Question 1

Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage.

Accepted Answer

This statement is true. Realignment in exchange rates can cause market forces to adjust the ask and bid rates of banks involved in locational arbitrage, resulting in the elimination of opportunities for profit through this practice.

Question 2

Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume the bid rate of an Australian dollar is $.62 while the ask rate is $.625 at Bank V. 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

The answer of Assume the bid rate of an Australian...

Question 3

The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

Accepted Answer

According to interest rate parity, the difference in interest rates between two countries should be equal to the difference in their exchange rates. In this case, the higher interest rate in the UK would lead to a stronger pound relative to the dollar. Therefore, US investors would earn a lower return domestically compared to British investors earning domestically due to the exchange rate advantage enjoyed by the latter.

Question 4

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Accepted Answer

The answer of If the cross exchange rate of two...

Question 5

Interest rate parity suggests that an exchange rate should change over time based on the difference in interest rates between foreign versus domestic risk-free interest-bearing securities as of today.

Accepted Answer

The answer of Interest rate parity suggests that an exchange...

Question 6

When using ____, funds are not tied up for any length of time.

Accepted Answer

Locational and triangular arbitrage do not require funds to be tied up for an extended period. These strategies involve taking advantage of price differences in different markets or between different currencies in a short time frame, allowing for quick transactions without long-term commitments.

Question 7

Which of the following is an example of triangular arbitrage initiation?​

Accepted Answer

Triangular arbitrage involves exploiting discrepancies between three currencies. In option C, the exchange rates allow for a profit by converting currencies in a loop: USD to SGD to SAR and back to USD.

Question 8

Assume the following information: U.S. investors have $1,000,000 to invest:
1-year deposit rate offered by U.S. banks
=
10%
1-year deposit rate offered on British pounds
=
13)5%
1-year forward rate of British pound
=
$1)26
Spot rate of British pound
=
$1)30
​
Given this information:

Accepted Answer

The answer of Assume the following information: U.S. investors have...

Question 9

Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.

Accepted Answer

Technology has enabled banks to use automated systems for foreign exchange transactions, which leads to more transparency and consistency in pricing across different locations. This reduces the likelihood of significant discrepancies in foreign exchange quotations among banks.

Question 10

Forward rates are driven by the government rather than market forces.

Accepted Answer

Forward rates are determined by the supply and demand in the market and not by the government. However, the government can influence market forces through their policy decisions and interventions.

Question 11

Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, which of the following adjustments must take place?

Accepted Answer

When arbitrageurs take advantage of a locational arbitrage opportunity, they buy the currency at a lower price in one bank and sell it at a higher price in the other bank. As a result, the demand for the currency increases in the lower-priced bank, causing their ask price to rise. Conversely, the supply of the currency increases in the higher-priced bank, causing their bid price to fall. This results in one bank's ask price rising and the other bank's bid price falling.

Moreover, as arbitrageurs buy and sell the currency between the banks, the bid/ask spread in the lower-priced bank will become narrower due to increased demand, while the bid/ask spread in the higher-priced bank will widen as arbitrageurs try to sell their currency. Therefore, one bank's bid/ask spread will widen, and the other bank's bid/ask spread will fall.

Question 12

Assume the following information: Current spot rate of New Zealand dollar
=
$)41
Forecasted spot rate of New Zealand dollar 1 year from now
=
$)43
One-year forward rate of the New Zealand dollar
=
$)42
Annual interest rate on New Zealand dollars
=
8%
Annual interest rate on U.S. dollars
=
9%
​
Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____ percent.

Accepted Answer

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

Question 13

The word "covered" in "covered interest arbitrage" refers to the investors hedging their position to protect against the possibility of default risk.

Accepted Answer

In "covered interest arbitrage," the term "covered" refers to the use of forward contracts to hedge against exchange rate risk, not default risk.

Question 14

For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective.

Accepted Answer

Covered interest arbitrage is possible for a foreign investor when the foreign interest rate, adjusted for the forward exchange rate, offers a higher return than the domestic rate, which occurs when points lie to the left of the IRP line.

