The most widely used currency in the Eurobond market is the euro . True or False

Question

The most widely used currency in the Eurobond market is the euro.   True or False?

As inflation in France increases and stays the same in the U.S., the exchange rate of the euro to the dollar will increase.   True or False?

The Swiss franc is selling for $.9412 and the British pound is selling for $1.5119. The cross rate between the franc and the pound (the number of Swiss francs that would buy one British pound) is approximately:

.161

1.61

.0322

3.22

Which of the following hedging strategies is not used to minimize transaction exposure?

The Eurobond market

The forward exchange market

The money market

Which of the following is NOT an example of a factor that can significantly influence exchange rates?

The cost to purchase a loaf of bread in the U.S. has increased by $.50 while the cost has remained the same in London.

The cost of capital has increased by 2% in the U.S. and has decreased by 2% in Germany.

Interest rates on short-term investments in the U.S. have decreased to 4% while interest rates in Japan are at 8%.

The U.S. has begun to export a higher level of goods to China than the prior year.

Explanation / Answer

(‘1) – False

Eurobond is an international bond that is denominated in a currency other than local currency to the country where it is issued. For example Euro dollar bond will be issued any country other than U S as dollar is a native currency for U.S. Similarly Euro yen bond can be issued in any country other than Japan.

Thus euro bonds will not be issued in euro but in any currency other than euro. They are same like foreign bonds.

(‘2) – False

The inflation rates prevailing in two countries affect the exchange rate between the currencies of those countries. High inflation rate in one country will be offset by the depreciation of the currency of that country. So if inflation increase in France but stays the same in US, the euro will be depreciated against dollar. For example if 1 Euro = 1.09 $ , then after increase in inflation in France it will be decreased as Euro will be depreciated against dollar.

(‘3) 1.61

GBP/ $= $ 1.5119

CHF/ $= $ 0.9412

Then $ / CHF= 1/0.9412= 1.0624

(GBP/$) x ($/CHF) = GBP/CHF

Hence 1.5119 x 1.0624= 1.61

(‘4) Money Market

Money market is a place for short term marketable debt instruments like Commercial Paper (CP), treasury bills (TB). Here transaction is done in native currency. So it cannot be used as a hedging where foreign exchange involved. For hedging we have to go forward exchange market of Eurobond market to minimise the transaction exposure because of exchange rate.

(‘5) Ans- The cost of capital has increased by 2 % in US and decreased by 2% in Germany.

The following factors affect the exchange rates.

(‘1) Inflation rate (‘2) Interest rate (‘3) Current account Deficit

Option no 1 comes under inflation rate reason and difference in inflation rate in two countries will affect the exchange rate.

Option no 3 comes under interest rate reason and difference in interest rate will affect the exchange rate.

Option no 4 comes under Current Account deficit and will affect the exchange rate. Current Account deficit is the balance between a country and its trading partners. If foreign exchange earnings is more than its expense then exchange rate will affected.

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