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Economic - Currency Exchange Rate

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40 views

Economic - Currency Exchange Rate

Uploaded by

Neyud Vũ
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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© CFA Institute. For candidate use only. Not for distribution.

Practice Problems 595

PRACTICE PROBLEMS
1. What will be the effect on a direct exchange rate quote if the domestic currency
appreciates?
A. Increase

B. Decrease

C. No change

2. An executive from Switzerland checks into a hotel room in Spain and is told by
the manager that EUR1 will buy CHF1.2983. From the executive’s perspective, an
indirect exchange rate quote would be:
A. EUR0.7702 per CHF1.

B. CHF0.7702 per EUR1.

C. EUR1.2983 per CHF1.

3. Over the past month, the Swiss franc (CHF) has depreciated 12 percent against
the British pound (GBP). How much has the pound sterling appreciated against
the Swiss franc?
A. 12 percent

B. Less than 12 percent

C. More than 12 percent

4. An exchange rate between two currencies has increased to 1.4500. If the base
currency has appreciated by 8 percent against the price currency, the initial ex-
change rate between the two currencies was closest to:
A. 1.3340.

B. 1.3426.

C. 1.5660.
© CFA Institute. For candidate use only. Not for distribution.
596 Learning Module 7 Capital Flows and the FX Market

SOLUTIONS
1. B is correct. In the case of a direct exchange rate, the domestic currency is the
price currency (the numerator) and the foreign currency is the base currency
(the denominator). If the domestic currency appreciates, then fewer units of
the domestic currency are required to buy one unit of the foreign currency, and
the exchange rate (domestic per foreign) declines. For example, if British pound
sterling (GBP) appreciates against the euro (EUR), then euro–sterling (GBP/EUR)
might decline.

2. A is correct. An indirect quote takes the foreign country as the price currency
and the domestic country as the base currency. To get Swiss francs—which is the
executive’s domestic currency—as the base currency, the quote must be stated
as EUR/CHF. Using the manager’s information, the indirect exchange rate is
(1/1.2983) = 0.7702.

3. C is correct. The appreciation of the British pound against the Swiss franc is the
inverse of the 12 percent depreciation of the Swiss franc against the pound ster-
ling: [1/(1 – 0.12)] – 1 = (1/0.88) – 1 = 0.1364, or 13.64%.

4. B is correct. The percentage appreciation of the base currency can be calculated


by dividing the appreciated exchange rate by the initial exchange rate. In this
case, the unknown is the initial exchange rate. The initial exchange is the value of
X that satisfies the formula:
1.4500/X = 1.08
Solving for X leads to 1.45/1.08 = 1.3426.
© CFA Institute. For candidate use only. Not for distribution.
Practice Problems 233

PRACTICE PROBLEMS
1. In order to minimize the foreign exchange exposure on a euro-denominated re-
ceivable due from a German company in 100 days, a British company would most
likely initiate a:
A. spot transaction.

B. forward contract.

C. real exchange rate contract.

2. A large industrialized country has recently devalued its currency in an attempt


to correct a persistent trade deficit. Which of the following domestic industries is
most likely to benefit from the devaluation?
A. Luxury cars

B. Branded prescription drugs

C. Restaurants and live entertainment venues

3. A country with a persistent trade surplus is being pressured to let its currency
appreciate. Which of the following best describes the adjustment that must occur
if currency appreciation is to be effective in reducing the trade surplus?
A. Domestic investment must decline relative to saving

B. Foreigners must increase investment relative to saving

C. Global capital flows must shift toward the domestic market


© CFA Institute. For candidate use only. Not for distribution.
234 Learning Module 7 Currency Exchange Rates

SOLUTIONS
1. B is correct. The receivable is due in 100 days. To reduce the risk of currency
exposure, the British company would initiate a forward contract to sell euros/buy
pounds at an exchange rate agreed to today. The agreed-upon rate is called the
forward exchange rate.

2. A is correct. A devaluation of the domestic currency means domestic producers


are cutting the price faced by their foreign customers. The impact on their unit
sales and their revenue depends on the elasticity of demand. Expensive luxury
goods exhibit high price elasticity. Hence, luxury car producers are likely to expe-
rience a sharp increase in sales and revenue due to the devaluation.

3. C is correct. The trade surplus cannot decline unless the capital account deficit
also declines. Regardless of the mix of assets bought and sold, foreigners must
buy more assets from (or sell fewer assets to) domestic issuers/investors.

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