflation can cause depreciation of the local currency against others, high interest rates in the foreign country may be somewhat offset by a weakening of the local currency over the time period of concern.




  1. Investors expecting the level of foreign interest rates to be __________ relative to their own would probably provide credit in foreign markets; borrowers expecting the level of foreign interest rates to be ___________ relative to their own would probably borrow in foreign markets.

  1. High; high

  2. Low; low

  3. Low; high

  4. High; low

  5. None of the above




  1. Investors expecting the foreign currency to __________ relative to their own would probably provide credit in foreign markets; borrowers expecting the foreign currency to ___________ relative to their own would probably borrow in foreign markets.

  1. Appreciate; appreciate

  2. Depreciate; depreciate

  3. Appreciate; depreciate

  4. Depreciate; appreciate




  1. Which of the following is not true regarding the Bretton Woods Agreement?

  1. It called for fixed exchange rates between currencies.

  2. Governments intervened to prevent exchange rates from moving more than 1% above or below their initially established levels.

  3. The agreement lasted from 1944 until 1971.

  4. Each country used gold to back its currency.

  5. All of the above are true regarding the Bretton Woods Agreement.




  1. The Smithsonian Agreement

  1. Devalued the U.S. dollar relative to the major currencies.

  2. Widened the boundaries within which exchange rates were allowed to fluctuate.

  3. Was a first step in letting market forces determine the appropriate price of a currency.

  4. a and b only

  5. a, b, and c




  1. The market in which the immediate exchange of currencies takes place is known as the _________ market.

  1. Spot

  2. Forward

  3. Futures

  4. Eurocurrency

  5. Eurocredit




  1. The market in which financial intermediaries transfer short-term funds from surplus units to deficit units is known as the _________ market.

  1. Spot

  2. Forward

  3. Futures

  4. International money

  5. International credit




  1. The average daily foreign exchange trading by banks around the world is closest to $____________.

  1. 600 billion

  2. 700 billion

  3. 1 trillion

  4. 1.3 trillion

  5. 1.5 trillion




  1. Which of the following is not a bank attribute important to customers in need for foreign exchange?

  1. Number of foreign branches

  2. Competitiveness of quote

  3. Speed of execution

  4. Advice about current market conditions

  5. Forecasting advice




  1. Which of the following is not a possible bid/ask quotation for the Barbados dollar?

  1. $.50/$.51

  2. $.49/$.50

  3. $.52/$.51

  4. $.51/$.52

  5. All of the above are possible bid/ask quotations


The following information refers to questions 12 through 14.


Assume a bank’s bid rate for the Danish kroner (DKK) is $0.1875, while its ask rate is $0.1895. Assume you convert $1,000 to Danish kroner to take on your trip to Denmark. Immediately after conversion, a family emergency arises, and you are unable to go on your trip. Thus, you convert the Danish kroner back to dollars.


  1. How many dollars will you have left after the two conversions?

  1. $1,000

  2. $998.37

  3. $989.45

  4. $500

  5. $998




  1. How many Danish kroner will you receive when converting the dollars initially?

  1. 189.50

  2. 187.50

  3. 5,333.33

  4. 5,277.04

  5. 5,000




  1. What is the bank’s bid/ask percentage spread?

  1. 1.06%

  2. 1%

  3. 2%

  4. 1.07%

  5. 0%




  1. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now if you sell yen forward?

  1. $44,500

  2. $45,000

  3. $526 million

  4. $47,500

  5. $556 million




  1. Which of the following is probably not an example of the use of forward contracts by an MNC?

  1. Hedging pound payables by selling pounds forward

  2. Hedging peso receivables by selling pesos forward

  3. Hedging yen payables by purchasing yen forward

  4. Hedging peso payables by purchasing pesos forward

  5. All of the above are examples of using forward contracts




  1. A quotation representing the value of a foreign currency in dollars is referred to as a(n) ___________ quotation; a quotation representing the number of units of a foreign currency per dollar is referred to as a(n) ______________ quotation.

  1. Direct; indirect

  2. Indirect; direct

  3. Direct; direct

  4. Indirect; indirect

  5. Cannot be answered without more information




  1. You observe a quotation of the Japanese yen (¥) of $0.007. You are, however, interested in the number of yen per dollar. Thus, you calculate the __________ quotation of ___________ ¥/$.

  1. Direct; 142.86

  2. Indirect; 142.86

  3. Indirect; 150

  4. Direct; 150

  5. Indirect; 0




  1. A Japanese Yen is worth $0.0080, and a Fijian dollar (F$) is worth $0.5900. What is the value of the yen in Fijian dollars (i.e., how many Fijian dollars do you need to buy a yen)?

