Eun & Resnick 4e

CHAPTER 2 International Monetary System

Evolution of the International Monetary System

Bimetallism: Before 1875
Classical Gold Standard: 1875–1914
Interwar Period: 1915–1944
Bretton Woods System: 1945–1972
The Flexible Exchange Rate Regime: 1973–Present
The Current Exchange Rate Arrangements
European Monetary System
The Euro and the European Monetary Union
A Brief History of the Euro
What Are the Benefits of Monetary Union?
Costs of Monetary Union
Prospects of the Euro: Some Critical
Questions
The Mexican Peso Crisis
The Asian Currency Crisis
Origins of the Asian Currency Crisis
Lessons from the Asian Currency Crisis
The Argentine Peso Crisis
Fixed versus Flexible Exchange Rate Regimes
Summary
MINI CASE: Will the U.K. Join the Euro Club?

Evolution of the International Monetary System

1) The international monetary system can be defined as the institutional framework within
which:
a) international payments are made
b) movement of capital is accommodated
c) exchange rates among currencies are determined
d) all of the above
Answer: d page 25.

2) The international monetary system went through several distinct stages of evolution.
These stages are summarized, in alphabetic order, as follows
(i)- Bimetallism
(ii)- Bretton Woods system
(iii)- Classical gold standard
(iv)- Flexible exchange rate regime
(v)- Interwar period

The chronological order that they actually occurred is:

a) (iii), (i), (iv), (ii), and (v)

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 b) (i), (iii), (v), (ii), and (iv)
c) (vi), (i), (iii), (ii), and (v)
d) (v), (ii), (i), (iii), and (iv)
Answer: b

Bimetallism: Before 1875

3) Gresham’s Law states that ( )

a) Bad money drives good money out of circulation.
b) Good money drives bad money out of circulation
c) If a country bases its currency on both gold and silver, at an official exchange rate,
it will be the more valuable of the two metals that circulate.
d) None of the above.
Answer: a

4) In the 1850s the French franc was valued by both gold and silver, under the official
French ratio which equated a gold franc to a silver franc 15½ times as heavy. At the
same time, the gold from newly discovered mines in California poured into the market,
depressing the value of gold. As a result,
a) The franc effectively became a silver currency.
b) The franc effectively became a gold currency.
c) Silver became overvalued under the French official ratio
d) Answers a) and c) are correct
Answer: b

5) Suppose that the pound is pegged to gold at £20 per ounce and the dollar is pegged to
gold at $35 per ounce. This implies an exchange rate of $1.75 per pound. If the
current market exchange rate is $1.80 per pound, how would you take advantage of
this situation? Hint: assume that you have $350 available for investment.
a) Start with $350. Buy 10 ounces of gold with dollars at $35 per ounce. Convert the
gold to £200 at £20 per ounce. Exchange the £200 for dollars at the current rate of
$1.80 per pound to get $360.
b) Start with $350. Exchange the dollars for pounds at the current rate of $1.80 per
pound. Buy gold with pounds at £20 per ounce. Convert the gold to dollars at $35
per ounce.
c) a) and b) both work
d) none of the above
Answer: a

6) Prior to the 1870s, both gold and silver were used as international means of payment
and the exchange rates among currencies were determined by either their gold or silver
contents. Suppose that the dollar was pegged to gold at $30 per ounce, the French
franc is pegged to gold at 90 francs per ounce and to silver at 6 francs per ounce of
silver, and the German mark pegged to silver at 1 mark per ounce of silver. What
would the exchange rate between the U.S. dollar and German mark be under this
system?
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 a) 1 German mark = $2
b) 1 German mark = $0.50
c) 1 German mark = $45
d) 1 German mark = $1
Answer: a page 26.
Rationale: Start with $30, buy one ounce of gold. Sell that ounce of gold for FF 90. Sell
the FF90 for 15 ounces of silver. Buy 15 German marks. Thus, $30 = DM15.

Classical Gold Standard: 1875-1914

7) An “international” gold standard can be said to exist when

a) gold alone is assured of unrestricted coinage
b) there is two-way convertibility between gold and national currencies at stable
ratios
c) gold may be freely exported or imported
d) all of the above
Answer: d - p. 28

8) Suppose that the British pound is pegged to gold at £6 per ounce, whereas one ounce
of gold is worth €12. Under the gold standard, any misalignment of the exchange rate
will be automatically corrected by cross border flows of gold. Calculate the possible
savings for buying €1,000, if the British pound becomes undervalued and trades for
€1.80. (Assume zero shipping costs).
(Hint: Gold is first purchased using the devalued British pound from the Bank of
England, then shipped to France and sold for €1,000 to the Bank of France).
a) £55.56
b) £65.56
c) £75.56
d) £85.56
Answer: a - p. 28

Rationale: Since an ounce of gold should be worth the same north or south of the English
Channel, it should be €12 = £6. So our exchange rate implied by gold prices is €2 = £1,
therefore buying €1,000 should cost £500:
€1,000×£1/€2 = £500.00

If the pound is undervalued at €1.80, we find that €1,000 costs £555.56:

€1,000×£1/€1.80 = £555.56

Savings in buying €1,000 by using gold and not posted exchange rates:
£555.56 - £500.00 = £55.56

9) Under a gold standard, if Britain exported more to France than France exported to
Great Britain,
a) Such international imbalances of payment will be corrected automatically.
b) This type of imbalance will not be able to persist indefinitely
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 c) Net export from Britain will be accompanied by a net flow of gold in the opposite
direction.
d) All of the above
Answer: d page 27.

10) Suppose that Britain pegs the pound to gold at six pounds per ounce, whereas the
exchange rate between pounds and U.S. dollars is $5 = £1. What should an ounce of
gold be worth in U.S. dollars?
a) $29.40
b) $30.00
c) $0.83
d) $1.20
Answer: b)
Rationale: 1oz. Au = £6 and £1 = $5 so £6 = $30 = 1oz. Au

11) Under the gold standard, international imbalances of payment will be corrected
automatically under the
a) Gresham Exchange Rate regime
b) European Monetary System
c) Price-specie-flow mechanism
d) Bretton Woods Accord
Answer: c

Interwar Period

12) During the period between World War I and World War II
a) The major European powers and the U.S. returned to the gold standard and fixed
exchange rates.
b) While most countries abandoned the gold standard during World War I,
international trade and investment flourished during the interwar period under a
coherent international monetary system.
c) The U.S. dollar emerged as the dominant world currency, gradually replacing the
British pound for the role.
d) None of the above.
Answer: c 29.

