Money and Foreign Currency Quiz
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Questions and Answers

What is the primary function of the foreign exchange market (FOREX)?

  • To dictate the value of commodities
  • To facilitate stock trading across countries
  • To regulate interest rates globally
  • To transfer purchasing power between currencies (correct)

    • Which of the following is NOT a characteristic that money must fulfill?

  • Unchangeable properties over time (correct)
  • Store of value for future consumption
  • Unit of account for pricing goods and services
  • Mean of payment universally accepted

    • What distinguishes foreign currency in the context of international transactions?

  • It must be universally accepted in domestic trade
  • It is always backed by gold reserves
  • It is only used in physical form like banknotes
  • It is a deposit in a foreign financial institution (correct)

    • How is the foreign exchange market classified in terms of its physical presence?

    <p>It is an interconnected non-physical market</p> Signup and view all the answers

    Which feature indicates that the FOREX market operates continuously?

    <p>It has a global character and works 24 hours a day</p> Signup and view all the answers

    What is a significant characteristic of the foreign exchange market regarding transactions?

    <p>It is primarily an interbank Over The Counter (OTC) market</p> Signup and view all the answers

    What is a limitation of using cash banknotes in defining foreign currency?

    <p>They are not considered foreign currency in the strict sense</p> Signup and view all the answers

    Which of the following statements about the foreign exchange market is incorrect?

    <p>It operates exclusively through physical locations</p> Signup and view all the answers

    What does counterparty risk in swap contracts refer to?

    <p>The risk that the negotiated party fails to comply with obligations</p> Signup and view all the answers

    How is counterparty risk mitigated in swap transactions?

    <p>By arranging the transaction through a financial intermediary</p> Signup and view all the answers

    Which of the following is a characteristic of an interest rate swap (IRS)?

    <p>Settlement of interest payments based on net differences</p> Signup and view all the answers

    What does a direct exchange rate represent?

    <p>The number of units of national currency needed to acquire one unit of foreign currency.</p> Signup and view all the answers

    If the exchange rate is 1.2050 EUR/USD, how much USD would one need to pay to acquire 100,000 EUR?

    <p>120,500 USD</p> Signup and view all the answers

    What is a 'fixed leg' in a fixed-variable interest rate swap?

    <p>The payment stream that remains constant over the term</p> Signup and view all the answers

    What is the role of a swap broker in an interest rate swap?

    <p>To act as a facilitator for buying and selling interest rates</p> Signup and view all the answers

    In the expression 1.25 EUR/USD, which currency is the base currency?

    <p>EUR</p> Signup and view all the answers

    Why do the two parties in an interest rate swap have contrary expectations?

    <p>To hedge against potential market fluctuations</p> Signup and view all the answers

    What misconception might arise from the representation of currency pairs such as EUR/USD?

    <p>The slash represents a division of currencies.</p> Signup and view all the answers

    When given an exchange rate format of 1.2050 $/€, what does it signify?

    <p>You need to pay 1.2050 Dollars to get one Euro.</p> Signup and view all the answers

    In a fixed-variable interest rate swap, how are cash flows typically characterized?

    <p>One cash flow is fixed, another is variable</p> Signup and view all the answers

    Which of the following accurately describes the 'notional' in a swap contract?

    <p>The basis on which interest is calculated</p> Signup and view all the answers

    What is the primary function of exchange rates?

    <p>To establish the equivalent amount in different currencies at a specific moment.</p> Signup and view all the answers

    How can the indirect exchange rate be defined?

    <p>The reciprocal of the direct exchange rate.</p> Signup and view all the answers

    Which of the following statements is accurate regarding currency exchange representation?

    <p>The given exchange rate can be expressed in multiple formats without changing its meaning.</p> Signup and view all the answers

    What is the primary purpose of an interest rate swap (IRS) in the context given?

    <p>To exchange fixed payments for variable payments between two companies</p> Signup and view all the answers

    What is the theoretical swap coupon calculated for the interest rate swap?

    <p>4.24%</p> Signup and view all the answers

    In the example given, which company wants to transition from fixed to variable interest rates?

    <p>Company (A) with 1 million EUR debt</p> Signup and view all the answers

    Which of the following describes the main purpose of a currency swap?

    <p>To exchange principals in different currencies</p> Signup and view all the answers

    How does a financial intermediary contribute to the interest rate swap?

    <p>By designing and facilitating the swap agreement between the two companies</p> Signup and view all the answers

    How is the fixed rate in an interest rate swap determined?

    <p>Based on the current market interest rates</p> Signup and view all the answers

    Which interest rate structure is Company (B) concerned about in the swap arrangement?