Question 15

Assume the following information: You have $400,000 to invest:
Current spot rate of Sudanese dinar (SDD)
=
$)00570
90-day forward rate of the Sudanese dinar
=
$)00569
90-day interest rate in the United States
=
4)0%
90-day interest rate in Sudan
=
4)2%
​
If you conduct covered interest arbitrage, what amount will you have after 90 days?

Accepted Answer

The answer of Assume the following information: You have $400,000...

Question 16

​Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate of the Swiss franc is $.560 while the ask rate is $.566 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

The correct answer is A.The gain from locational arbitrage is the difference between the ask rate at Bank X and the bid rate at Bank Y, multiplied by the amount of currency exchanged. In this case, the gain is ($0.579 - $0.560) * $1,000,000 = $7,067.

Question 17

The yield curve of every country has its own unique shape.

Accepted Answer

Every country's economy and monetary policies vary, which can lead to differences in the shape of their yield curve. Factors such as inflation rates, interest rates, and market expectations can all influence the shape of the yield curve in a particular country.

Question 18

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

Accepted Answer

According to the interest rate parity theory, if the interest rate in the Eurozone is higher than in the United States, the euro is expected to depreciate against the dollar in the forward market, not trade at a premium. This is because investors will seek the higher interest rates in the Eurozone, leading to an initial appreciation of the euro, but expect it to depreciate in the future due to the interest rate differential.

Question 19

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

Accepted Answer

This is the basic process of covered interest arbitrage, where the investor takes advantage of higher interest rates in a foreign country by investing in that country's currency and simultaneously hedging against exchange rate fluctuations by selling the foreign currency forward.

Question 20

The interest rate on yen is 7 percent. The interest rate in the United States is 9 percent. The yen's forward rate should exhibit a premium of about 2 percent.

Accepted Answer

According to the interest rate parity theory, the forward rate of a currency should reflect the interest rate differential between two countries. In this case, since the US interest rates are higher than those in Japan, the forward rate for yen should exhibit a premium (higher than spot rate) of approximately 2 percent to compensate for the lower interest rate. Therefore, the statement is true.

Quiz 7: International Arbitrage and Interest Rate Parity

The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Interest rate parity suggests that an exchange rate should change over time based on the difference in interest rates between foreign versus domestic risk-free interest-bearing securities as of today.

When using ____, funds are not tied up for any length of time.

Which of the following is an example of triangular arbitrage initiation?

Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 10% 1-year deposit rate offered on British pounds = 13) 5% 1-year forward rate of British pound = $1) 26 Spot rate of British pound = $1) 30 Given this information:

Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.

Forward rates are driven by the government rather than market forces.

Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, which of the following adjustments must take place?

The word "covered" in "covered interest arbitrage" refers to the investors hedging their position to protect against the possibility of default risk.

For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective.

The yield curve of every country has its own unique shape.

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

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

The interest rate on yen is 7 percent. The interest rate in the United States is 9 percent. The yen's forward rate should exhibit a premium of about 2 percent.

Quiz 7: International Arbitrage and Interest Rate Parity

The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Interest rate parity suggests that an exchange rate should change over time based on the difference in interest rates between foreign versus domestic risk-free interest-bearing securities as of today.

When using ____, funds are not tied up for any length of time.

Which of the following is an example of triangular arbitrage initiation?​

Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 10% 1-year deposit rate offered on British pounds = 13) 5% 1-year forward rate of British pound = $1) 26 Spot rate of British pound = $1) 30 ​ Given this information:

Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.

Forward rates are driven by the government rather than market forces.

Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, which of the following adjustments must take place?

The word "covered" in "covered interest arbitrage" refers to the investors hedging their position to protect against the possibility of default risk.

For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective.

The yield curve of every country has its own unique shape.

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

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

The interest rate on yen is 7 percent. The interest rate in the United States is 9 percent. The yen's forward rate should exhibit a premium of about 2 percent.

Which of the following is an example of triangular arbitrage initiation?

Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 10% 1-year deposit rate offered on British pounds = 13) 5% 1-year forward rate of British pound = $1) 26 Spot rate of British pound = $1) 30 Given this information: