Question 1

National Bank quotes the following for the British pound and the New Zealand dollar: ​
Quoted Bid Price
Quoted Ask Price
Value of a British pound (£) in $
$1)61
$1)62
Value of a New Zealand dollar (NZ$) in $
$)55
$)56
Value of a British pound in
​
​
New Zealand dollars
NZ$2.95
NZ$2.96
Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy?

Accepted Answer

The answer of National Bank quotes the following for the...

Question 2

Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____.​

Accepted Answer

Triangular arbitrage will correct the mispricing among currencies. Initially, $1 buys NZ$3, but through NZ$1 = MXP2 and $1 = MXP5, $1 should buy NZ$2.5 (since NZ$1 = MXP2 and MXP5 = $1, so NZ$1 = $0.4, or $1 = NZ$2.5). This means the NZ dollar will appreciate (as it takes fewer NZ dollars to equal $1), and the Mexican peso will depreciate (as it will take more pesos to equal $1, correcting the initial discrepancy).

Question 3

​Assume that interest rate parity holds, and the euro's interest rate is 9 percent while the U.S. interest rate is 12 percent. Then the euro's interest rate increases to 11 percent while the U.S. 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

According to interest rate parity, the forward rate must adjust to reflect the difference in interest rates between two countries. As the euro's interest rates increase relative to the U.S. interest rates, demand for euros will increase which will drive up the value of the euro. This will result in a premium on the euro's forward rate, as investors will be willing to pay more for the forward contract in order to lock in the higher interest rate on euros. Therefore, the euro's forward premium will increase to maintain interest rate parity.

Question 4

Assume the following information: Spot rate today of Swiss franc
=
$)60
1-year forward rate as of today for Swiss franc
=
$)63
Expected spot rate 1 year from now
=
$)64
Rate on 1-year deposits denominated in Swiss francs
=
7%
Rate on 1-year deposits denominated in U.S. dollars
=
9%
​
From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of ____ percent.

Accepted Answer

Covered interest arbitrage involves converting USD to CHF at the spot rate, investing in CHF, and converting back to USD at the forward rate. The return is calculated as:  1. Convert $1,000,000 to CHF at $0.60/CHF = 1,666,667 CHF.  2. Invest at 7% for 1 year = 1,666,667 * 1.07 = 1,783,334 CHF.  3. Convert back to USD at $0.63/CHF = 1,783,334 * 0.63 = $1,123,500.  4. Rate of return = ($1,123,500 - $1,000,000) / $1,000,000 = 12.35%.

Question 5

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 is the process of taking advantage of the interest rate differential of two currencies by borrowing in a low-interest-rate currency and investing in a high-interest-rate currency. This should result in a forward premium on the high-interest-rate currency relative to the low-interest-rate currency to compensate for the interest rate differential. If the forward premium is lower than expected, market forces should work to realign it with the interest rate differential through increased demand for the high-interest-rate currency, which should drive up its value and increase the forward premium. Conversely, if the forward premium is higher than expected, market forces should drive down its value and decrease the forward premium to make it more in line with the interest rate differential.

Question 6

Due to ____, market forces should realign the spot rate of a currency among banks.​

Accepted Answer

Locational arbitrage refers to the process of exploiting differences in exchange rates between different locations within the same market to make a profit. By engaging in locational arbitrage, market forces should realign the spot rate of a currency among banks. Choice A, B, and C refer to other types of arbitrage that do not necessarily involve market forces realigning spot rates.

Question 7

Which of the following is not mentioned in the text as a form of international arbitrage?

Accepted Answer

The text mentions locational, triangular, and covered interest arbitrage as forms of international arbitrage, but does not mention transactional arbitrage.

Question 8

Assume the following information: ​
You have $1,000,000 to invest:
Current spot rate of pound
=
$1)30
90-day forward rate of pound
=
$1)28
3-month deposit rate in United States
=
3%
3-month deposit rate in Great Britain
=
4%
​
If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days?

Accepted Answer

The answer of Assume the following information: ​
You have $1,000,000...

Question 9

Assume the following information: U.S. investors have $1,000,000 to invest:
1-year deposit rate offered by U.S. banks
=
12%
1-year deposit rate offered on Swiss francs
=
10%
1-year forward rate of Swiss francs
=
$)62
Spot rate of Swiss franc
=
$)60
​
Given this information:

Accepted Answer

Interest rate parity doesn't exist because the forward rate does not offset the interest rate differential. U.S. investors can earn a higher yield by converting dollars to Swiss francs, investing at the Swiss rate, and using the forward rate to convert back to dollars.

Question 10

Assume the following information for a bank quoting on spot exchange rates: ​
Exchange rate of Singapore dollar in U.S.$
=
$)60
Exchange rate of pound in U.S.$
=
$1)50
Exchange rate of pound in Singapore dollars
=
S$2)6
​
Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot exchange rates?

Accepted Answer

According to the given exchange rates, if we use triangular arbitrage:
1) Convert 1 U.S. dollar to Singapore dollars: 1 USD x 1/0.60 SGD/USD = 1.67 SGD
2) Convert the obtained Singapore dollars to pounds: 1.67 SGD x 1/2.6 SGD/GBP = 0.64 GBP
3) Convert the obtained pounds back to U.S. dollars: 0.64 GBP x 1.50 USD/GBP = 0.96 USD
Therefore, by using triangular arbitrage, we obtained 0.96 U.S. dollars by investing 1 U.S. dollar. As this value is more than the initial value of 1 U.S. dollar, arbitrage opportunities will exist, leading to an increase in demand for pounds and a decrease in demand for Singapore dollars, which will eventually result in the Singapore dollar value in U.S. dollars depreciating, the pound value in U.S. dollars appreciating, and the pound value in Singapore dollars depreciating. Thus, option B is the best choice.

