Chapter 7 International Arbitrage and Interest Rate Parity 1. Due to _______, market fores should realign the relationship bet!een the interest rate di"erential of t!o urrenies and the forward premium (or discount) on the forward exchange rate bet!een the t!o urrenies. A# for!ard realignment arbitrage $# triangular arbitrage C) covered interest arbitrage D# loational arbitrage A%&'(R) C *. Due to _______, market fores should realign the spot rate of a urreny among banks. A# for!ard realignment arbitrage $# triangular arbitrage C# o+ered interest arbitrage D) locational arbitrage A%&'(R) D . Due to _______, market fores should realign the ross e-hange rate bet!een t!o foreign urrenies based on the spot e-hange rates of the t!o urrenies against the .&. dollar. A# for!ard realignment arbitrage B) triangular arbitrage C# o+ered interest arbitrage D# loational arbitrage A%&'(R) $ /. If interest rate parity e-ists, then _______ is not feasible. A# for!ard realignment arbitrage $# triangular arbitrage C) covered interest arbitrage D# loational arbitrage A%&'(R) C 0. In !hih ase !ill loational arbitrage most likely be feasible A# 2ne bank3s ask prie for a urreny is greater than another bank3s bid prie for the urreny. B) One bank's bid price for a currency is greater than another bank's ask price for the currency C# 2ne bank3s ask prie for a urreny is less than another bank3s ask prie for
the urreny. D# 2ne bank3s bid prie for a urreny is less than another bank3s bid prie for the urreny. A%&'(R) $ 4. 'hen using _______, funds are not tied up for any length of time. A# o+ered interest arbitrage B) locational arbitrage C) triangular arbitrage D) B and C A%&'(R) D 7. 'hen using _______, funds are typially tied up for a signi!cant period of time. ") covered interest arbitrage $# loational arbitrage C# triangular arbitrage D# $ and C A%&'(R) A 5. Assume that the interest rate in the home ountry of Curreny 6 is a muh higher interest rate than the .&. interest rate. Aording to interest rate parity, the forward rate of Curreny 6) ") should exhibit a discount $# should e-hibit a premium. C# should be ero 8i.e., it should e9ual its spot rate#. D# $ or C A%&'(R) A :. If the interest rate is higher in the .&. than in the nited ;ingdom, and if the for!ard rate of the $ritish pound 8in .&. dollars# is the same as the pound3s spot rate, then) A# .&. in+estors ould possibly bene
for!ard rate of the $ritish pound is the same as its spot rate) ") #$ investors could possibly bene!t from covered interest arbitrage $# $ritish in+estors ould possibly bene or in+est funds in ?e-io at 1/>. @he spot rate of the peso is .1= !hile the oneByear for!ard rate of the peso is .1=. If .&.
.0 at $ank 6. Assume the bid rate of the %e! ealand dollar is .* !hile the ask rate is .*0 at $ank E.Fi+en this information, information, !hat !ould be your gain if if you use 1,===,= 1,===,=== == and e-eute loational arbitrage arbitrage @hat is, ho! muh !ill you end up !ith o+er and abo+e the 1,===,=== you started !ith A# 10,50. $# 10,4*0. C# **,14. D# 1,*0=. A%&'(R) A &2G@I2% *+++*+++,-./ 0 12-*+34*5.- x -- 0 *+/*-6/ 7hus* the pro!t is /*-6/ 10. $ased on interest rate parity, the larger the degree by !hih the foreign interest rate e-eeds the .&. interest rate, the) ") larger will be the forward discount of the foreign currency . $# larger !ill be the for!ard premium of the foreign urreny. C# smaller !ill be the for!ard premium of the foreign urreny. D# smaller !ill be the for!ard disount of the foreign urreny. A%&'(R) A 14. Assume the follo!ing information) Eou Eou ha+e 1,===,= 1,===,=== == to in+est in+est Current spot rate of pound H 1.= :=Bday for!ard rate of pound H 1.*5 Bmonth deposit rate in .&. H > Bmonth deposit rate in Freat $ritain H /> If you use o+ered interest arbitrage for a :=Bday in+estment, !hat !ill be the amount of .&. dollars you !ill ha+e after := days ") *+.8*+++ $# 1,==,===. C# 1,=/=,===. D# 1,=/,===. (# none of the abo+e A%&'(R) A &2G@I2%) *+++*+++,-+ 0 345*.- pounds x (+8) 0 6++*+++ pounds x .6 0 *+.8*+++
17. Assume that the .&. interest rate is 1=>, !hile the $ritish interest rate is 10>. If interest rate parity exists, then) A# $ritish in+estors !ho in+est in the nited ;ingdom !ill ahie+e the same return as .&. in+estors !ho in+est in the .&. $# .&. in+estors !ill earn a higher rate of return !hen using o+ered interest arbitrage than !hat they !ould earn in the .&. C# .&. in+estors !ill earn 10> !hether they use o+ered interest arbitrage or in+est in the .&. D) #$ investors will earn +9 whether they use covered interest arbitrage or invest in the #$ A%&'(R) D 15. Assume the follo!ing information) .&. in+estors ha+e 1,===,=== to in+est 1Byear deposit rate o"ered on .&. dollars H 1*> 1Byear deposit rate o"ered on &ingapore dollars H 1=> 1Byear for!ard rate of &ingapore dollars H ./1* &pot rate of &ingapore dollar H ./== Fi+en this information) information) A# interest rate parity e-ists and o+ered interest arbitrage by .&. in+estors results in the same yield as in+esting domestially. B) interest rate parity doesn't exist and covered interest arbitrage by #$ investors results in a yield above what is possible domestically C# interest rate parity e-ists and o+ered interest arbitrage by .&. in+estors results in a yield abo+e !hat is possible domestially. D# interest rate parity doesn3t e-ist and o+ered interest arbitrage by .&. in+estors results in a yield belo! !hat is possible domestially. A%&'(R) $ &2G@I2%) 1,===,===./== H &*,0==,=== - 81.1# H &*,70=,=== - ./1* H 1,1,=== Eield H 81,1,=== 81,1,=== B 1,===,== 1,===,===#1,== =#1,===,=== =,=== H 1.> @his yield e-eeds e-eeds !hat !hat is possible domestially. domestially.
