Question 1

Currently,you can exchange $1 for SF1.14.Assume the average inflation rate in the U.S.over the next two years will be 2.5 percent annually as compared to 3 percent in Switzerland.Based on this information and relative purchasing power parity,which of the following assumptions can you make regarding the next two years?

Accepted Answer

Based on relative purchasing power parity and the difference in inflation rates, the U.S. dollar is expected to appreciate against the Swiss franc. This means that it will cost fewer Swiss francs to buy one U.S. dollar in the future. Therefore, the exchange rate of SF1.14 to $1 may decrease, indicating an appreciation of the U.S. dollar against the Swiss franc.

Question 2

Assume you can exchange $1 for either £1 or ? .50 in the U.S.In the London market,you can exchange £1 for ?
)52.This situation creates an opportunity to profit immediately
From which one of the following?

Accepted Answer

Triangle arbitrage involves exploiting a pricing discrepancy between three currencies in order to make a profit. In this case, one can use the exchange rates of USD/GBP and USD/other currency to calculate the implied exchange rate of GBP/other currency. If the currency exchange rate in London market differs from the implied exchange rate, then one can use the opportunity to make a profit.

Question 3

Which statement is correct?

Accepted Answer

The statement "The foreign exchange market is the largest financial market in the world" is correct, making E the best choice. A is incorrect because exchange rates can fluctuate throughout the day. B is incorrect because the French franc has been replaced by the euro in most countries. C is incorrect because not all South American countries use the peso. D is incorrect because New Zealand uses its own currency, the New Zealand dollar (NZD).

Question 4

Assume you can currently exchange $1 for ¥100.Also assume the inflation rate will be 2.5 percent annually in the U.S.and 2 percent in Japan.Given these assumptions,how many yen should you expect in exchange for $1 next year?

Accepted Answer

With a higher inflation rate in the U.S. than Japan, we expect the value of the dollar to decrease relative to the yen. Therefore, we can expect to receive fewer yen for $1 next year, leading to the answer of less than 100 yen.

Question 5

Suppose you could buy 1,115 South Korean won or 100 Pakistani rupees last year for $1.Today,$1 will buy you 1,113 won or 102 rupees.Which one of the following occurred over the past year?

Accepted Answer

The answer of Suppose you could buy 1,115 South Korean...

Question 6

Assume that PE is the euro price of a product,PUS is the U.S.price of the identical product,and S0 is the spot exchange rate,quoted as the amount of foreign currency per dollar.Given this,which one of the following correctly expresses absolute purchasing power parity?

Accepted Answer

The answer of Assume that PE is the euro price...

Question 7

Interest rate parity defines the relationships among which of the following?

Accepted Answer

Interest rate parity describes the equilibrium relationship between forward rates, spot rates, and interest rates. It suggests that the difference in interest rates between two countries should be reflected in the exchange rate between their currencies, which can be observed using forward exchange rates. Therefore, interest rate parity defines the relationships between forward exchange rates, relative interest rates, and spot exchange rates.

Question 8

Which of these must be significantly eliminated if interest rate parity is to exist?

Accepted Answer

Covered interest arbitrage opportunities must be significantly eliminated if interest rate parity is to exist. Interest rate parity is a condition in which the returns on comparable domestic and foreign assets are equalized by the exchange rate. Covered interest arbitrage occurs when investors borrow in a low-interest rate country to invest in higher-yielding assets in a high-interest rate country while covering their exchange rate risk through a forward contract. The existence of covered interest arbitrage opportunities would prevent interest rate parity from holding because investors could earn more than the equalized return by exploiting the interest rate differential without taking on any exchange rate risk.

Question 9

Which of the following parties are participants in the foreign exchange market?
I.U.S.importers
II.U.S.exporters
III.U.S.travelers to Europe
IV.Foreign portfolio managers who purchase American securities

Accepted Answer

All four parties listed (U.S. importers, U.S. exporters, U.S. travelers to Europe, and foreign portfolio managers who purchase American securities) are participants in the foreign exchange market.

Question 10

Which one of the following formulas illustrates the mechanics of covered interest arbitrage? Assume the $1 is borrowed and S0 = spot rate; F1 = one-year forward rate; RF = foreign country risk-free rate; and RUS = U.S.risk-free rate.

Accepted Answer

Covered interest arbitrage involves borrowing in one currency, converting that currency to another currency, investing the proceeds in that currency for one year, then converting it back to the original currency using the one-year forward exchange rate. The goal is to generate a risk-free profit based on the interest rate differential between the two currencies. In this formula, the $1 is multiplied by the spot exchange rate (S₀), then multiplied by (1 + RF) / (1 + RUS) to get the amount of foreign currency obtained. This foreign currency is then invested for one year, earning interest at the foreign risk-free rate, RF. At the end of the year, the investment is worth (1 + RF) times its original value. This amount is then divided by the one-year forward exchange rate (F₁) to give the amount of U.S. dollars received. Finally, the U.S. dollars are used to repay the original loan, with interest at the U.S. risk-free rate, RUS. Therefore, the formula is $1 × S₀ × (1 + RF)/(1 + RUS) / F₁ - $1 × (1 + RUS).

Question 11

Later this week,you are traveling from the U.S.to Canada for a week's vacation.This morning,you exchanged some U.S.dollars for Canadian dollars in preparation for that trip.Which one of the following best describes this exchange?

Accepted Answer

This exchange is a spot trade, which is the exchange of one currency for another at the current market rate with delivery of the funds within two business days.

Question 12

Assume a canned soft drink costs $1 in the U.S.and $1.30 in Canada.At the same time,the currency per U.S.dollar is C$1.30.Which one of the following conditions exists in this situation?

Accepted Answer

The answer of Assume a canned soft drink costs $1...

Question 13

Which one of the following is an example of long-run exposure to exchange rate risk? Ignore all fees and transaction costs.

Accepted Answer

Building a factory in a foreign location to take advantage of labor costs is a long-term investment, and any changes in exchange rates that affect the relative cost of labor between the two countries will have a long-term impact on the profitability of the investment. The other options are short-term exposures to exchange rate risk.

Question 14

Short-run exposure to exchange rate risk is best illustrated by which one of the following?

Accepted Answer

Short-run exposure to exchange rate risk is typically associated with the day-to-day fluctuations in the spot rate, which can result in gains or losses when transactions are settled in a foreign currency. Options A, C, D, and E are not necessarily related to short-run exposure to exchange rate risk.

Question 15

Suppose a U.S.firm builds a factory in China,staffs it with Chinese workers,uses materials supplied by Chinese companies,and finances the entire operation with a loan from a Chinese bank located in the same town as the factory.This firm is most likely trying to greatly reduce,or eliminate,which one of the following?

Accepted Answer

By building a factory in China and financing the operations with a loan from a Chinese bank, the U.S. firm is eliminating long-run exposure to exchange rate risk. This is because the firm will be operating in the same local economy where the bank and suppliers are located, and will therefore be earning and spending in the same currency without having to worry about exchange rate fluctuations. It is important to note that the firm may still face other types of risk, such as political risk or operational risk, but this decision was made with the specific goal of mitigating exchange rate risk.

Question 16

Relative purchasing power parity is based on the principle that the expected percentage change in the exchange rate between two countries is equal to which one of the following?

Accepted Answer

Relative purchasing power parity states that the expected percentage change in the exchange rate between two countries is equal to the difference in inflation rates between the two countries. This means that if one country has a higher inflation rate than another, its currency will weaken relative to the other country's currency. Therefore, the best choice is D, which states the difference in inflation rates between two countries.

Question 17

You have just agreed to a forward trade that will be settled six months from now.When is the exchange rate for this transaction determined?

Accepted Answer

The answer of You have just agreed to a forward...

Question 18

The U.S.dollar equivalent is .3897 for the Brazilian real and 1.5649 for the UK pound.Which one of the following statements is correct given this information?

Accepted Answer

The answer of The U.S.dollar equivalent is .3897 for the...

Question 19

Which one of the following best describes an agreement you make today to exchange U.S.dollars for British pounds three months from now?

Accepted Answer

A forward trade refers to an agreement made today to exchange currencies at a predetermined rate on a future date. In this case, the agreement is to exchange U.S. dollars for British pounds three months from now, making it a forward trade.

Question 20

Assume the exchange rates for the Canadian dollar versus the U.S.dollar are $$\begin{array} { | l | r | r | } 
\hline & \text { USD equiv } & \text { Currency per USD } \
\hline \text { Last week } & .8759 & 1.1417 \
\hline \text { This week } & .8761 & 1.1414 \
\hline
\end{array}$$ Which statement is correct given this information?

Accepted Answer

The answer of Assume the exchange rates for the Canadian...

Quiz 18: International Aspects of Financial Management

Assume you can exchange $1 for either £1 or ? .50 in the U.S.In the London market,you can exchange £1 for ? ) 52.This situation creates an opportunity to profit immediately From which one of the following?