  1. 73.75

  2. 125

  3. 1.69

  4. 0.014

  5. None of the above




  1. Which of the following is probably not an option for an MNC wishing to reduce its exposure to British pound payables?

  1. Purchase pounds forward

  2. Buy a pound futures contract

  3. Buy a pound put option

  4. Buy a pound call option

  5. Remain unhedged if the British pound is expected to depreciate




  1. Which of the following was not a reason for the emergence of the Eurocurrency market?

  1. The growth of MNCs in the ‘60s and ‘70s.

  2. U.S. regulations encouraging foreign lending by U.S. banks.

  3. Interest rate ceilings on dollar deposits in the U.S.

  4. Absence of reserve requirements for Eurodollar deposits

  5. All of the above are reasons for the emergency of the Eurocurrency market.




  1. All of the following are provisions of the Single European Act regarding bank regulation, except

  1. Capital can flow freely throughout Europe.

  2. Banks can offer a wide variety of lending, leasing, and securities activities in the EEC.

  3. The regulations regarding competition, mergers, and taxes will be similar throughout the EEC.

  4. A bank established in any one of the EEC countries will have the right to expand into any or all of the other EEC countries.

  5. Capital requirements of EEC banks will be based on the bank’s risk-weighted assets.




  1. The Basel II Accord would not

  1. Account for differences among countries with respect to loan collateral.

  2. Account for operational risk, which is the risk of losses resulting from financing activities.

  3. Encourage banks to improve their techniques for controlling operational risk.

  4. Require banks to provide more information to existing and prospective shareholders about their exposure to different types of risk.

  5. The Basel II Accord would do all of the above.




  1. MNCs may choose to issue bonds in the international bond market because

  1. They may be able to attract stronger demand by issuing their bonds in a particular foreign country rather than in their home country.

  2. They may prefer to finance a specific foreign project in a particular currency and therefore may attempt to obtain funds where that currency is widely used.

  3. Financing in a foreign currency with a lower interest rate may enable an MNC to reduce its financing costs.

  4. All of the above




  1. A bond sold in countries other than the country represented by the currency denominating it is known as a

  1. Eurobond.

  2. Foreign bond.

  3. Parallel bond.

  4. Eurocredit loan.

  5. Floating rate note.




  1. A bond issued by a borrower foreign to the country where the bond is placed is called a

  1. Eurobond.

  2. Foreign bond.

  3. Parallel bond.

  4. Eurocredit loan.

  5. Floating rate note.




  1. Futures contracts are sold on exchanges and are consequently _____________ than forward contracts, which can be _____________ to satisfy an MNCs needs.

  1. More standardized; standardized

  2. More standardized; custom-tailored

  3. More custom-tailored; standardized

  4. More custom-tailored; custom-tailored

  5. Less standardized; custom-tailored




  1. Which of the following is not a reason why an MNC may decide to issue stock in a foreign country?

  1. The market in which the stock is to be issued is highly liquid.

  2. The market in which the stock is to be issued is very large, contributing to the market’s liquidity.

  3. Regulations in the market in which the stock is to be issued are more stringent than regulations in the home market.

  4. The MNC wishes to establish a global image.

  5. All of the above are reasons why an MNC may decide to issue stock in a foreign country.


The following information refers to questions 29 and 30.


A share of the ADR of the German firm Bergerschnus represents one share of this firm’s stock that is traded on the Frankfurt Stock Exchange. The share price of Bergerschnus was 30 euros when the Frankfurt exchange closed. When the U.S. market opens, the euro is worth $1.15.


  1. The price of the ADR should be

  1. $30.00.

  2. $34.50.

  3. $26.09.

  4. $31.15.

  5. None of the above




  1. If the Bergerschnus ADR is convertible into three shares of stock, the ADR price would be

  1. $34.50.

  2. $78.27.

  3. $103.50.

  4. $93.45.

  5. None of the above




  1. An MNC’s short-term financing decisions are probably satisfied in the __________ market, while its medium financing decisions are probably satisfied in the _________________ market.

  1. International money; international credit

  2. International money; international bond

  3. International credit; international money

  4. International bond; international credit

  5. International money; international stock




  1. An MNC’s long-term financing decisions are satisfied in the _________________ market and the ___________.

  1. International money; international credit

  2. International money; international bond

  3. International credit; international money

  4. International bond; international credit

  5. International bond; international stock




  1. Which of the following is not true regarding electronic communications networks (ECNs)?

  1. They have a visible trading floor.

  2. Trades are executed by a computer network.

  3. They have been created in many countries to match orders between buyers and sellers.

  4. They allow investors to place orders on their computers.

  5. All of the above are true




  1. A year ago, Peter Allan invested in the stock of Jober, a German company. Over the last year, the stock declined in value by 20%. However, the euro appreciated over the year by 10 percent. If Peter sold the stock today, his return would be _________.

  1. –10%

  2. 32%

  3. –12%

  4. 30%

  5. None of the above




  1. Which of the following is not a method that can be used to invest internationally?

  1. Investment in MNC stocks

  2. American depository receipts (ADRs)

  3. World Equity benchmark Shares (WEBS)

  4. International mutual funds

  5. All of the above are methods that can be used to invest internationally.


Answers to Multiple Choice Problems


  1. b

  2. a

  3. d

  4. c

  5. d

  6. e

  7. a

  8. d

  9. e

  10. a

  11. c

  12. c




  1. d




  1. a




  1. d



  1. a

  2. a

  3. b




  1. d




  1. c

  2. b

  3. e

  4. b

  5. d

  6. a

  7. b

  8. b

  9. c

  10. b



  1. c



  1. a

  2. e

  3. a

  4. c



  1. e


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