6 Suppose that the one-year interest rate is 3.0 percent in the Italy, the spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.18/€. What must one year interest rate be in the United States?
a) 1.2833%
b) 1.0128%
c) 4.75%
d) None of the above.
2 Interest Rate Parity (IRP) is best defined as:
a) When a government brings its domestic interest rate in line with other major financial markets
b) When the central bank of a country brings its domestic interest rate in line with its major trading partners
c) An arbitrage condition that must hold when international financial markets are in equilibrium
d) None of the above
Answer: c)
3 When Interest Rate Parity (IRP) does not hold
a) there is usually a high degree of inflation in at least one country
b) the financial markets are in equilibrium
c) there are opportunities for covered interest arbitrage
d) b and c
Answer: C)
5 Suppose that the one-year interest rate is 5.0 percent in the United States, the spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.16/€. What must one-year interest rate be in the euro zone?
a) 5.0%
b) 1.09%
c) 8.62%
7 A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain profit via covered interest arbitrage.
a) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at i€ = 6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600.
b) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit $2,400.
c) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit €2,000.
d) Answers c) and b) are both correct
8 Suppose that you are the treasurer of IBM with an extra US$1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (that’s a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. The interest rate in Japan (on an investment of comparable risk) is 13 percent. What is your strategy?
a) take $1m, invest in U.S. T-bills
b) take $1m, translate into yen at the spot, invest in Japan, repatriate your yen earnings back into dollars at the spot rate prevailing in six months.
c) take $1m, translate into yen at the spot, invest in Japan, hedge with a short position in the forward contract d) take $1m, translate into yen at the forward rate, invest in Japan, hedge with a short position in the spot contract
A U.S.-based currency dealer has good credit and can borrow $1,000,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the oneyear interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain dollar profit via covered interest arbitrage.
10 An Italian currency dealer has good credit and can borrow €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain euro-denominated profit via covered interest arbitrage.
11 Suppose that you are the treasurer of IBM with an extra US$1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (that’s a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. What must the interest rate in Japan (on an investment of comparable risk) be before you are willing to consider investing there for six months?
a) 11.991%
b) 1.12%
c) 7.45%
d) –7.45%
12 Covered Interest Arbitrage (CIA) activities will result in
a) an unstable international financial markets
b) restoring equilibrium quite quickly
c) a disintermediation
d) no effect on the market
Answer: b).
13 Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the one-year forward exchange rate, is $1.16/€. Assume that an arbitrageur can borrow up to $1,000,000.
a) This is an example where interest rate parity holds.
b) This is an example of an arbitrage opportunity; interest rate parity does NOT hold.
c) This is an example of a Purchasing Power Parity violation and an arbitrage opportunity.
14 Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the forward exchange rate, with one-year maturity, is $1.16/€. Assume that an arbitrager can borrow up to $1,000,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?
a) $10,690
b) $15,000
c) $46,207
d) $21,964.29
Answer: d)
15 Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/€. What must the spot exchange rate be?
a) $1.1768/€
b) $1.1434/€.
c) $1.12/€
Answer: b)
16 A higher U.S. interest rate (i$ ↑) will result in
a) a stronger dollar
b) a lower spot exchange rate (expressed as foreign currency per U.S. dollar)
c) both a) and b)
Answer: a) Rationale: all else equal, a higher U.S. interest rate will attract capital to the U.S., increasing demand for dollars, which leads to a stronger dollar (and a lower spot rate when the sport rate is quoted as the number of U.S. dollars per unit of foreign currency).
17 If the interest rate in the U.S. is i$ = 5 percent for the next year and interest rate in the U.K. is i£ = 8 percent for the next year, uncovered IRP suggests that
a) The pound is expected to depreciate against the dollar by about 3 percent.
b) The pound is expected to appreciate against the dollar by about 3 percent.
c) The dollar is expected to appreciate against the pound by about 3 percent.
d) a) and c) are both true
Answer: d
18 A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities?
a) $1.2471 = €1.00
b) $1.20 = €1.00
c) $1.1547 = €1.00
d) none of the above
20 If IRP fails to hold
a) Pressure from arbitrageurs should bring exchange rates and interest rates back into line
b) It may fail to hold due to transactions costs
c) It may be due to government-imposed capital controls
d) All of the above
Answer d)
21 Although IRP tends to hold, it may not hold precisely all the time
a) Due to transactions costs, like the bid ask spread
b) Due to asymmetric information
c) Due to capital controls imposed by governments
d) a) and c)
22 If a foreign county experiences a hyperinflation
a) Its currency will depreciate against stable currencies
b) Its currency may appreciate against stable currencies
c) Its currency may be unaffected—it’s difficult to say.