1:. Assume the follo!ing information)
Current spot rate of %e! ealand dollar H ./1 Joreasted spot rate of %e! ealand dollar 1 year from no! H ./ One:year forward rate of the 1ew 2ealand dollar 0 8. Annual interest rate on %e! ealand dollars H 5> Annual interest rate on .&. dollars H :> Fi+en the information in this 9uestion, the return from o+ered interest arbitrage by .&. in+estors !ith 0==,=== 0==,=== to in+est is _______>. A# about 11.:7 $# about :.4 C# about 11.1* D# about 11.4/ ;) about +4A%&'(R) ( &2G@I2%) 0==,===./1 H %1,*1:,01* - 81.=5# H %1,17,=7 - ./* H 00,171 Eield H 800,171 800,171 B 0==,===# 0==,===#0==,=== 0==,=== H 1=.4> 1=.4> *=. Assume the follo!ing bid and ask rates of the pound for t!o banks as sho!n belo!) $id Ask $ank A) 1./1 1./* $ank $) 1.: 1./= As loational arbitrage ours) A# the bid rate for pounds at $ank A !ill inrease the ask rate for pounds at $ank $ !ill inrease. $# the bid rate for pounds at $ank A !ill inrease the ask rate for pounds at $ank $ !ill derease. C# the bid rate for pounds at $ank A !ill derease the ask rate for pounds at $ank $ !ill derease. D) the bid rate for pounds at Bank " will decrease& the ask rate for pounds at Bank B will increase A%&'(R) D
*1. Assume the bid rate of a &ingapore dollar is ./= !hile the ask rate is ./1 at $ank 6. Assume the bid rate of a &ingapore dollar is ./* !hile the ask rate is ./*0 at $ank . Fi+en this information, !hat !ould be your gain if you use 1,===,=== and
e-eute loational arbitrage arbitrage @hat is, ho! muh !ill you end up !ith o+er and abo+e the 1,===,=== you started !ith A# 11,74/. $# B11,:4/. C# 4,050. D# */,:=. (# 15,*1:. A%&'(R) D &2G@I2% *+++*+++,8 0 $.*8-5*+.8 x 8. 0 *+.8*-5+ **. $ased on interest rate parity, the larger the degree by !hih the .&. interest rate e-eeds the foreign interest rate, the) A# larger !ill be the for!ard disount of the foreign urreny. B) larger will be the forward premium of the foreign currency C# smaller !ill be the for!ard premium of the foreign urreny. D# smaller !ill be the for!ard disount of the foreign urreny. A%&'(R) $ *. Assume the follo!ing e-hange rates) 1 H %, %1 H ?6P*, and 1 H ?6P0. Fi+en this information, as you and others perform triangular arbitrage, the e-hange rate of the %e! ealand dollar 8%# !ith respet to the .&. dollar should _______, and the the e-hange e-hange rate of the ?e-ian ?e-ian peso 8?6P# 8?6P# !ith respet to the .&. dollar should _______. ") appreciate& depreciate $# depreiate appreiate C# depreiate depreiate D# appreiate appreiate (# remain stable appreiate A%&'(R) A
Chapter 5 Relationships among InKation,Interest Rates, and (-hange Rates 1. Assume a t!oBountry !orld) Country A and Country $. 'hih of the follo!ing is orret about purhasing po!er parity 8PPP# as related to these t!o ountries ")
urreny !ill !eaken. C# If Country A3s interest rate e-eeds Country $3s inKation rate, Country A3s urreny !ill strengthen. strengthen. D# If Country $3s inKation rate e-eeds Country A3s inKation rate, Country A3s urreny !ill !eaken. A%&'(R) A *. Fi+en a home ountry and a foreign ountry, purhasing po!er parity 8PPP# suggests that) A# a home urreny !ill depreiate if the urrent home inKation rate e-eeds the urrent foreign interest rate. $# a home urreny !ill appreiate if the urrent home interest rate e-eeds the urrent foreign interest rate. C# a home urreny !ill appreiate if the urrent home inKation rate e-eeds the urrent foreign inKation rate. D) a home currency will depreciate if the current home in=ation rate exceeds the current foreign in=ation rate A%&'(R) D . 7he international >isher e?ect (<>;) suggests that) ") a home currency will depreciate if the current home interest rate exceeds the current foreign interest rate $# a home urreny !ill appreiate if the urrent home interest rate e-eeds the urrent foreign interest rate. C# a home urreny !ill appreiate if the urrent home inKation rate e-eeds the urrent foreign inKation rate. D# a home urreny !ill depreiate if the urrent home inKation rate e-eeds the urrent foreign inKation rate. A%&'(R) A /. $eause there are a variety of factors in addition to in=ation that a?ect exchange rates* this !ill) ") reduce the probability that @@@ shall hold $# inrease the probability that PPP shall hold.
