Question 1

You are considering a project in Norway with an initial cost of NKr135,000.The project is expected to return a one-time payment of NKr200,000 at the end of Year 5.Assume the risk-free rate of return is 2.6 percent in the U.S.and 3.1 percent in Norway.Assume the inflation rate is 1.6 percent in the U.S.and 2.3 percent in Norway.Lastly,assume the current exchange rate is $1 = NKr7.9271.Approximately how much will the payment at the end of 5 Years be worth in U.S.dollars?

Accepted Answer

The correct answer is A because the payment at the end of 5 years will be worth $24,609 in U.S. dollars. This is calculated by first converting the payment to U.S. dollars using the current exchange rate, which gives us NKr200,000 / 7.9271 = $25,238.09. We then need to adjust this amount for inflation in the U.S. over the next 5 years, which gives us $25,238.09 * (1 + 0.016)^5 = $24,609.

Question 2

Assume the current spot rate is Can$1.2803 and the one-year forward rate is Can$1.2745.Also assume the nominal risk-free rate in Canada is 4.8 percent while it is 4.2 percent in the U.S.Using covered interest arbitrage,you can earn a profit of ________ for every $1 invested over the next year.

Accepted Answer

Covered interest arbitrage involves borrowing in a currency with a lower interest rate, converting to a currency with a higher interest rate, and investing in a risk-free bond. The profit comes from the difference in interest rates and any change in the exchange rate. 
In this case, to earn a profit, we would borrow in USD at 4.2%, convert to CAD at the spot rate of Can$1.2803, and invest in a CAD risk-free bond earning 4.8%. After one year, we would receive Can$1.2803 x 1.048 = Can$1.3419. We would then convert back to USD at the forward rate of Can$1.2745 and receive $1.0516, for a profit of $0.0108 per USD invested.

Question 3

Angie has been offered Can$1.75 for £1.How much profit can she earn on a triangle arbitrage if the official rate is $1 = Can$1.2834 and the USD equivalent of £1 is $1.3699? Assume she currently has $100 in cash.

Accepted Answer

Angie can buy £1 with $1.3699 and sell it for Can$1.75. The profit is Can$1.75 - Can$1.2834 = Can$0.4666.

Question 4

Assume $1 = ¥106.83 = £.7309.If a TV in London costs £430,what will that identical TV cost in Tokyo if absolute purchasing power parity exists?

Accepted Answer

Absolute purchasing power parity states that the exchange rate between two currencies should equal the ratio of the price levels in the two countries. 
So, we need to find the price of the TV in Tokyo which can be calculated as:

Price in Tokyo = Price in London x (Tokyo price level/London price level)

Price in Tokyo = £430 x (¥/£) x (Tokyo price level/London price level)

Price in Tokyo = £430 x (106.83/1) x (1/0.7309)

Price in Tokyo = £430 x 146.1319

Price in Tokyo = £62,849.77 or ¥6,284,977 (rounded)

Therefore, the best choice is C, ¥62,849.77.

Question 5

Assume a risk-free asset in the U.S.is currently yielding 2.7 percent while a Canadian risk-free asset is yielding 2.8 percent and the current spot rate is Can$1.2849 = $1.What is the approximate 6-month forward rate if interest rate parity holds?

Accepted Answer

To find the 6-month forward rate under the interest rate parity condition, we use the formula: Forward Rate = Spot Rate * (1 + interest rate of domestic country) / (1 + interest rate of foreign country). Here, the domestic country is the U.S. and the foreign country is Canada. The interest rates are annual, so for 6 months, we divide them by 2. Thus, Forward Rate = 1.2849 * (1 + 0.027/2) / (1 + 0.028/2) = 1.2849 * (1.0135) / (1.014) ≈ Can$1.2855.

Question 6

Assume the spot rate for the British pound currently is £.7287 per dollar and the one-year forward rate is £.7304.A risk-free asset in the U.S.is currently earning 3 percent.If interest rate parity holds,approximately what rate can you earn on a one-year risk-free British security?

Accepted Answer

The answer of Assume the spot rate for the British...

Question 7

Assume the current spot rate for the Norwegian krone is $1 = NKr7.9323,the expected inflation rate in Norway is 2.1 percent and 1.2 percent in the U.S.Also assume a risk-free asset in the U.S.is yielding 3.7 percent.What nominal risk-free rate of return should you expect on a Norwegian security?