Answer: a)
23 As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?
a) €1.00 = $1.2379
b) €1.00 = $1.2623
c) €1.00 = $0.9903
d) $1.00 = €1.2623
24 Purchasing Power Parity (PPP) theory states that:
a) The exchange rate between currencies of two countries should be equal to the ratio of the countries’ price levels.
b) As the purchasing power of a currency sharply declines (due to hyperinflation) that currency will depreciate against stable currencies.
c) The prices of standard commodity baskets in two countries are not related.
d) a) and b)
25 If the annual inflation rate is 5.5 percent in the United States and 4 percent in the U.K., and the dollar depreciated against the pound by 3 percent, then the real exchange rate, assuming that PPP initially held, is:
a) 0.07
b) 0.98
c) –0.0198
d) 4.5
Answer: A
31 Forward parity states that
a) Any forward premium or discount is equal to the expected change in the exchange rate.
b) Any forward premium or discount is equal to the actual change in the exchange rate
c) The nominal interest rate differential reflects the expected change in the exchange rate.
d) An increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.
32 The International Fisher Effect suggests that
33 The Fisher effect states that:
34 If you could accurately and consistently forecast exchange rates
a) This would be a very handy thing.
b) You could impress your dates.
c) You could make a great deal of money.
Answer: d) Rationale: What date wouldn’t be impressed with ―Hey baby, in three months the euro will appreciate by 5 percent against the dollar.‖?
35 The main approaches to forecasting exchange rates are:
a) Efficient market, Fundamental, and Technical approaches
b) Efficient market and Technical approaches
c) Efficient market and Fundamental approaches
d) Fundamental and Technical approaches
36 The benefit to forecasting exchange rates:
a) Are greatest during periods of fixed exchange rates
b) Are nonexistent now that the euro and dollar are the biggest game in town
c) Accrue to and are a vital concern for MNCs formulating international sourcing, production, financing and marketing strategies.
d) All of the above.
37 The Efficient Markets Hypothesis states
a) Markets tend to evolve to low transactions costs and speedy execution of orders.
b) Current asset prices (e.g. exchange rates) fully reflect all the available and relevant information.
c) Current exchange rates cannot be explained by such fundamental forces as money supplies, inflation rates and so forth.
38 Good, inexpensive, and fairly reliable predictors of future exchange rates include:
a) Today’s exchange rate.
b) Current forward exchange rates (e.g. the six-month forward rate is a pretty good predictor of the spot rate that will prevail six months from today).
c) Esoteric fundamental models that take an econometrician to use and no one can explain.
d) Both a) and b)
39 If the exchange rate follows a random walk
a) The future exchange rate is unpredictable
b) The future exchange rate is expected to be the same as the current exchange rate, St = E(St+1)
c) The best predictor of future exchange rates is the forward rate Ft = E(St+1|It).
d) b) and c)
Answer: b) Rationale: c) is wrong because the forward rate model is distinct from the random walk mode
40 The random walk hypothesis suggests that:
a) The best predictor of the future exchange rate is the current exchange rate.
b) The best predictor of the future exchange rate is the current forward rate.
c) Both a) and b) are consistent with the efficient market hypothesis.
Answer: a) Rationale: the forward rate model is distinct from the random walk model. Tough question
41 With regard to fundamental forecasting versus technical forecasting of exchange rates
a) The technicians tend to use ―cause and effect‖ models.
b) The fundamentalists tend to believe that ―history will repeat itself‖ is the best model.
c) Both a) and b)
42 Generating exchange rate forecasts with the fundamental approach involves
a) Looking at charts of the exchange rate and extrapolating the patterns into the future
b) Estimation of a structural model
c) Substituting the estimated values of the independent variables into the estimated structural model to generate the forecast
43 Researchers have found that the fundamental approach to exchange rate forecasting
a) Outperforms the efficient market approach b) Fails to more accurately forecast exchange rates than either the random walk model or the forward rate model.
c) Fails to more accurately forecast exchange rates than the random walk model but is better than the forward rate model.
d) Outperforms the random walk model, but fails to more accurately forecast exchange rates than the forward rate model,
Answer b)
44 Academic studies tend to discredit the validity of technical analysis.
a) However, this can be viewed as support technical analysis.
b) However, it can be rational for individual traders to use technical analysis—if enough traders use technical analysis the predictions based on it can become selffulfilling to some extent, at least in the short-run.
c) But that can be explained by the difficulty professors may have in differentiating between technical analysis and fundamental analysis.
45 The moving average crossover rule
a) Is a fundamental approach to forecasting exchange rates.
b) States that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is appreciating.
c) States that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is depreciating.
46 According to the technical approach, what matters in exchange rate determination
a) The past behavior of exchange rates
b) The velocity of money
c) The future behavior of exchange rates
d) The beta
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