Question 1

The interest rate on euros is 8%. The interest rate in the UK is 5%. The euro's forward rate should exhibit a premium of about 3%.

Accepted Answer

The euro's forward rate should exhibit a discount of about 3% because the interest rate on euros is higher than in the UK, leading to a forward rate adjustment in favor of the currency with the lower interest rate.

Question 2

Bank A quotes a bid rate of £0.125 and an ask rate of £0.155 for the Malaysian ringgit (MYR). Bank B quotes a bid rate of £0.162 and an ask rate of £0.171 for the ringgit. What will be the profit for an investor who has £500,000 available to conduct locational arbitrage?

Accepted Answer

The investor can buy MYR from Bank A at £0.155 and sell it to Bank B at £0.162. The profit is calculated as follows: Buy MYR with £500,000 at £0.155 = 3,225,806.45 MYR. Sell 3,225,806.45 MYR at £0.162 = £522,581. Profit = £522,581 - £500,000 = £22,581.

Question 3

Assume the UK interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss franc has a 4% premium. Given this information:

Accepted Answer

The answer of Assume the UK interest rate is 2%...

Question 4

Assume that the UK investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from the act of this covered interest arbitrage?

Accepted Answer

The answer of Assume that the UK investors are benefiting...

Question 5

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

Accepted Answer

The answer of If interest rate parity (IRP) exists, then...

Question 6

Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.

Accepted Answer

Covered interest arbitrage refers to the strategy where investors borrow funds in a currency with a low interest rate and invest in a currency with a higher interest rate. This strategy should result in a realignment of the relationship between the interest rate differential and the forward premium/discount for the two currencies, as market forces should bring the forward exchange rate in line with the interest rate differential.

Question 7

You just received a gift from a friend consisting of 1,000 Thai baht, which you would like to exchange for Australian dollars (A$). You observe that exchange rate quotes for the baht are currently £0.0115, while quotes for the Australian dollar are £0.288. How many Australian dollars should you expect to receive for your baht?

Accepted Answer

To convert Thai baht to Australian dollars, we need to first convert Thai baht to British pounds and then convert British pounds to Australian dollars.1,000 Thai baht = 1,000 x £0.0115 = £11.50£11.50 = £11.50 x A$0.288 = A$399Therefore, you should expect to receive A$399 for your 1,000 Thai baht.

Question 8

Assume the US dollar is worth £0.82, and the Canadian dollar is worth £0.61. What is the value of the Canadian dollar in US dollars to the nearest cent?

Accepted Answer

To find the value of the Canadian dollar in US dollars, divide the value of the Canadian dollar in pounds (£0.61) by the value of the US dollar in pounds (£0.82). £0.61/£0.82 = 0.7439, which rounds to 0.74.

Question 9

Assume that interest rate parity holds. The Nigerian interest rate is 50%, and the UK interest rate is 8%. Subsequently, the UK interest rate decreases to 7%. According to interest rate parity, the peso's forward ____ will ____.

Accepted Answer

According to interest rate parity, the forward rate reflects the interest rate differential between two countries. Initially, the UK interest rate is 8%, and the Nigerian interest rate is 50%, leading to a forward discount on the Nigerian currency. When the UK interest rate decreases to 7%, the interest rate differential increases, causing the forward discount on the Nigerian currency to increase.

Question 10

Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in forward contracts.

Accepted Answer

Locational arbitrage involves taking advantage of price differences for the same asset in different markets, not investing in foreign countries and hedging against exchange rate risk.

Question 11

To capitalize on high foreign interest rates using covered interest arbitrage, a UK investor would convert pounds to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward.

Accepted Answer

Covered interest arbitrage involves converting domestic currency to foreign currency, investing in the foreign country, and using a forward contract to lock in the future exchange rate, thus eliminating exchange rate risk.

Question 12

Assume the bid rate of a Swiss franc is £0.42 while the ask rate is £0.45 at Bank X. Assume the bid rate of the Swiss franc is £0.40 while the ask rate is £0.41 at Bank Y. Given this information, what would be your gain if you use £1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the £1,000,000 you started with?

Accepted Answer

To execute locational arbitrage, buy Swiss francs at Bank Y at £0.41 and sell them at Bank X at £0.42. With £1,000,000, you can buy 2,439,024.39 Swiss francs at Bank Y. Selling these at Bank X at £0.42 gives you £1,024,390.24, resulting in a gain of £24,390.24 - £1,000,000 = £24,390.24. However, the closest option is £24,340.

Question 13

Assume that the euro's interest rates are higher than US interest rates, and that interest rate parity exists. Which of the following is true?

Accepted Answer

The answer of Assume that the euro's interest rates are...

Question 14

Assume the following information: ​
Current spot rate of Australian dollar = £0.40
Forecasted spot rate of Australian dollar 1 year from now = £0.37
1-year forward rate of Australian dollar = £0.38
Annual interest rate for Australian dollar deposit = 9%
Annual interest rate in the UK = 6%
​
Given the information in this question, the return from covered interest arbitrage by UK investors is ______%.

Accepted Answer

The answer of Assume the following information: ​
Current spot rate...

Question 15

If the interest rate is higher in the US than in the United Kingdom, and if the forward rate of the British pound (in US dollars) is the same as the pound's spot rate, then:

Accepted Answer

The answer of If the interest rate is higher in...

Question 16

Assume that a UK firm can invest funds for one year in the UK at 12% or invest funds in Mexico at 14%. The spot rate of the peso is £0.06 while the one-year forward rate of the peso is £0.06. If UK firms attempt to use covered interest arbitrage, what forces should occur?

Accepted Answer

The correct answer is A because covered interest arbitrage will lead to an increase in the spot rate of the peso and a decrease in the forward rate of the peso. This is because UK firms will sell pesos forward to lock in the higher interest rate in Mexico, which will increase the demand for pesos in the spot market and drive up the spot rate. At the same time, the increased supply of pesos in the forward market will drive down the forward rate.

Question 17

Due to ____, market forces should realign the cross-exchange rate between two foreign currencies based on the spot exchange rates of the two currencies against the US dollar.

Accepted Answer

Triangular arbitrage is the process of taking advantage of an arbitrage opportunity resulting from a pricing discrepancy among three different currencies in the foreign exchange market. In this scenario, market forces should realign the cross-exchange rate between two foreign currencies based on the spot exchange rates of the two currencies against the US dollar. Therefore, the correct choice is B.

Question 18

Assume that Swiss investors are benefiting from covered interest arbitrage due to a high UK interest rate. Which of the following forces results from the act of this covered interest arbitrage?

Accepted Answer

Covered interest arbitrage involves converting Swiss francs to British pounds to take advantage of higher UK interest rates, then using a forward contract to convert back to Swiss francs. This increases demand for forward contracts on Swiss francs, putting upward pressure on the Swiss franc's forward rate.

Question 19

Assume that interest rate parity holds, and the euro's interest rate is 9% while the US interest rate is 12%. Then the euro's interest rate increases to 11% while the US interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity.

Accepted Answer

The answer of Assume that interest rate parity holds, and...

Question 20

If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage should be equal to the rate available in the foreign country.

Accepted Answer