Accepted Answer

The expected nominal risk-free rate of return on a Norwegian security can be calculated using the International Fisher Effect (IFE), which suggests that the expected difference in the nominal interest rates between two countries is approximately equal to the expected difference in their inflation rates. According to the IFE, the formula is: $$ i_{Norway} = i_{US} + (Inflation_{Norway} - Inflation_{US}) $$Given that $ i_{US} = 3.7\% $, $ Inflation_{Norway} = 2.1\% $, and $ Inflation_{US} = 1.2\% $, we can substitute these values into the formula:$$ i_{Norway} = 3.7\% + (2.1\% - 1.2\%) = 3.7\% + 0.9\% = 4.6\% $$Therefore, the expected nominal risk-free rate of return on a Norwegian security should be 4.6 percent.

Question 8

Assume today you can exchange $100 for either Can$128 or Ps1,892.Also assume that last year,$100 was worth Can$126 or Ps1,847.Which one of the following statements is correct given this information?

Accepted Answer

First, we need to find the change in exchange rates for both currencies:
- Canadian dollar: (128/126) - 1 = 1.59%
- Mexican peso: (1892/1847) - 1 = 2.44%
Next, we need to apply these changes to $100:
- Canadian dollar: $100 * (1 + 1.59%) = $101.59
- Mexican peso: $100 * (1 + 2.44%) = $102.44
Finally, we convert both amounts to Canadian dollars using today's exchange rates:
- $101.59 / 128 = Can$0.794
- $102.44 / 128 = Can$0.801
Therefore, the correct statement is: $100 invested in Canadian dollars last year would now be worth Ps1,862.44. (Choice E)

Question 9

Assume the current spot rate for the Norwegian krone is $1 = NKr7.93,the expected inflation rate in Norway is 2.4 percent while it is 2.6 percent in the U.S.Also assume a risk-free asset in the U.S.is yielding 4.5 percent.What real rate of return should you expect on a risk-free Norwegian security?

Accepted Answer

The answer of Assume the current spot rate for the...

Question 10

You are expecting a payment of Can$138,000 two years from now.Assume the risk-free rate of return is 2.7 percent in Canada and 3.1 percent in the U.S.Also assume the current exchange rate is Can$1.2903 = $1.Approximately how much will the payment two years from now be worth in U.S.dollars?

Accepted Answer

To find the present value of the Can$138,000 in U.S. dollars, first discount it using the Canadian risk-free rate: Can$138,000 / (1 + 0.027)^2 = Can$130,747. Then convert to U.S. dollars using the current exchange rate: Can$130,747 / 1.2903 = $107,813.

Question 11

Assume you can exchange $1 for £.7347 today.Assume that last week,£1 was worth $1.3613.If you had converted £100 into dollars last week and then exchanged your dollars back into pounds today,you would now have a:

Accepted Answer

First, converting £100 into dollars last week at a rate of $1.3613 per £1 would have given you $136.13. Converting $136.13 back into pounds today at a rate of £.7347 per $1 gives you £100.015. This results in a profit of £.015.

Question 12

Assume the expected inflation rate in Finland is 2 percent while it is 4 percent in the U.S.Also assume a risk-free asset in the U.S.is yielding 4.5 percent.What nominal rate of return should you expect on a risk-free Finnish security?

Accepted Answer

Based on the information given, we can calculate the real rate of return for the U.S. risk-free asset as follows:
Real rate of return in the U.S. = Nominal rate of return in the U.S. - Expected inflation rate in the U.S.
Real rate of return in the U.S. = 4.5% - 4% = 0.5%

Since the expected inflation rate in Finland is lower than in the U.S., the nominal rate of return on a risk-free Finnish security should also be lower than the nominal rate of return on a U.S. risk-free asset. We can use the real rate of return in the U.S. and the expected inflation rate in Finland to calculate the nominal rate of return on a risk-free Finnish security:

Nominal rate of return in Finland = Real rate of return in the U.S. + Expected inflation rate in Finland
Nominal rate of return in Finland = 0.5% + 2% = 2.5%

Therefore, the best choice is D) 2.5 percent.

Question 13

Assume the spot market exchange rate for $1 is currently A$1.2902.Also assume the expected inflation rate is 3.3 percent in Australia compared to the U.S.rate of 2.8 percent.What is the expected exchange rate one year from now if relative purchasing power parity exists?