13) During the period between World War I and World War II, many central banks
followed a policy of sterilization of gold
a) This restricted the rate of growth in the supply of gold
b) By matching inflows and outflows of gold respectively with reductions and
increases in domestic money and credit.
c) By matching inflows and outflows of gold respectively with increases and
reductions in domestic money and credit.
d) None of the above.
Answer: b page 29.

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14) At the outbreak of World War I
a) Major countries such as Great Britain, France, Germany and Russia suspended
redemption of banknotes in gold
b) Major countries such as Great Britain, France, Germany and Russia imposed
embargoes on the export of gold
c) The classical gold standard was abandoned
d) All of the above.
Answer: b page 28

Bretton Woods System: 1945-1972

15) Under the Bretton Woods system

a) there was an explicit set of rules about the conduct of international monetary
policies
b) each country was responsible for maintaining its exchange rate within 1 percent of
the adopted par value by buying or selling foreign exchanges as necessary
c) the U.S. dollar was the only currency that was fully convertible to gold
d) all of the above
Answer: d.

16) Under the Bretton Woods system:

a) Each country established a par value for its currency in relation to the dollar.
b) The U.S. dollar was pegged to gold at $35 per ounce.
c) each country was responsible for maintaining its exchange rate within 1 percent of
the adopted par value by buying or selling foreign exchanges as necessary
d) all of the above
Answer: d.

17) Since the SDR is a “portfolio” of currencies

a) Its value tends to be more stable than the value of any of the individual currencies
included in the SDR
b) Its value tends to be less stable than the value of any of the individual currencies
included in the SDR
c) Its value tends to be as stable as the average of the individual currencies included
in the SDR
d) None of the above
Answer: a)
Rationale: while this is in the book on page 31, many students tend to miss this one. Any
portfolio is less volatile than the average volatility of the individual securities, as long as at
least two securities are not perfectly positively correlated. This is certainly the case with
currencies.

18) Special Drawing Rights (SDR) are:

a) an artificial international reserve allotted to the members of the International
Monetary Fund (IMF), who can then use it for transactions among themselves or
with the IMF
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 b) a “portfolio” of currencies, and its value tends to be more stable than the
currencies that it is comprised of
c) used in addition to gold and foreign exchanges, to make international payments
d) all of the above
Answer: d - p. 32

The Flexible Exchange Rate System

19) Gold was officially abandoned as an international reserve asset:

a) In the January 1976 Jamaica Agreement
b) In the 1971 Smithsonian Agreement
c) In the 1944 Bretton Woods Agreement
d) None of the above
Answer: a

20) Following the demise of the Bretton Woods system, the IMF
a) Created a new role for itself, providing loans to countries facing balance-of-
payments and exchange rate difficulties.
b) Ceased to exists, since the era of fixed exchange rates had ended.
c) Became the sole agent responsible for maintaining fixed exchange rates.
d) Became the central bank of the United Nations
Answer a page 32.

21) Under a purely flexible exchange rate system

a) Supply and demand set the exchange rates
b) Governments can set the exchange rate by buying or selling reserves
c) Governments can set exchange rates with fiscal policy
d) B) and c) are correct.
Answer a
Rationale: under a purely flexible system, the government doesn’t interfere.

Current Exchange Rate Arrangements

22) A currency board arrangement is:

a) When the currency of another country circulates as the sole legal tender
b) When the country belongs to a monetary or currency union in which the same legal
tender is shared by the members of the union.
c) A monetary regime based on an explicit legislative commitment to exchange
domestic currency for a specified foreign currency at a fixed exchange rate,
combined with restrictions on the issuing authority to ensure the fulfillment of its
legal obligation.
d) Where the country pegs its currency at a fixed rate to a major currency where the
exchange rate fluctuates within a narrow margin of less than one percent.
Answer: c page 34.

23) Ecuador does not have its own national currency, circulating the U.S. dollar instead.
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 About how many countries do not have their own national currency?
a) 10
b) 20
c) 30
d) 40
Answer: d page 35.

24) With regard to the current exchange rate arrangement between the U.S. and the U.K.,
it is best characterized as
a) Independent floating (market determined)
b) Managed float
c) Currency board
d) Pegged exchange rate within a horizontal band.
Answer: a page 34-35.

25) With regard to the current exchange rate arrangement between Italy and Germany., it
is best characterized as
a) Independent floating (market determined)
b) Managed float
c) An exchange arrangement with no separate legal tender.
d) Pegged exchange rate within a horizontal band.
Answer: c page 34.

European Monetary System

26) To pave the way for the European Monetary Union, the member countries of the
European Monetary System agreed to achieve a convergence of their economies.
Which of the following is NOT a condition of convergence:
a) Keep the ratio of government budget deficits to GDP below 3 percent
b) Keep gross public debts below 60 percent of GDP
c) Achieve a high degree of price stability
d) Maintain its currency at a fixed exchange rate to the ERM
Answer d) page 38.
For d) to be true, it should read “Maintain its currency within the prescribed exchange
rate ranges of the ERM.”

27) The European Monetary System (EMS) has the following chief objectives:
a) to establish a “zone of monetary stability” in Europe
b) to coordinate exchange rate policies vis-à-vis the non-EMS currencies
c) to pave the way for the eventual European monetary union
d) all of the above
Answer: d - p. 38

28) The Exchange Rate Mechanism (ERM) is

a) the procedure by which ERM member countries collectively manage their
exchange rates
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 b) based on a “parity-grid” system, which is a system of par values among ERM
countries
c) a and b
d) none of the above
Answer: c - p. 38

29) The Maastricht Treaty

a) Irrevocably fixed exchange rates among the member currencies
b) Commits the members of the European Union to political union as well as
monetary union.
c) Was signed and subsequently ratified by the 12 member states.
d) All of the above.
Answer d) page 38.

30) The single European currency, the euro, was adopted by 11 member nations on
January 1 of what year?
a) 1984
b) 1991
c) 1999
d) 2001
Answer c) page 39.

Euro and the European Monetary Union

31) Benefits from adopting a common European currency include

a) Reduced transaction costs
b) Elimination of exchange rate risk
c) Increased price transparency will promote Europe-wide competition
d) All of the above
Answer d) page 41-42.

32) Monetary policy for the euro-12 countries is now conducted by:
a) The Federal Reserve
b) The Bundesbank
c) European Central Bank
d) None of the above
Answer c) page 40.

33) Following the introduction of the euro, the national central banks of the euro-12
nations
a) disbanded
b) Formed the ESCB, which is analogous to the Federal Reserve System in the
United States
c) Continue to perform important functions in their jurisdictions
d) b) and c) are correct.
Answer d) page 40.
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34) The main cost of monetary union is
a) The loss of national monetary and exchange rate policy independence
b) Increased exchange rate uncertainty
c) Lessened political integration
d) None of the above
Answer a) page 42. Costs of Monetary Union

35) The euro zone remarkably comparable to the United States in terms of
a) Population size
b) GDP
c) International trade share
d) All of the above
Answer a) page 45.

