Question 1

Suppose a U.S. firm buys a one-year U.K. bond for 6,000 British pounds when 1 British pound is worth $1.50 on the foreign exchange market. What is the firm's approximate rate of return on the bond if the interest rate on the bond is 15 percent and the exchange rate is 1 British pound is worth $1.93 at maturity?

Accepted Answer

The initial investment in USD is 6,000 pounds * $1.50/pound = $9,000. The bond pays 15% interest, so it matures at 6,000 pounds * 1.15 = 6,900 pounds. At maturity, 1 pound is worth $1.93, so the bond's value in USD is 6,900 pounds * $1.93/pound = $13,317. The rate of return is (13,317 - 9,000) / 9,000 = 4,317 / 9,000 = 0.4797, or approximately 48%.

Question 2

If you receive a dollar return of 6 percent on a one-year Korean bond that yields 10 percent annually, this means that between the purchase date and the time of maturity:

Accepted Answer

The dollar return of 6 percent is a return in relation to the initial dollar investment. However, the bond yield of 10 percent is a return in relation to the Korean won. Therefore, to calculate the percentage change in the exchange rate between the purchase date and maturity, we need to find the difference between the Korean won yield and the dollar return, which is 4 percent (10% - 6%). A depreciation of the Korean won against the dollar means that it takes more Korean won to buy one dollar, which is the case here as the dollar return is lower than the Korean bond yield.

Question 3

Given a one-year Canadian bond with a yield of 8 percent, what will be the U.S. investor's rate of return at maturity if the Canadian dollar appreciates 10 percent against the U.S. dollar?

Accepted Answer

The U.S. investor's rate of return combines the yield from the bond and the appreciation of the Canadian dollar against the U.S. dollar. The yield is 8 percent, and the currency appreciation adds another 10 percent, making the total return 8% + 10% = 18%.

Question 4

Suppose that the price of an ounce of gold is 120 pesos in Mexico and 2,400 yen in Japan. Then the Japanese yen is worth two hundred times the value of a Mexican peso.

Accepted Answer

The statement provided does not give enough information to determine the relative value of the yen to the peso. It only gives the price of gold in each currency, not the exchange rate between the two currencies.

Question 5

Assume a U.S. firm invests $1,500 to buy a one-year U.K. bond. What is the dollar value of the proceeds if the dollar return on the U.K. bond is 20 percent at maturity?

Accepted Answer

The dollar value of the proceeds is calculated by taking the initial investment and adding the return on investment. In this case, the initial investment is $1,500, and the return is 20 percent of that, which is $300 ($1,500 * 20% = $300). Adding the return to the initial investment gives $1,800 ($1,500 + $300 = $1,800).

Question 6

Assume a U.S. investor buys a Mexican bond with a face value of MXP 1,000 and a 20 percent annual interest yield while the exchange rate is MXP 10 per dollar. What is the dollar return from the bond if the exchange rate at the end of the year is MXP 11 per dollar?

Accepted Answer

The answer of Assume a U.S. investor buys a Mexican...

Question 7

Assume that a one-year Malaysian bond yields 10 percent interest and that the dollar return on maturity is 5 percent. If the exchange rate at maturity is $1 = MYR 4.00 (Malaysian ringgit), what was the exchange rate at the time the bond was purchased?

Accepted Answer

Let's assume we invest $100 USD, which would give us MYR 400 based on the exchange rate at the time of purchase, which we will call X.

After one year, the bond yields 10 percent interest, which means we will receive MYR 440. However, when we convert the MYR back to USD, we will only receive $110 USD, because the exchange rate at maturity is $1 = MYR 4.00.

We know that the dollar return on maturity is 5 percent. Therefore, $110 USD must be equal to $100 USD plus 5 percent return (which is $5 USD).

So, we have the equation:

$110 USD = $100 USD + $5 USD

Solving for $1 USD, we get:

$1 USD = MYR 3.8 at the time of purchase (X)

Therefore, the correct answer is B.

Question 8

In the foreign exchange market where French francs are traded for Japanese yen, a decrease in the interest rate in France is most likely to cause:

Accepted Answer

EA decrease in the interest rate in France makes holding francs less attractive, leading to a decrease in the yen price of the French franc as investors sell francs for yen. This also increases the supply of yen in the market as more yen are offered in exchange for francs.

Question 9

Suppose you are a U.S. exporter expecting to receive a payment of NZD₁,000 (New Zealand dollars) in 12 months. The annual interest rate on NZD deposits is 5 percent, and the annual interest rate on dollar deposits is 9 percent. If the present exchange rate is $0.50 per NZD and interest rate parity holds, how many dollars do you expect to receive at the maturity date of the export contract?

Accepted Answer

The answer of Suppose you are a U.S. exporter expecting...

Question 10

Assume a one year U.S. bond pays 4.0% interest and a similar U.K. bond pays 5.2% interest. Which of the following changes will establish interest rate parity?

Accepted Answer

Interest rate parity suggests that the currency of the country with the higher interest rate (in this case, the U.K.) is expected to depreciate against the currency of the country with the lower interest rate (in this case, the U.S.) to offset the interest rate differential. Therefore, the British pound would be expected to depreciate by 1.2% against the U.S. dollar.

Question 11

Suppose a Japanese investor purchases a dollar deposit that yields 5 percent interest at the end of a year. What will be the approximate return in terms of yen at maturity if the exchange rate moves from $1 = ¥100 to $1 = ¥105 during the year?

Accepted Answer

If the exchange rate moves from $1 = ¥100 to $1 = ¥105 during the year, the yen has appreciated (increased in value) relative to the dollar. Therefore, when the investor converts the dollar deposit back to yen at maturity, they will receive more yen than they initially invested. To calculate the approximate return in terms of yen, we can first convert the initial investment (in yen) to dollars using the initial exchange rate:
Initial investment in dollars = 1 / 100 = ¥0.01
Next, we can calculate the return in dollars by multiplying the initial investment by the interest rate:
Return in dollars = ¥0.01 * 1.05 = $0.000105
Finally, we can convert the return in dollars back to yen using the final exchange rate:
Return in yen = $0.000105 * 105 = ¥0.011
To calculate the percentage return in terms of yen, we can divide the return in yen by the initial investment in yen and multiply by 100:
Percentage return = (¥0.011 / ¥1) * 100 = 1.1%
Therefore, the approximate return in terms of yen at maturity is 1.1%, which is closest to choice C (10%).

Question 12

Suppose a Canadian investor buys a one-year U.S. government bond that pays 7 percent interest. If the U.S. dollar appreciates 4 percent against the Canadian dollar during the year, what must be the yield on a comparable Canadian government bond for interest rate parity to hold?

Accepted Answer

The answer of Suppose a Canadian investor buys a one-year...

Question 13

Suppose a U.S. citizen purchases a one-year Norwegian bond that yields 10 percent interest. Between the purchase date and the maturity date, the exchange rate changes from  to  How much was initially invested in the bond if the dollar value of the proceeds at maturity is $3,500? (roundoff up to the nearest whole number)

Accepted Answer

The answer of Suppose a U.S. citizen purchases a one-year...

Question 14

Interest rate parity can be summarized by which of the following equilibrium conditions?

Accepted Answer

The answer of Interest rate parity can be summarized by...

Question 15

What is the interest rate on a 12-month U.K. certificate of deposit if the dollar return on the certificate is 4 percent and the dollar has appreciated 9 percent against the British pound?

Accepted Answer

To calculate the interest rate on the CD in terms of pounds, we need to convert the dollar return (4%) into pounds using the new exchange rate:

4% × (1 + 9%) = 4.36% return in pounds

Then, using the formula for the interest rate on a CD:

(1 + r) = (1 + 4.36%)^(1/12)

r = 12 × (1.0436^(1/12) - 1) = 12 × 0.0343 = 0.4116 = 41.16%

However, we need to convert this back into dollars to compare it to the given options. Using the new exchange rate:

41.16% × (1 - 9%) = 37.54% return in dollars

Therefore, the interest rate on the 12-month U.K. CD is approximately 37.54%. The closest option to this is B) 13%, which is the correct answer.

