Which of the following is not correct about the purchasing power parity theory of explaining changes in exchange rates?
Answer(s): C
Choice "c" is correct. The purchasing power parity theory holds that inflation will cause exchange rates to automatically adjust to ensure that an equal amount of a common currency will purchase similar goods in separate economies. The International Fischer effect considers the premium or discount on interest rates as an indicator of inflation. Choice "a" is incorrect. The basic idea underlying the purchasing power parity theory is that the purchasing power of a common currency in different economies for similar products will remain the same and that inflation in any particular economy will cause exchange rates to adjust until parity is consistently achieved.Choice "b" is incorrect. The purchasing power parity theory holds that inflationary forces on foreign and domestic currencies will cause the exchange rates to automatically adjust to ensure that a common currency will have identical or similar purchasing power in each economy for similar goods. Choice "d" is incorrect. The purchasing power parity theory is presented as both an absolute theory of parity determination regardless of market imperfections and as a relative concept that considers market imperfections.
Which of the following methods of measuring transaction exposure to exchange rate risk uses standard deviation, coefficient of correlation and other formal statistical techniques?I). Measurement of currency variability.II). Measurement of currency correlations.
Choice "c" is correct. The currency variability approach uses standard deviations as a means of predicting future exchange rates while the currency correlation approach is often applied to circumstances involving multiple currencies and evaluates exposure in relation to the statistically computed degree of correlation between the movements of different currencies. Choices "a", "b", and "d" are incorrect, per above Explanation.
Which of the following methods is designed to measure transaction exposure in terms of the maximum one day loss related to holdings denominated in foreign currency?I). Measurement of currency variability.II). Measurement of currency correlations.III). Value at risk.
Choice "c" is correct. The value at risk method seeks to quantify the exposure of business to a one day loss in the value of its positions in foreign currencies. Choices "a", "b", and "d" are incorrect, per above Explanation.
Atlas Worldwide Industries conducts business in a number of different countries and is trying to evaluate its economic exposure to exchange rate risk. Which of the following statements is not correct?
Choice "c" is correct. Atlas will benefit from an economic gain in the event that it has net cash inflows of a foreign currency and the foreign currency appreciates (the domestic currency depreciates). Atlas will collect a more valuable currency that can buy more of its domestic currency. Choices "a", "b", and "d" are incorrect because they are correct statements.
Universal Industries limits its operations to exports to foreign countries. What can be said about Universal's exposures to exchange rate risk?
Answer(s): B
Choice "b" is correct. Universal is subject to transaction risks associated with settlement of export transactions and is subject to economic risks associated with the satisfaction of domestic expenses denominated in domestic currencies with imported revenues denominated in a foreign currency. No translation exposure exists since there is no foreign investment or subsidiary. Choices "a", "c", and "d" are incorrect, per the above Explanation.
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