36) According to the theory of optimum currency areas,

a) The relevant criterion for identifying and designing a common currency zone is the
degree of factor (i.e. capital and labor) mobility within the zone
b) Exchange rates should reflect the degree to which workers are willing to move to
get a better job.
c) Exchange rates are determined by portfolio managers seeking the highest return
d) None of the above.
Answer a) page 42.

The Mexican Peso Crisis

37) The Mexican Peso Crisis was touched off by

a) An unsurprising announcement by the Mexican government to devalue to peso
against the dollar by 14 percent.
b) An unexpected announcement by the Mexican government to devalue to peso
against the dollar by 14 percent.
c) An announcement by the Mexican government to enact a currency board
arrangement with the U.S. dollar
d) Contagion from other Latin American and Asian financial markets.
Answer b) page 47. The outgoing Salinas administration hid the true state of the Mexican
economy—that’s why it was an unexpected announcement.

38) Prior to the peso crisis, Mexico depended on foreign portfolio capital to finance its
economic development. This foreign capital influx
a) Caused higher domestic inflation
b) Led to an overvalued peso
c) Helped Mexico’s trade balances
d) a) and b) are correct
Answer d) page 48.

39) The Mexican peso crisis is significant in that

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 a) It is perhaps the first serious international financial crisis touched off by cross-
border flight of portfolio capital.
b) Selling by international portfolio managers had a highly destabilizing, contagious
effect on the world financial system.
c) It provides a cautionary tale that as the world’s financial markets are becoming
more integrated, this type of contagious financial crisis is likely to occur more
often.
d) All of the above.
Answer d) page 47.

The Asian Currency Crisis

40) The Asian Currency Crisis

a) Happened just prior to the Mexican peso crisis
b) Turned out to be far more serious than the Mexican peso crisis in terms of the
extent of contagion.
c) Was limited to Asian currencies
d) Was almost over before anyone outside the pacific rim noticed.
Answer b) page 49.

41) Generally speaking, liberalization of financial markets when combined with a weak,
underdeveloped domestic financial system tends to
a) Strengthen the domestic financial system in the short run
b) Create an environment susceptible to currency and financial crises.
c) Raise interest rates and lead to domestic recession
d) None of the above
Answer b) page 51.

42) According to the “Trilemma” a country can attain only two of the following three
conditions: 1) A fixed exchange rate, (2) Free international flows of capital, (3) An
independent monetary policy. This difficulty is also known as
a) The incompatible trinity
b) The Trilemma
c) The Tobin tax
d) All three can be had at the same time.
Answer a) page 51. Answer b) is wrong since the question asks for another name for the
Trilemma. By the way, in your personal spending, you can have only two of the following
three things: quality, service, low price.

43) To avoid currency crisis in the face of fully integrated capital markets, a country can
a) Have a floating exchange rate
b) Have a fixed exchange rate
c) Have a fixed exchange rate that adjusts
d) a) and b) can both help to avoid currency crises
Answer d) page 52

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The Argentine Peso Crisis

44) Prior to the Argentine Peso Crisis

a) Argentina had a “dirty float” where the government allowed the exchange rate to
float within wide bands
b) Argentina had a currency board arrangement with the peso pegged to the U.S.
dollar at parity.
c) The Argentine government defaulted on its international debts.
d) Weakening of the U.S. dollar led the Argentine government to abandon
dollarization.
Answer d) page 52-53.

Fixed versus Flexible Exchange Rate Regimes

45) A “good” (or ideal) international monetary system should provide:

a) liquidity, elasticity, and flexibility
b) elasticity, sensitivity, and reliability
c) liquidity, adjustments, and confidence
d) none of the above
Answer: c - p. 54

46) Advantages of a flexible exchange rates include:

a) National policy autonomy
b) Easier external adjustments
c) The government can use monetary and fiscal policies to pursue whatever economic
goals it chooses.
d) All of the above
Answer d) page 53.

47) Advantages of a fixed exchange rates include

a) Reduction in exchange rate risk for businesses
b) Reduction in transactions costs
c) Reduction in trading frictions
d) All of the above
Answer d).

48) Once capital markets are integrated, it is difficult for a country to maintain a fixed
exchange rate. Why?
a) The market forces may be stronger than the exchange rate intervention that the
government can muster.
b) Portfolio managers will not invest in countries with fixed exchange rates.
c) Because of the Tobin Tax
d) None of the above
Answer a.

49) Consider the supply-demand framework for the British pound relative to the U.S.
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 dollar shown in the nearby chart. The exchange rate is currently $1.80 = £1.00. Which
of the following is correct?

a) At an exchange S

Dollar price per pound

rate of $1.80 = £1.00,
demand for British

(exchange rate)
pounds exceeds supply
b) A
t an exchange rate of
$1.80 = £1.00, supply for
British pounds exceeds
demand $1.90
c) U $1.80
nder a flexible exchange
rate regime, the U.S.
dollar will depreciate to D’ D
an exchange rate of $1.90
S D Q£
= £1.00
d) a
D=S
) and c) are correct
Answer d). See page 54.

50) Consider the supply-demand framework for the British pound relative to the U.S.
dollar shown in the nearby chart. The exchange rate is currently $1.80 = £1.00. Which
of the following is correct?

a) To “fix” the S
Dollar price per pound

exchange rate at $1.80 =

£1.00, the Federal S’
(exchange rate)

Reserve could use

contractionary monetary
policy to shift the demand
curve to the left.
b) To “fix” the
$1.90
exchange rate at $1.80 =
£1.00, the U.S. $1.80
government could use
contractionary fiscal D
D’
policy to shift the demand
curve to the left. Q£
S D
c) T
he British Government D=S
could use fiscal or
monetary policy to shift
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 the supply curve to the
right to fix the exchange
rate to $1.80 = £1.00
d) A
ll of the above.
Answer d. See page 54.