    <p>A possible rise in interest rates</p> Signup and view all the answers

    At the end of a currency swap agreement, what is exchanged between the parties?

    <p>Principal amounts at the predetermined exchange rate</p> Signup and view all the answers

    What is the nominal value of the debt each company is dealing with in the swap?

    <p>1 million EUR</p> Signup and view all the answers

    What is the notional amount considered in the valuation of the swap as given?

    <p>1,000,000</p> Signup and view all the answers

    Which of the following conventions is used to adjust the days for the money market?

    <p>Commercial years (360 days)</p> Signup and view all the answers

    Which of the following statements is true regarding interest rate swaps?

    <p>They help manage risk associated with interest rate changes.</p> Signup and view all the answers

    What role does the EURIBOR play in the context of the interest rate swap?

    <p>It serves as a benchmark for the variable interest rate in Company (B)</p> Signup and view all the answers

    Which technique is used to calculate the fixed coupon in an interest rate swap?

    <p>Discounting future cash flows</p> Signup and view all the answers

    What is a key benefit of arranging a swap through a financial intermediary?

    <p>Expertise in designing the contract to meet both parties’ needs</p> Signup and view all the answers

    What factor is crucial in determining the fixed coupon rate in an interest rate swap?

    <p>The evolution of interest rates</p> Signup and view all the answers

    Study Notes

    Money and Foreign Currency

    • Money is legal tender used as a unit of measurement in economic transactions.
    • Money functions as a mean of payment, store of value, and unit of account.
    • Foreign currency is the currency acceptable in international transactions.
    • Foreign currency is typically held in deposits at financial institutions, banknotes are not considered foreign currency.

    Foreign Exchange Market (FOREX)

    • The FOREX is where suppliers and demanders of foreign currency meet to determine its price.
    • Its main function is to facilitate international trade and investment by transferring purchasing power between currencies.
    • It is the largest and oldest financial market in the world, trading over $7.5 billion USD daily.
    • It is an Over The Counter (OTC) market, primarily interbank.
    • It functions 24 hours a day, due to its global character, consisting of interconnected markets.

    Exchange Rates

    • Exchange rates reflect the price of one currency in terms of another.
    • The direct exchange rate indicates the units of domestic currency needed to acquire one unit of foreign currency.
    • The indirect exchange rate indicates the units of foreign currency needed to acquire one unit of domestic currency.
    • Both measures express the same value, as one is the inverse of the other.
    • In FOREX, a standard representation uses currency symbols separated by a slash, with the base currency on the left and the counter currency on the right.
    • The ratio represents the units of counter currency required to buy one unit of the base currency.

    Swap Contracts

    • Swap contracts involve the exchange of future cash flows between two parties.
    • They can be used to hedge against interest rate or exchange rate volatility.
    • Swap contracts are typically arranged through financial intermediaries to mitigate counterparty risk.

    Interest Rate Swap (IRS)

    • An IRS allows parties to manage interest rate risk by exchanging interest payments based on different rates.
    • Requirements for an IRS:
      • Two parties with contrary expectations about interest rate movements.
      • Access to different markets with potentially favorable conditions.
      • The combined position of both parties generates savings compared to individual actions.
    • An IRS involves exchange of future cash flows calculated based on different interest rate bases (fixed and variable or both variable).
    • Interest payments are settled based on the net difference between the payments.
    • Cash flows are denominated in the same currency.
    • The principal amount is not exchanged.

    Fixed-Variable IRS (Plain Vanilla Swap)

    • Each IRS leg represents a set of payments associated with a specific interest rate.
      • Fixed leg (typically annual)
      • Variable leg (typically semiannual)
    • The fixed rate to be paid is the swap coupon.
    • The notional principal (notional) is the base on which interest is calculated.
    • A swap broker acts as an intermediary who buys and sells interest rates.

    Valuation of an IRS

    • Valuation allows calculating the theoretical swap coupon at any time.
    • The theoretical swap coupon is the fixed coupon that equates the present values of both legs of the swap.
    • Changes in interest rates affect the theoretical swap coupon.

    Currency Swaps

    • Currency swaps are used to hedge against exchange rate volatility.
    • Two parties exchange principals of equal amounts in different currencies.
    • During the swap term, interest payment streams are exchanged in different currencies.
    • At the end of the term, principal amounts are exchanged at the exchange rate agreed upon at the beginning of the contract.
    • Principals are typically obtained through borrowing in the respective currency markets.

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    International Finance 4th Grade/GE PDF

    Description

    Explore the essential concepts of money and foreign currency in this quiz. Understand how money functions in economic transactions and the role of the Foreign Exchange Market (FOREX). Test your knowledge of exchange rates and their impact on international trade.

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