Currency Risk

A venture organizer accepts contributions of equipment and volunteer labor, rather than cash, in exchange for a share of future profits. Does that satisfy the investment of money element of the Howey test?

1. A.Yes; the element is met by any contribution of value the participant surrenders for the interest.Correct. Investment of money is read as any consideration of value placed at risk, including property and services.
2. B.No; the element requires a payment of cash or a cash equivalent to the promoter.Wrong. Nothing in the test turns on the form of payment, and a cash-only reading would let a promoter escape by simply invoicing in goods.
3. C.No; contributions of labor are compensation arrangements and can never create a security.Wrong. Labor can be the very consideration a participant surrenders, and an automatic exclusion would gut the element.
4. D.Yes, but only once the organizer converts the contributed property into cash.Wrong. Conversion to cash is a later act of the venture and has no bearing on whether the participant placed value at risk.

Why: The first Howey element asks whether the participant committed something of value in exchange for the interest, not whether that value arrived as currency. Contributions of property, services or other securities all count, because each represents something the contributor surrendered and now has at risk. Here the contributors handed over equipment and labor for a profit share, so the element is met and the analysis proceeds to common enterprise and reliance on the efforts of others. Only if a participant gave up nothing at all, receiving the interest as an outright gift, would this element fail.

A dollar-based investor buys a fund holding shares of companies that report results and pay dividends in a foreign currency. Which additional risk has she taken on?

1. A.Prepayment risk, because foreign issuers may repay their obligations earlier than scheduled.Wrong. Prepayment risk belongs to mortgage-backed and similar amortizing debt, not to holdings of equity.
2. B.Currency risk, because the returns must eventually be converted back into dollars.Correct. Even if the shares perform well abroad, an adverse exchange rate move can erase the gain in dollars.
3. C.Reinvestment risk, because foreign dividends arrive on a different payment schedule.Wrong. Reinvestment risk concerns the rate available on cash flows and is not created by a payment calendar.
4. D.Call risk, because foreign shares may be redeemed by their issuers without notice.Wrong. Call features attach to bonds and preferred issues rather than to ordinary common shares.

Why: An investor whose spending is in dollars ultimately measures returns in dollars, so any holding denominated in another currency carries two exposures: how the investment performs and how the currency moves. A foreign portfolio can gain in local terms and still lose in dollars if that currency weakens. The exposure is present no matter how many different foreign companies the fund owns, because it attaches to the currency rather than to any issuer. Hedging the currency, rather than adding more foreign names, is what addresses it.

The Federal Reserve eases aggressively while other major central banks hold steady. Holding other factors constant, what is the likely effect on the dollar and on a domestic manufacturer that exports most of its output?

1. A.The dollar strengthens, and the exporter's goods become cheaper for foreign buyers.Wrong. The first half is backwards, because lower domestic yields make dollar assets less attractive rather than more.
2. B.The dollar weakens, and the exporter's goods become cheaper for foreign buyers.Correct. Easing tends to push the dollar down, and a cheaper dollar lowers the foreign-currency price of domestic goods.
3. C.The dollar weakens, and the exporter's goods become more expensive for foreign buyers.Wrong. The currency direction is right, but a weaker dollar makes domestic goods cheaper abroad rather than dearer.
4. D.The dollar strengthens, and the exporter's foreign revenue converts into more dollars.Wrong. Both halves fail, since a stronger dollar converts foreign revenue into fewer dollars, not more.

Why: Capital chases yield, so when one central bank eases while others do not, that country's assets pay relatively less and demand for its currency falls. A weaker dollar means each unit of foreign currency buys more dollars, so goods priced in dollars grow cheaper for foreign customers. The exporter therefore gains competitiveness and converts foreign sales into more dollars. A domestic firm importing its raw materials would be hurt by the very same move, which is why currency effects must be traced firm by firm.

Tighter monetary policy in one country tends to strengthen its currency against others. What is the mechanism that produces that result?

1. A.Higher yields attract foreign capital, and buying those assets requires buying the currency.Correct. Cross-border investors must acquire the currency in order to buy its assets, and that demand bids it higher.
2. B.Tighter policy reduces imports, so fewer of the country's own units are sold abroad.Wrong. Weaker imports can help a trade balance, but that channel is far slower and smaller than capital flows.
3. C.Central banks agree to support one another's currencies whenever their policies diverge.Wrong. No such standing arrangement drives ordinary exchange rate moves between floating currencies.
4. D.A smaller money supply means each remaining unit is redeemable for more reserves.Wrong. Modern currencies are not redeemable for anything, so scarcity does not work through a redemption claim.

Why: Exchange rates in the short run are driven mostly by capital flows rather than by trade. When one country's yields rise relative to others, investors move funds to capture the difference, and buying assets denominated in that currency requires first buying the currency itself. That demand bids its value up. The effect can be swamped if investors doubt the country's stability or expect its inflation to run higher, which is why this is a tendency rather than a rule.