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 Eun & Resnick 4e
CHAPTER 3 Balance of Payments

Balance-of-Payments Accounting
Balance-of-Payments Accounts
The Current Account
The Capital Account
Statistical Discrepancy
Official Reserve Account
International Finance in Practice: How One Word Haunts Dollar
The Balance-of-Payments Identity
Balance-of-Payments Trends in Major Countries
International Finance in Practice: The Dollar and the Deficit
Summary
MINI CASE: Mexico’s Balance-of-Payments Problem
Appendix 3A: The Relationship between Balance of Payments and National Income Accounting

Balance of Payments Accounting

1 Balance of payments
a) is defined as the statistical record of a country’s international transactions over a
certain period of time presented in the form of a double-entry bookkeeping
b) provides detailed information concerning the demand and supply of a country’s
currency
c) can be used to evaluate the performance of a country in international economic
competition
d) all of the above
Answer: d - p. 59

2 If the United States imports more than it exports, then

a) The supply of dollars is likely to exceed the demand in the foreign exchange
market, ceteris paribus.
b) One can infer that the U.S. dollar would be under pressure to depreciate against
other currencies
c) a) and b)
d) None of the above
Answer: c - p. 59

3 If Japan exports more than it imports, then

a) The supply of dollars is likely to exceed the demand in the foreign exchange
market, ceteris paribus.
b) One can infer that the yen would be likely to appreciate against other currencies
c) a) and b)
d) None of the above
Answer: b - p. 59 There’s no guarantee that the U.S. is Japan’s only trading partner.

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4 Generally speaking, any transaction that results in a receipt from foreigners
a) Will be recorded as a debit, with a negative sign, in the U.S. balance of payments
b) Will be recorded as a debit, with a positive sign, in the U.S. balance of payments
c) Will be recorded as a credit, with a negative sign, in the U.S. balance of payments
d) Will be recorded as a credit, with a positive sign, in the U.S. balance of payments
Answer d) page 60.

5 Generally speaking, any transaction that results in a payment to foreigners

a) Will be recorded as a debit, with a negative sign, in the U.S. balance of payments
b) Will be recorded as a debit, with a positive sign, in the U.S. balance of payments
c) Will be recorded as a credit, with a negative sign, in the U.S. balance of payments
d) Will be recorded as a credit, with a positive sign, in the U.S. balance of payments
Answer a) page 60.

6 Suppose the McDonalds Corporation imports 100 tons of Canadian beef, paying for it
by transferring the funds to a New York bank account kept by the Canadian Beef
Conglomerate.
a) Payment by McDonalds will be recorded as a debit
b) The deposit of the funds by the seller will be recorded as a debit
c) Payment by McDonalds will be recorded as a credit
d) The deposit of the funds by the buyer will be credit
Answer: a page 60.

7 Since the balance of payments is presented as a system of double-entry bookkeeping,

a) Every credit in the account is balanced by a matching debit
b) Every debit in the account is balanced by a matching credit
c) a) and b) are both true
d) None of the above
Answer c) page 60

Balance of Payments Accounts

8 A country’s international transactions can be grouped into the following three main
types:
a) current account, medium term account, and long term capital account
b) current account, long term capital account, and official reserve account
c) current account, capital account, and official reserve account
d) capital account, official reserve account, trade account
Answer: c - p. 60

9 Invisible trade refers to:

a) services that avoid tax payments
b) underground economy
c) legal, consulting, and engineering services

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 d) tourist expenditures, only
Answer: c - p 62

The Current Account

10 The current account is divided into four finer categories:

a) Merchandise trade, services, factor income, and statistical discrepance.
b) Merchandise trade, services, factor income, and unilateral transfers
c) Merchandise trade, services, portfolio investment, and unilateral transfers
d) Merchandise trade, services, factor income, and direct investment
Answer: b page 62.

11 Factor income
a) Consists largely of interest, dividends, and other income on foreign investments.
b) Is a theoretical construct of the factors of production, land, labor, capital, and
entrepreneurial ability.
c) Is generally a very minor part of national income accounting, smaller than the
statistical discrepancy.
d) None of the above
Answer: a) page 63

USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT TWO

QUESTIONS
The entries in the “current account” and the “capital account”, combined together, can be
outlined (in alphabetic order) as:
(i)- direct investment (v)- other capital
(ii)- factor income (vi)- portfolio investment
(iii)- merchandise (vii)- private transfer
(iv)- official transfer (viii)- services

12 Current account includes

a) (i), (ii), and (iii)
b) (ii), (iii), and (vii)
c) (iv), (v), and (vii)
d) (i), (v), and (vi)
Answer: b - p. 62

13 Capital account includes

a) (i), (ii), and (iii)
b) (ii), (iii), and (vii)
c) (iv), (v), and (vii)

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 d) (i), (v), and (vi)
Answer: d - p. 60

14 The “J-curve effect” shows:

a) the initial deterioration and the eventual improvement of a country’s trade balance
following a currency depreciation
b) the initial improvement and the eventual depreciation of a country’s trade balance
following a currency depreciation
c) the trade balance’s lack of responsiveness to the exchanges rate changes
d) none of the above
Answer: a - pp. 63

15 The “J-curve effect”

a) Happens most of the time, in the short run.
b) Actually only occurs in about 40 percent of the cases according to a study by
Sebastian Edwards
c) Is a long-run phenomenon, not a short-run.
d) None of the above.
Answer: b p 63.

16 A depreciation will begin to improve the trade balance immediately if

a) Imports and exports are responsive to the exchange rate changes.
b) Imports and exports are inelastic to the exchange rate changes.
c) Consumers exhibit brand loyalty and price inelasticity
d) b) and c)
Answer: a) page 64.

17 In the long run, both exports and imports tend to be

a) Unresponsive to changes in exchange rates
b) Responsive to changes in exchange rates
c) Both a) and b)
d) None of the above
Answer: b) page 64.

The Capital Account

18 The difference between Foreign Direct Investment and Portfolio Investment is that:
a) Portfolio Investment mostly represents the sale and purchase of foreign financial

Eun/Resnick 4e 30
 assets such as stocks and bonds that do not involve a transfer of control.
b) Foreign Direct Investment mostly represents the sale and purchase of foreign
financial assets such as stocks whereas Portfolio Investment mostly involves the
sales and purchase of foreign bonds.
c) Foreign direct investment is about buying land and building factories, whereas
portfolio investment is about buying stocks and bonds.
d) All of the above
Answer: a page 65.

19 In the latter half of the 1980s, with a strong yen, Japanese firms
a) Faced difficulty exporting
b) Could better afford to acquire U.S. assets that had become less expensive in terms
of yen.
c) Financed a sharp increase in Japanese FDI in the United States
d) All of the above
Answer: d page 65.

20 International portfolio investments have boomed in recent years, as a result of

a) A depreciating U.S. dollar
b) Increased gasoline and other commodity prices.
c) The general relaxation of capital controls and regulation in many countries
d) None of the above
Answer: c page 65.

21 If the interest rate rises in the U.S. while other variables remain constant
a) Capital inflows into the U.S. will increase
b) Capital inflows into the U.S. may not materialize
c) Capital will flow out of the U.S.
d) None of the above
Answer: a) p 66.

22 If for a particular county an increase in the interest rate is more or less matched by an
expected depreciation in the local currency.
a) Traders will probably be tempted to find another country to invest in
b) The interest rate increase per se will not be enough to spark capital flow into the
country
c) Both a) and b) are true
d) Capital will glow out of the country as the disgruntled citizens riot and go to war
with the neighbors.
Answer: c) p 66.

23 The capital account measures

a) The sum of U.S. sales of assets to foreigners and U.S. purchases of foreign assets.
b) The difference between U.S. sales of assets to foreigners and U.S. purchases of
foreign assets.

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 c) The difference between U.S. sales of manufactured goods to foreigners and U.S.
purchases of foreign products.
d) None of the above
Answer: b) page 64

24 When Honda, a Japanese auto maker, built a factory in Ohio,

a) It was engaged in foreign direct investment
b) It was engaged in portfolio investment
c) It was engaged in a cross-border acquisition
d) None of the above.
Answer: a) page 64.

25 The capital account may be divided into three categories:

a) Cross-border mergers and acquisitions, portfolio investment, and other investment
b) Direct investment, portfolio investment, and Cross-border mergers and
acquisitions
c) Direct investment, mergers and acquisitions, and other investment
d) Direct investment, portfolio investment, and other investment
Answer: d) page 64

26 When Nestlé, a Swiss firm, bought the American firm Carnation, it was engaged in
foreign direct investment. If Nestlé had only bought a non-controlling number of
shares of the firm
a) Nestlé would have been engaged in portfolio investment
b) Nestlé would have been engaged in a cross-border acquisition
c) It would depend if they bought the shares from an American or a Canadian
d) None of the above.
Answer: a) page 64.

27 Transactions in currency, bank deposits and so forth

a) Tend to be insensitive to both changes in relative interest rates and the anticipated
change in exchange rate.
b) Tend to be sensitive to both changes in relative interest rates and the anticipated
change in exchange rate.
c) Tend to be sensitive to changes in relative interest rates but insensitive to the
anticipated change in exchange rate.
d) Tend to be insensitive to changes in relative interest rates but sensitive to the
anticipated change in exchange rate.
Answer: b) page 65.

28 Since security returns tend to have low correlations among countries,

a) Investors can reduce risk more effectively if they diversify their portfolio holdings
internationally rather than purely domestically.
b) Investors who have a domestically diversified portfolio, with exposures across

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 industry types will not gain much from diversifying abroad.\
c) Investors who diversify internationally will likely underperform investors who keep
all their investments in one country.
d) None of the above
Answer: a) page 65.

29 Foreign direct investment (FDI) occurs

a) when an investor acquires a measure of control of a foreign business
b) when there is an acquisition, by a foreign entity in the U.S., of 10 percent or more
of the voting shares of a business
c) with sales and purchases of foreign stocks and bonds that do not involve a transfer
of control
d) a and b
Answer: d - p.63

Statistical Discrepancy

30 Statistical discrepancy, which by definition represents errors and omissions

a) Cannot be calculated directly
b) Is calculated by taking into account the balance-of-payments identity
c) Probably has some elements that are honest mistakes, it can’t all be money
laundering and drugs.
d) All of the above
Answer: d) page 66.

31 The statistical discrepancy in the balance-of-payments accounts

a) Arise since recordings of payments and receipts are done at different times, in
different places, possibly using different methods.
b) Arise since some transactions (illegal transactions?) occur “off the books”.
c) Represents omitted and misrecorded transactions.
d) All of the above
Answer: d) p 65.

32 Regarding the statistical discrepancy in the balance-of-payments accounts

a) There is some evidence that financial transactions may be mainly responsible for
the discrepancy.
b) The sum of the balance on the capital account and the statistical discrepancy is
very close to the balance of the current account in magnitude.
c) It tends to be positive one year and negative in others, so it’s safe to ignore it
d) a) and b)
Answer: d) p 65.

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Official Reserve Account

33 When a country must make a net payment to foreigners because of a balance-of-

payments deficit, the central bank of the country
a) Should do nothing
b) Should run down its official reserve assets (e.g. gold, foreign exchanges, and
SDRs)
c) Should borrow anew from foreign central banks.
d) b) or c) will work
Answer: d): page 66.

34 Continued U.S. trade deficits coupled with foreigners’ desire to diversify their
currency holdings away from U.S. dollars
a) could further diminish the position of the dollar as the dominant reserve currency
b) could affect the value of U.S. dollar (e.g. through the currency diversification
decisions of Asian central banks)
c) Could lend steam to the emergence of the euro as a credible reserve currency
d) All of the above
Answer: d page 68.

35 Currently, international reserve assets are comprised of

a) gold, platinum, foreign exchanges, and special drawing rights (SDRs)
b) gold, foreign exchanges, special drawing rights (SDRs), and reserve positions in
the International Monetary Fund (IMF)
c) gold, diamonds, foreign exchanges, and special drawing rights (SDRs)
d) reserve positions in the International Monetary Fund (IMF), only
Answer: b - p. 65

36 International reserve assets include “foreign exchanges”. These are

a) Special Drawing Rights (SDRs) at the IMF
b) reserve positions in the International Monetary Fund (IMF)
c) Foreign currency held by a country’s central bank
d) None of the above
Answer: c - p. 66

37 The most important international reserve asset, comprising 94 percent of the total
reserve assets held by IMF member countries is
a) Gold
b) Foreign exchanges
c) Special Drawing Rights (SDRs)
d) Reserve positions in the International Monetary Fund (IMF)
Answer: b) page 66.

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38 The balance of payments identity is given by BCA + BKA + BRA = 0. Rearrange the
identity for a country with a pure flexible exchange rate regime
a) BCA + BKA + BRA = 0
b) BCA = –BKA
c) BCA + BKA = –BRA
d) BRA = –BCA
Answer: b page 69.
Rationale: equation 3.3

The Balance of Payments Identity

USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT TWO
QUESTIONS

Assume that the balance-of-payments accounts for a country are recorded correctly.
balance on the current account = BCA = $130 billion
balance on the capital account = BKA = -$86 billion
balance on the reserves account = BRA = ?

39 The balance on the reserves account (BRA), under the fixed exchange regime is
a) –$44 billion
b) $44 billion
c) $216 billion
d) none of the above
Answer: a - p 69 Equation 3.2
Rationale: BCA + BKA = –BRA
$130 + (–$86) = –BRA
BRA = –$44

40 The balance on the reserves account (BRA), under the pure flexible exchange regime
is:
a) –$44 billion
b) $44 billion
c) $216 billion
d) none of the above
Answer: d - p. 69

41 The “one word that haunts the dollar” is

a) (Central bank) diversification
b) Reunification (Korean)
c) Misinterpretation
d) Terrorism
Answer: a - p. 68. While some students will pick d), I don’t think that’s the right answer.
It’s not like the book was written in August of 2001.

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42 The vast majority of the foreign-exchange reserves held by central banks are
denominated in
a) Local currencies
b) U.S. dollars
c) Yen
d) Euro
Answer: b - p. 68

Balance of Payments Trends in Major Countries

43 The U.S. Trade Deficit

a) Is a capital account surplus
b) Is a current account deficit
c) Is both a capital account surplus and a current account deficit
d) None of the above
Answer: c) page 70.

44 Over the last several years the U.S. has run persistent
a) Balance-of-payments deficits
b) Balance-of-payments surpluses
c) Current Account deficits
d) Capital Account deficits
Answer: c) page 70.

45 More important than he absolute size of a country’s balance-of-payments

disequilibrium
a) is the nature and cause of the disequilibrium
b) is whether it is a trade surplus or deficit
c) is whether the local government is mercantilist or not
d) Nothing is more important than he absolute size of a country’s balance-of-
payments disequilibrium
Answer: a) page 72.

Appendix 3A: The Relationship between Balance of Payments and National Income Accounting

For questions in this section, the notation is

Y = GNP = national income
C = consumption
I = private investment
G = government spending
X = exports
M = imports

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46 National income, or Gross National Product is given by:
a) GNP = Y = C + I + G + X + M
b) GNP = Y = C + I + G + X – M
c) GNP = I = C + Y + G + X – M
d) GNP = Y = C + I + X + M – G
Answer: b) page 77.

47 Which of the following is a true statement?

a) BCA ≡ X – M
b) BKA ≡ X – M
c) BKA – BCA ≡ X – M
d) BKA ≡ X – M
Answer a) page 77

48 There is an intimate relationship between a country’s BCA and how the country
finances its domestic investment and pays for government expenditures. This
relationship is given by BCA ≡ X – M ≡ (S – I) + (T – G). Given this, which of the
following is a true statement?
a) If (S – I) < 0, it implies that a country’s domestic savings is insufficient to finance
domestic investment.
b) If (T – G) < 0, it implies that a country’s tax revenue is insufficient to finance
government spending
c) both a) and b) are true
d) none of the above
Answer c) page 77

49 There is an intimate relationship between a country’s BCA and how the country
finances its domestic investment and pays for government expenditures. This
relationship is given by BCA ≡ X – M ≡ (S – I) + (T – G). Given this, which of the
following is a true statement?
a) If (S – I) < 0, it implies that a country’s domestic savings is insufficient to finance
domestic investment.
b) If (T – G) < 0, it implies that a country’s tax revenue is insufficient to finance
government spending
c) when BCA is negative, it implies that government budget deficits an/or part of
domestic investment are being finance with foreign-controlled capital
d) all of the above are true
Answer d) page 77.

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50 There is an intimate relationship between a country’s BCA and how the country
finances its domestic investment and pays for government expenditures. This
relationship is given by BCA ≡ X – M ≡ (S – I) + (T – G). Given this, in order for a
country to reduce a BCA deficit, which of the following must occur?
a) For a given level of S and I, the government budget deficit (T – G) must be
reduced
b) For a given level of I and (T – G), S must be increased
c) For a given level of S and (T – G), I must fall
d) All of the above would work to reduce a BCA deficit
Answer d) page 77.

Eun/Resnick 4e 38
 Eun & Resnick 4e
CHAPTER 4 Corporate Governance Around the World
Governance of the Public Corporation: Key Issues
The Agency Problem
Remedies for the Agency Problem
Board of Directors
International Finance in Practice: When Boards Are All in the Family
Incentive Contracts
Concentrated Ownership
Accounting Transparency
Debt
Overseas Stock Listings
Market for Corporate Control
Law and Corporate Governance
Consequences of Law
Ownership and Control Pattern
Private Benefits of Control
Capital Markets and Valuation
Corporate Governance Reform
Objectives of Reform
Political Dynamics
The Cadbury Code of Best Practice
Summary
MINI CASE: Parmalat: Europe’s Enron

1 Corporate governance can be defined as:

a) the economic, legal, and institutional framework in which corporate control and cash
flow rights are distributed among shareholders, managers and other stakeholders of the
company
b) the general framework in which company management is selected and monitored
c) the rules and regulations adopted by boards of directors specifying how to manage
companies
d) the government-imposed rules and regulations affecting corporate management
Answer: a)

2 When managerial self-dealings are excessive and left unchecked

a) They can have serious negative effects on share values
b) They can impede the proper functions of capital markets
c) They can impede such measures as GDP growth
d) All of the above
Answer: d)

3 Corporate governance structure

a) Varies a great deal across countries
b) Has become homogenized following the integration of capital markets
c) Has become homogenized due to cross-listing of shares of many public corporations
d) None of the above
Answer: a)

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Governance of the Public Corporation: Key Issues

4 The central issue of corporate governance is

a) how to protect creditors from managers and controlling shareholders
b) how to protect outside investors from the controlling insiders
c) how to alleviate the conflicts of interest between managers and shareholders
d) how to alleviate the conflicts of interest between shareholders and bondholders
Answer: b)
5 The key weakness of the public corporation is
a) too many shareholders, which makes it difficult to make corporate decision
b) relatively high corporate income tax rates
c) conflicts of interest between managers and shareholders
d) conflicts of interests between shareholders and bondholders
Answer: c)
6 When company ownership is diffuse,
a) A “free rider” problem discourages shareholder activism
b) The large number of shareholders ensures strong monitoring of managerial behavior
because with a large enough group, there’s almost always someone who will to incur the
costs of monitoring management.
c) Few shareholders have a strong enough incentive to incur the costs of monitoring
management.
d) a) and c) are correct
Answer: d)
7 In what country do the three largest shareholders control, on average, about 60 percent of the
shares of a public company?
a) United States
b) Canada
c) Great Britain
d) Italy
Answer: d)
8 The public corporation
a) Is jointly owned by a (potentially) large number of shareholders
b) Offers shareholders limited liability
c) Separates the ownership and control of a firms assets
d) All of the above
Answer: d)
9 The key strengths of the public corporation is/are
a) Their capacity to allow efficient risk sharing among many investors
b) Their capacity to raise large amounts of funds at relatively low cost
c) Their capacity to consolidate decision-making
d) All of the above
Answer: d)

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10 In theory,
a) Managers are hired by the shareholders at the annual stockholders meeting. If the
managers turn in a bad year, new ones get hired.
b) Shareholders hire the managers to oversee the board of directors.
c) Managers are hired by the board of directors; the board is accountable to the
shareholders.
d) None of the above
Answer: c)
11 In many countries with concentrated ownership
a) The conflicts of interest between shareholders and managers are worse than in countries
with diffuse ownership of firms.
b) The conflicts of interest are greater between large controlling shareholders and small
outside shareholders than between managers and shareholders.
c) The conflicts of interest are greater between managers and shareholders than between
large controlling shareholders and small outside shareholders
d) Corporate forms of business organization with concentrated ownership are rare
Answer: b)
12 In the reality of corporate governance at the turn of this century,
a) Boards of directors are often dominated by management-friendly insiders.
b) A typical board of directors often has relatively few outside directors who can
independently and objectively monitor the management.
c) Managers of one firm often sit on the boards of other firms, whose managers are on the
board of the first firm. Due to the interlocking nature of these boards, there can exist a
culture of “I’ll overlook your problems if you overlook mine.”
d) All of the above have been true to a greater or lesser extent in the recent past.
Answer: d)
The Agency Problem

13 A complete contract between shareholders and managers

a) Would specify exactly what the manager will do under each of all possible future
contingencies
b) Would be an expensive contract to write and a very expensive contract to monitor.
c) Would eliminate any conflicts of interest (and managerial discretion)
d) All of the above
Answer: d)
14 Most shareholders are “weak” in that they give up control to the managers of the firm.
a) This may be rational when shareholders may be neither qualified nor interested in making
business decisions.
b) This may be rational since many shareholders find it easier to sell their shares in an
underperforming firm than to monitor the management
c) This may be rational to the extent that managers are answerable to the board of directors
d) All of the above are explanations for the separation of ownership and control.
Answer: d)

Eun/Resnick 4e 41
15 Free cash flow refers to
a) a firm's cash reserve in excess of tax obligation
b) a firm's funds in excess of what's needed for undertaking all profitable projects
c) a firm's cash reserve in excess of interest and tax payments
d) a firm's income tax refund that is due to interest payments on borrowing
Answer: b)
16 Self-interested managers may be tempted to
a) Indulge in expensive perquisites at company expense
b) Adopt antitakeover measures for their company to ensure their personal job security
c) Waste company funds by undertaking unprofitable projects that benefit themselves but
not shareholders
d) All of the above are potential abuses that self-interested managers may be tempted to visit
upon shareholders.
Answer: d)
17 Why do managers tend to retain free cash flow?
a) Managers are in the best position to decide the best use of those funds
b) These funds are needed for undertaking profitable projects and the issue costs are less
than new issues of stocks or bonds.
c) Managers may not be acting in the shareholders best interest, and for a variety of reasons,
want to use the free cash flow.
d) None of the above
Answer: c)
Rationale: Free cash flow is defined as firm's funds in excess of what's needed for undertaking
all profitable projects.

18 The agency problem tends

a) To be more serious in firms with free cash flows
b) To be more serious in firms with excessive amounts of excess cash
c) To be less serious in firms with few numbers of shareholders
d) All of the above
Answer: d)

Remedies for the Agency Problem

Board of Directors

19 In the United States

a) Boards of directors are legally responsible for representing the interests of the
shareholders
b) Due to the diffused ownership structure of the public company, management often gets to
choose board members who are likely to be friendly to management.
c) There is a correlation between underperforming firms and boards of directors who are not
fully independent.
d) All of the above are true, in the United States.
Answer: d)

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International Finance in Practice: When Boards Are All in the Family

20 In the United States, it is well documented that

a) Boards dominated by their chief executives are prone to trouble
b) Public scrutiny can help improve corporate governance
c) As public firms improve their corporate governance, the stock price goes up
d) All of the above
Answer: d)

Incentive Contracts

21 The board of directors may grant stock options to managers in order to

a) save executive compensation costs
b) use as a substitute for bonus
c) align the interest of managers with that of shareholders
d) none of the above
Answer: c)
22 When designing an incentive contract,
a) It is important for the board of directors to set up an independent compensation
committee that can carefully design the contract and diligently monitor manager’s
actions.
b) Senior executives can be trusted to not abuse incentive contracts by artificially
manipulating accounting numbers since the auditors should look in to that.
c) The presence of any incentive is enough, whether it is accounting based or stock-price
based.
d) The board of directors should always give the managers a “heads I win, tails you lose”
type of option.
Answer: a)
Concentrated Ownership

23 Concentrated ownership of a public company

a) Is normal in the United States, following the well-publicized scandals of recent years.
b) Is relatively rare in the United States and common in many other parts of the world.
c) Leads to a free-rider problem with the minority shareholders relying on the majority
shareholders to assume an undue burden in monitoring the management
d) Is the norm in Great Britain
Answer: b)

24 Concentrated ownership of a public company

a) Can be an effective way to alleviate the agency problem between shareholders and
managers.
b) Is the norm in Great Britain
c) Tends to be an ineffective way to alleviate conflicts of interest between groups of
shareholders
d) None of the above
Answer: a)

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 Accounting Transparency

25 Accounting Transparency
a) Can only be achieved when managers commit to serving on their own audit committee.
b) Occurs when the accounting department has translucent cubicles for their workers
c) Promises to reduce the information asymmetry between corporate insiders and the public.
d) None of the above
Answer: c)

Debt

26 While debt can reduce agency costs between shareholders and management
a) Debt can create its own agency costs
b) This only happens at extreme levels of debt
c) This does not work for firms in mature industries with large cash reserves
d) None of the above are true.
Answer: a)

27 Debt can reduce agency costs between shareholders and management.

a) But only if the firm is totally up to its eyeballs in debt.
b) Only to the extent that the firm can commit all of its free cash flow.
c) But excessive debt can create its own agency conflicts.
d) Debt is best used as a corporate governance mechanism by young companies with limited
cash reserves.
Answer: c)
Overseas Stock Listings

28 Companies domiciled in countries with weak investor protection can reduce agency costs
between shareholders and management
a) By moving to a better county
b) By listing their stocks in countries with strong investor protection
c) By voluntarily complying with the provisions of theU.S. Sarbanes-Oxley Act
d) Having a press conference and promising to be nice to their investors.
Answer: b)
29 Benetton, an Italian clothier, is listed on the New York Stock Exchange.
a) This decision provides their shareholders with a higher degree of protection than is
available in Italy.
b) This decision can be a signal of the company’s commitment to shareholder rights.
c) This may make investors both in Italy and abroad more willing to provide capital and to
increase the value of the pre-existing shares.
d) All of the above
Answer: d)

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 Market for Corporate Control