Accepted Answer

The expected exchange rate can be calculated using the formula for relative purchasing power parity (PPP): E(S1) = S0 * (1 + i_foreign) / (1 + i_domestic), where E(S1) is the expected exchange rate in one year, S0 is the current exchange rate, i_foreign is the inflation rate in the foreign country (Australia), and i_domestic is the inflation rate in the domestic country (U.S.). Plugging in the given values: E(S1) = 1.2902 * (1 + 0.033) / (1 + 0.028) = 1.2902 * 1.033 / 1.028 ≈ A$1.2967.

Question 14

Suppose the spot rate on the Canadian dollar is C$1.2797.Also assume the risk-free nominal rate in the U.S.is 3.8 percent while it is only 3.3 percent in Canada.Which one of the following three-year forward rates best establishes the approximate interest rate parity condition?

Accepted Answer

The answer of Suppose the spot rate on the Canadian...

Question 15

Assume the spot rate for the Japanese yen currently is ¥106.83 per dollar while the one-year forward rate is ¥107.20.Also assume a risk-free asset in Japan is currently earning 4.6 percent.If interest rate parity holds,approximately what rate can you earn on a one-year risk-free U.S.security?

Accepted Answer

The interest rate parity (IRP) formula relates the spot exchange rate, the forward exchange rate, the domestic interest rate, and the foreign interest rate. According to IRP, the return on a domestic risk-free asset should equal the return on a foreign risk-free asset, adjusted for the change in exchange rates. The formula for IRP is: (1 + i_d) = (F/S) * (1 + i_f), where i_d is the domestic interest rate, i_f is the foreign interest rate, F is the forward exchange rate, and S is the spot exchange rate. Rearranging to solve for i_d gives: i_d = (F/S) * (1 + i_f) - 1. Plugging in the given values: i_d = (107.20/106.83) * (1 + 0.046) - 1 ≈ 0.0424 or 4.24%.

Question 16

Assume the current spot rate is Can$1.2811 and the one-year forward rate is Can$1.2767.Also assume the nominal risk-free rate in Canada is 3.2 percent while the U.S.rate is 3.5 percent.Using covered interest arbitrage you can earn an extra profit of ________ for every $1 invested over the next year.

Accepted Answer

The answer of Assume the current spot rate is Can$1.2811...

Question 17

Assume the spot rate of $1 is £.7347.Also assume the expected inflation rate in the U.K.is 2.1 percent while the U.S.inflation rate is 3.6 percent.What is the expected exchange rate three years from now if relative purchasing power parity exists?

Accepted Answer

The answer of Assume the spot rate of $1 is...

Question 18

The camera you want to buy costs $399 in the U.S.If absolute purchasing power parity exists,the identical camera will cost ________ in Australia if the exchange rate is A$1 = $.7752.

Accepted Answer

The answer of The camera you want to buy costs...

Question 19

Suppose the spot rate on the Indian rupee is Rs65.2203,the risk-free nominal rate in the U.S.is 4.6 percent,and the Indian risk-free nominal rate is 6.2 percent.Which one of the following one-year forward rates best establishes the approximate interest rate parity condition?

Accepted Answer

According to Interest Rate Parity (IRP), the one-year forward exchange rate should be such that it eliminates any arbitrage opportunities between the spot exchange rate and the risk-free interest rates in the two countries.

The formula for IRP is:

(1 + r₽ ) = (1 + rf)/(1 + Sf/S)

where, 
r₽  = Indian risk-free nominal rate = 6.2%
rf = U.S. risk-free nominal rate = 4.6%
S = spot exchange rate = Rs65.2203
Sf = one-year forward exchange rate
 
Substituting the given values:

(1 + 0.062) = (1 + 0.046)/(1 + Sf/65.2203)

Solving for Sf, we get:

Sf = Rs66.2638

Therefore, the best choice is B.

Question 20

A new sweater costs SF67 in Switzerland.Assume SF1 = $1.0563 and €1 = $1.2195.How much will the identical sweater cost in euros if absolute purchasing power parity exists?

Accepted Answer

First, convert the price of the sweater from Swiss Francs (SF) to US Dollars (USD) using the given exchange rate: SF67 * $1.0563/SF = $70.7721. Then, convert this amount to Euros (€) using the given exchange rate: $70.7721 / $1.2195/€ = €58.03.

Quiz 31: International Corporate Finance