1. Identify the one false statement about bid/ask spreads: a. The bid-ask spread increases in the liquidity of the currency that you transact in, i.e., the more liquid a foreign currency the higher the bid-ask spread. b. The terms bid and ask are from the perspective of the bank, i.e., the bank bids an amount of home currency for one unit of foreign currency and the bank asks an amount of home currency for one unit of foreign currency. c. The bid-ask spread increases in the time-to-maturity of a forward contract, i.e., the longer the time-to-delivery the higher the bid-ask spread. d. As the customer of a bank, you always transact at the less favourable rate, i.e., you buy at the ask rate and you sell at the bid rate. e.

When the currency you transact in is in the denominator (as is always the case in our textbook), the bid rate is lower than the ask rate. 2. Identify the one false statement about the current banking system: a. In foreign exchange markets, a market maker in one currency pair is a commercial bank obliged to state a bid and an ask rate for this currency pair b. As foreign exchange markets are de-centralized, you can always buy or sell foreign currency during working days, even on, e.g., Thursday 1am. c. In foreign exchange markets, foreign exchange dealers always state the name instead of the dimension of the currency pair they want to trade in. d. The wholesale tier of the foreign exchange markets consists exclusively of a number of large commercial banks. e. At each point in time, the limit order book shows the best bid and ask quote.

3. Identify the one true statement about the covered interest parity (CIP) theory: a. CIP says that synthetic forward rates and direct forward rates should be equal. b. CIP is not reliable as it only takes into account the domestic interest rate. c. CIP always holds. d. CIP takes into account transaction costs. e. None of the suggested answers.

4. Identify the one false statement about futures: a. Futures are traded on organised markets. b. Futures are standardised contracts. c. Futures have zero initial value. d. Trading with futures will result in a margin call. e. Marking to market is a primitive version of daily re-contracting, where the discounting is omitted.

5. Identify the one true statement about currency forward contracts in the absence of bid-ask spreads: 3 Please turn over a. If you believe that the spot rate in 3 months will be larger than todays 3-month forward rate, you should then sell forward. b. Extreme bind hedging, which is hedging the present value of all future FC cashflows, carries very little risk. c. A combination of forward contracts with the same maturity and different inception allows us to speculate on the value of forward contracts. d. The best way to hedge against FC cashflows is to simply avoid FC cashflows and invoice always in HC. There is no economic loss from doing this. e. None of the suggested answers.

6. The short position in a forward contract can be replicated by: a. selling a put and buying a call. b. selling a foreign T-bill and buying a domestic T-bill. c. buying a put and selling a call. d. both b and c e. all of the above

7. In the context of currency risk and exposure, which of the statements below is true? a. Operating exposure is the exposure that results when the forward rate is at a discount with respect to the spot rate at the moment you sign a sales or purchase contract. b. Exchange risk describes how volatile a firms cash flows are with respect to a particular exchange rate. c. Exchange exposure is a measure of the sensitivity of a firms cash flows to a change in the spot exchange rate. d. Options are undoubtedly the best choice for hedging foreign currency exposure because the possibility of profiting from a favourable change in the exchange rate remains open without the losses from an unfavourable change in the exchange rate. e. Operating exposure is the exposure that results when the forward rate is at a premium with respect to the spot rate at the moment you sign a sales or purchase contract.

8. Suppose that the value of the firm, expressed in terms of the owners currency, is a nonlinear function of the exchange rate up to random noise. Suppose that you fit a linear regression through this relationship, and you hedge with a forward sale with size equal to the regression coefficient. Which of the statements below is true? a. All risk will be eliminated. b. There is remaining risk, but it is uncorrelated to the realised value of the exchange rate. c. There is no way to further reduce the variance of the firms hedged value. d. Hedging with contracts on any two different currencies will always lead to a lower risk than hedging with a single currency contract. e. None of the above.

9. Which of the statements below regarding the cost of capital in the international context is false? 4 Please turn over a. If you discount expected cash flows that are already expressed in home currency, the cost of capital should include a risk premium for exposure to the host-currency exchange rate. b. A particularly risk-averse investor will always select a low-return portfolio. This is because low return means low risk, and because the investor does not want to bear a lot of risk. c. The entire NPV analysis can be conducted in terms of the host currency if money markets, stock markets, and exchange markets are fully integrated with the home market. d. If you discount expected cash flows that are already expressed in home currency, the cost of capital should include a risk premium for exposure to all relevant exchange rates. e. A risk-averse investor will select a low-return portfolio only if the variance is sufficiently low.

10. Which of the statements below regarding international capital budgeting is true? a. Since borrowing reduces corporate taxes, one should always compute the tax savings (borrowing capacity interest rate tax rate), and add their present value in the first-stage NPV. b. A sound rule of thumb is that the company should borrow in a weak currency for two reasons. First, the firm can expect a capital gain when the loan is paid back. Second, the high interest payments mean that there is a large interest tax shield. c. Leading and lagging are ways to speculate on changes in transfer prices. d. The best way to account for transfer risk is to add a risk premium to the discount rate. The next best way is to subtract the expected losses on blocked funds from the operating cash flows. e. Any royalty payments to the parent company should be considered only in the second stage (unbundling stage) of the NPV analysis.