30 Suppose the managers of a company have driven the stock price down because they have
spent the investors’ money on lavish perquisites like golf club memberships and great
buckets of guacamole.
a) This situation may prompt a corporate raider to buy up the shares of the firm in a hostile
takeover.
b) If the hostile takeover is successful, the managers will probably lose their jobs in the
ensuing restructuring.
c) If the restructuring is successful, the stock price should rise, and the corporate raider can
sell his shares at a profit.
d) All of the above
Answer: d)

Law and Corporate Governance

31 Private benefits of corporate control will tend to be higher in

a) French civil law countries than in English common law countries
b) English common law countries than in French civil law countries
c) French civil law countries than in Scandinavian civil law countries
d) English common law countries than in German civil law countries
Answer: a)

32 English common law countries tend to provide a stronger protection of shareholder rights
than French civil law countries because
a) the former countries tend to be more democratic than the latter.
b) the former countries tend to protect property rights better than the latter.
c) the former countries tend to have more separation of power than the latter.
d) All of the above.
Answer: b)

33 Studies show that the quality of law enforcement, as measured by the rule of law index, will
tend to be
a) Higher in French civil law countries than in English common law countries
b) Higher in English common law countries than in Scandinavian civil law countries
c) highest in Scandinavian civil law countries and German civil law countries
d) Highest in English common law countries
Answer: c)

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Consequences of Law
Ownership and Control Pattern

34 Suppose Mr. Lee and his relatives hold 30% of shares outstanding of Samsung Life, which in
turn holds 20% of Samsung Electronics. What is the cash flow right of the Lee family in
Samsung Electronics?
a) 50 percent
b) 10 percent
c) 20 percent
d) 6 percent
Answer: d)
Rationale: .30 × .20 = .06
35 Concentrated corporate ownership is most prevalent in
a) Italy
b) The U.K.
c) The U.S.
d) Australia
Answer: a)
36 In countries with concentrated ownership
a) Hostile takeovers are quite rare
b) Hostile takeovers are quite common
c) All of the above
d) None of the above
Answer: a)
37 What is the difference between control rights and cash flow rights?
a) Since all shareholders benefit only from pro-rata cash flows, control rights and cash flow
rights are the same thing.
b) Large investors may be able to derive private benefits from control, thus control rights
can exceed cash flow rights.
c) Cash flow rights are more important than control rights since the only reason to invest in
anything is to generate cash.
d) None of the above
Answer: b)

Private Benefits of Control

38 One way to measure the value of private benefits of control

a) Is to measure the difference in value between non voting shares and voting shares
b) Is to measure the value of the “block premium” the value difference between the price
per share paid for a control block of shares versus the exchange price of regular shares.
c) Both a) and b)
d) None of the above
Answer: c)

Eun/Resnick 4e 46
 Capital Markets and Valuation

39 Several studies document the empirical link between

a) Weak investor protection and GDP growth
b) Financial development and economic growth
c) Growth in GDP and concentrated ownership
d) None of the above
Answer: b)

40 Financial development can contribute to economic growth in what way(s)?

a) Financial development enhances savings
b) Financial development channels savings toward real investments in productive capacities
c) Financial development enhances the efficiency of investment allocation through the
monitoring and signaling functions of capital markets.
d) All of the above.
Answer: d)

Corporate Governance Reform

41 Comparing the U.S. with the German and Japanese corporate governance systems,
a) The U.S. system is “market centered”.
b) The German and Japanese systems are “bank centered”.
c) It seems fair to say that no country has a perfect system.
d) All of the above.
Answer: d)

Objectives of Reform

42 Among the objectives of corporate governance reform,

a) Introduce expensive and burdensome accounting reforms.
b) Strengthen the protection of outside investors from expropriation by managers and controlling
insiders.
c) Provide taxpayer financing for corporate raiders to strengthen the discipline of the marketplace.
d) None of the above
Answer: b)

43 In the U.S., corporate governance reform has included all of the following except:
a) Strengthen the independence of boards of directors
b) Enhancing the transparency and disclosure of financial statements
c) Energizing the regulatory an monitoring functions of the SEC
d) Requiring auditors to sit on the boards of directors
Answer: d)
Rationale: that would be a clear conflict of interest.

44 The Sarbanes-Oxley Act of 2002 stipulates that

a) a public accounting oversight board be created
b) the company should appoint independent financial experts to its audit committee
c) CEO and CFO sign off the company's financial statements
d) all of the above
Answer: d)

Eun/Resnick 4e 47
45 The Sarbanes-Oxley Act of 2002
a) Has had the consequence that many foreign firms have de-listed in the U.S. exchanges and listed
their shares on the London Stock Exchange and other European exchanges.
b) Has increased the pace of foreign firms listing their shares in the U.S.
c) a) and b) are both true
d) all of the above
Answer: a)
Students may enjoy arguing about the logical structure of this question, but clearly no one in their right
mind would select c).
46 The cost of compliance with the Sarbanes-Oxley Act of 2002
a) Is a small amount, since most firms were playing by rules to begin with.
b) Disproportionately affects small firms
c) Is paid for with tax credits for firms found to be in compliance.
d) all of the above
Answer: b)
47 The major components of the Sarbanes-Oxley Act include all of the following except
a) Accounting regulation—The creation of a public accounting oversight board charged with
overseeing the auditing of public companies, and restricting the consulting services that auditors
can provide to clients.
b) Audit committee—the company should appoint independent “financial experts” to its audit
committee.
c) Shareholder voting rights reform—“one share one vote” is now the law of the land.
d) Executive responsibility—CEOs and CFOs must sign off on the company’s financial statements.
Answer: c)
Rationale: there are still many different classes of stock with varying voting rights.

The Cadbury Code of Best Practice

48 The Cadbury Code of Best Practice
a) Is the U.N. equivalent of the Sarbanes-Oxley Act
b) Is voluntary, but firms that fail to comply must explain why they choose not to comply
c) Has the force of law, like the Sarbanes-Oxley Act
d) None of the above
Answer: b)
49 Following the adoption of the Cadbury Code of Best practice,
a) Joint CEO/COB (chief executive officer and chairman of the board) positions declined
b) There has been a significant impact on the internal governance mechanisms of U.K. companies
c) CEOs have become more sensitive to company performance, strengthening managerial
accountability and weakening managerial entrenchment.
d) All of the above
Answer: d)
50 The key requirements of the Cadbury Code of Best Practice
a) Boards of directors should include at least three outside directors
b) The positions of CEO and chairman of the board should not reside in the same individual
c) Compliance is mandatory for public corporations, optional for listed non-public corporations
d) a) and b) but not c)
Answer: d)

Eun/Resnick 4e 48