Question 16

Suppose the 12-month interest rate on a U.S. Treasury bill is 16 percent, and the one-year interest rate on a comparable British Treasury bill is 6 percent. The exchange rate today is $2.00 per pound. What must be the expected exchange rate at maturity for interest rate parity to hold?

Accepted Answer

Interest rate parity ensures that the return on investments in different currencies will be equal once the exchange rate adjustment is taken into account. Using the formula for interest rate parity: $F = S \times \frac{1 + i_{domestic}}{1 + i_{foreign}}$, where $F$ is the future exchange rate, $S$ is the spot exchange rate, $i_{domestic}$ is the domestic interest rate, and $i_{foreign}$ is the foreign interest rate. Plugging in the given values: $F = 2.00 \times \frac{1 + 0.16}{1 + 0.06}$, we get $F = 2.00 \times \frac{1.16}{1.06} = 2.00 \times 1.09434 = 2.18868$, which rounds to approximately $2.20 per pound, making option C correct.

Question 17

Suppose a U.S. citizen invests $1,000 to purchase a one-year Japanese bond that has an interest yield of 10 percent. If the dollar appreciates 20 percent against the Japanese yen by the maturity date, the dollar value of the proceeds is _____.

Accepted Answer

The answer of Suppose a U.S. citizen invests $1,000 to...

Question 18

Countries that maintain a constant gold value for their currencies are said to be on a gold standard.

Accepted Answer

This is true. Countries on a gold standard set the value of their currency in terms of a fixed weight of gold, and maintain that value by buying and selling gold at a fixed price.

Question 19

An Australian investor buys a U.S. Treasury bond that has a price of $10,000, pays 5 percent interest, and matures in a year. Between the purchase date and the maturity date, the exchange rate changes from $1 = AUD 5.0 to $1= AUD 5.2. What will be the Australian investor's rate of return from the U.S. bond?

Accepted Answer

The purchase price of the U.S. Treasury bond is $10,000, which means that it pays $500 in interest ($10,000 x 0.05) for a total return of $10,500.

When the exchange rate changes from $1 = AUD 5.0 to $1 = AUD 5.2, the value of the U.S. bond in Australian dollars increases because the Australian dollar has weakened.

We can calculate the value of the bond in Australian dollars before and after the exchange rate change:

Before: $10,000 x 5.0 = AUD 50,000 
After: $10,000 x 5.2 = AUD 52,000

So the value of the bond in Australian dollars increased by AUD 2,000 due to the exchange rate change.

The Australian investor's rate of return can be calculated as:
(Return in Australian dollars / Initial investment in Australian dollars) x 100%

(Return in Australian dollars = Total return + Increase in value due to exchange rate change = AUD 10,500 + AUD 2,000 = AUD 12,500)
(Initial investment in Australian dollars = Purchase price of bond x Exchange rate at purchase = $10,000 x 5.0 = AUD 50,000)

Rate of return = (AUD 12,500 / AUD 50,000) x 100% = 25%

Therefore, the Australian investor's rate of return from the U.S. bond is 25%. The correct answer is C.

Question 20

If a dollar invested in the United States yields the same return as a dollar's worth of yen invested in Japan, then it implies that:

Accepted Answer

If a dollar invested in the United States yields the same return as a dollar's worth of yen invested in Japan, then it implies that interest rate parity exists. Interest rate parity refers to the condition where the return on a domestic currency investment is equal to the return on a foreign currency investment after adjusting for the exchange rate. This ensures that there is no opportunity for arbitrage and the exchange market is in equilibrium. Purchasing power parity (A) refers to the condition where the price of a basket of goods is the same in two different currencies. The dollar/yen exchange rate being fixed (C) would mean that the central banks of both countries have agreed to set a fixed exchange rate, which is unlikely. Both currencies being pegged to a fixed amount of gold (E) would mean that the exchange rate is fixed based on the amount of gold reserves held by both countries, which is also unlikely in the current global financial system.

Quiz 21: Exchapterange Rates and Financial Links Between Countries