C# inrease the probability the IJ( !ill hold. D# $ and C A%&'(R) A 0. $eause there are sometimes no substitutes for traded goods , this !ill) ") reduce the probability that @@@ shall hold $# inrease the probability that PPP shall hold. C# inrease the probability the IJ( !ill hold. D# $ and C A%&'(R) A 4. Aording to the IJ(, if British interest rates exceed #$ interest rates) A# the $ritish pound3s +alue !ill remain onstant. B) the British pound will depreciate against the dollar C# the $ritish inKation rate !ill derease. D# the for!ard rate of the $ritish pound !ill ontain a premium. (# today3s for!ard rate of the $ritish pound !ill e9ual today3s spot rate. A%&'(R) $ 7. Fi+en a home ountry and a foreign ountry, the international >isher e?ect (<>;) suggests that A# the nominal interest rates of both ountries are the same. $# the inKation rates of both ountries are the same. C# the e-hange rates of both ountries !ill mo+e in a similar diretion against other urrenies. D) none of the above A%&'(R) D
5. Fi+en a home ountry and a foreign ountry, purhasing po!er parity suggests that) A# the inKation rates of both ountries !ill be the same. $# the nominal interest rates of both ountries !ill be the same. C# A and $ D) none of the above A%&'(R) D :. If interest rates on the euro are onsistently belo! .&. interest rates, then for the international Jisher e"et 8IJ(# to hold) ") the value of the euro would often appreciate against the dollar $# the +alue of the euro !ould often depreiate against the dollar. C# the +alue of the euro !ould remain onstant most of the time.
D# the +alue of the euro !ould appreiate in some periods and depreiate in other periods, but on a+erage ha+e a ero rate of appreiation. A%&'(R) A international >isher e?ect (<>;) did not hold based on historical 1=. If the international data, then this suggests that) A# some orporations !ith e-ess ash an lok in a guaranteed higher return on future foreign shortBterm in+estments. $# some orporations !ith e-ess ash ould ha+e generated pro
A%&'(R) C 11. nder purhasing po!er parity, the future spot exchange rate is a function of the initial spot rate in eAuilibrium and) A# the inome di"erential. $# the for!ard disount or premium. C) the in=ation di?erential D# none of the abo+e A%&'(R) C
1*. Aording to the international Jisher e"et, if #$ investors expect a /9 rate of domestic in=ation over one year* and a *> rate of inKation in (uropean (uropean ountries that use the euro, and reAuire a -9 real return on investments over one year , the nominal interest rate on oneByear .&. @reasury seurities !ould be) A# *>. $# >. C# B*>.
D# 0>. ;) 69 A%&'(R) ( &2G@I2%) /9 -9 0 69 1. Aording to the international Jisher e"et, if in+estors in all ountries re9uire the same real rate of return, the di"erential in nominal interest rates bet!een any t!o ountries) A# follo!s their e-hange rate mo+ement. B) is due to their in=ation di?erentials C# is ero. D# is onstant o+er time. (# C and D A%&'(R) $ 1/. Assume that .&. and $ritish in+estors re9uire a real return of *>. If the nominal .&. interest rate is 10>, and the nominal $ritish rate is 1>, then aording to the IJ(, the $ritish inKation rate is e-peted to be about _______ the .&. inKation rate, and the $ritish pound is e-peted e-peted to _______. A# * perentage points abo+e depreiate by about *> $# perentage points abo+e depreiate by about > C# perentage points belo! appreiate by about > D# perentage points belo! depreiate by about > ;) . percentage points below& appreciate appreciate by about .9 A%&'(R) ( 10. Assume .&. and &!iss in+estors re9uire a real rate of return of >. Assume the nominal .&. interest rate is 4> and the nominal &!iss rate is />. Aording to the international Jisher e"et, the fran !ill _______ by about _______. A# appreiate > $# appreiate 1> C# depreiate > D# depreiate *> ;) appreciate& .9 A%&'(R) (