Question 11

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:​

Accepted Answer

According to interest rate parity, if the US interest rate is higher than the foreign interest rate, then the foreign currency is expected to trade at a forward premium to compensate for the differential. The higher the differential, the larger the expected forward premium. Therefore, the correct answer is B.

Question 12

​Assume the following information: You have $900,000 to invest:
Current spot rate of Australian dollar (A$)
=
$)62
180-day forward rate of the Australian dollar
=
$)64
180-day interest rate in the United States
=
3)5%
180-day interest rate in Australia
=
3)0%
​
If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days?

Accepted Answer

To conduct covered interest arbitrage, we will convert our $900,000 into A$ and invest it in Australia for 180 days. After 180 days, we will convert our investment back into dollars at the forward rate of $)64.

Investment in Australia = $900,000 / $)62 = A$14,516,129.03
Interest earned in Australia = A$14,516,129.03 * 3% * (180/360) = A$217,741.94
Conversion of investment back into dollars = A$14,516,129.03 * $)64 = $928,571.43
Interest earned in the US = $928,571.43 * 3.5% * (180/360) = $16,317.46
Profit = $16,317.46 - ($900,000 * 3%) = $56,903. Therefore, the answer is A.

Question 13

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts ____ pressure on the pound's spot rate and ____ pressure on the pound's forward rate.​

Accepted Answer

Covered interest arbitrage involves borrowing in the currency with lower interest rates (USD) and investing in the currency with higher interest rates (GBP). This increases demand for the pound in the spot market (upward pressure) and increases supply in the forward market (downward pressure).

Question 14

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 $.023, while quotes for the Australian dollar are $.576. How many Australian dollars should you expect to receive for your baht?

Accepted Answer

To find the amount in Australian dollars, first convert Thai baht to US dollars: 1,000 baht * $0.023 = $23. Then, convert US dollars to Australian dollars: $23 / $0.576 = A$39.93.

Question 15

When using ____, funds are typically tied up for a significant period of time.

Accepted Answer

Covered interest arbitrage involves investing in foreign currency fixed-income securities, which typically requires locking in funds for the duration of the investment period, making them less liquid and tying up funds for a significant period.

Question 16

According to interest rate parity (IRP):​

Accepted Answer

According to interest rate parity, the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies. This means that if the interest rate differential between two currencies is higher, the forward rate will be higher than the spot rate, and vice versa.

Question 17

If interest rate parity exists, then ____ is not feasible.​

Accepted Answer

Interest rate parity ensures that covered interest arbitrage is not feasible because it implies that the forward exchange rate adjusts to offset any interest rate differentials between two currencies, eliminating the opportunity for arbitrage profits.

Question 18

Assume that the interest rate in the home country of Currency X is much higher than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X:

Accepted Answer

Interest rate parity suggests that the currency of the country with a higher interest rate will trade at a discount in the forward market compared to the spot market. This compensates for the higher interest income that could be earned by holding the higher-yielding currency.

Question 19

Exhibit 7-1
Assume the following information:
​
You have $300,000 to invest:
The spot bid quote for the euro (€) is $1.08
The spot ask quote for the euro is $1.10
The 180-day forward rate (bid) of the euro is $1.08
The 180-day forward rate (ask) of the euro is $1.10
The 180-day interest rate in the United States is 6%
The 180-day interest rate in Europe is 8%
​
-Refer to Exhibit 7-1 above. If you conduct covered interest arbitrage, what is your percentage return after 180 days? Is covered interest arbitrage feasible in this situation?

Accepted Answer

Covered interest arbitrage involves converting dollars to euros at the spot rate, investing in Europe, and converting back at the forward rate. The return in euros is 8%, and converting back to dollars at the same rate gives a return of 6.04%, which is feasible as it is higher than the US rate of 6%.

Question 20

Assume the following information for a bank quoting on spot exchange rates: ​
Exchange rate of Singapore dollar in U.S.$
=
$)32
Exchange rate of pound in U.S.$
=
$1)50
Exchange rate of pound in Singapore dollars
=
S$4)50
​
Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot exchange rates?

Accepted Answer

The answer of Assume the following information for a bank...

Quiz 7: International Arbitrage and Interest Rate Parity

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.

Due to ____, market forces should realign the spot rate of a currency among banks.

Which of the following is not mentioned in the text as a form of international arbitrage?

Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 12% 1-year deposit rate offered on Swiss francs = 10% 1-year forward rate of Swiss francs = $) 62 Spot rate of Swiss franc = $) 60 Given this information:

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts pressure on the pound's spot rate and pressure on the pound's forward rate.

When using ____, funds are typically tied up for a significant period of time.

According to interest rate parity (IRP) :

If interest rate parity exists, then ____ is not feasible.

Assume that the interest rate in the home country of Currency X is much higher than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X:

Quiz 7: International Arbitrage and Interest Rate Parity

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.

Due to ____, market forces should realign the spot rate of a currency among banks.​

Which of the following is not mentioned in the text as a form of international arbitrage?

Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 12% 1-year deposit rate offered on Swiss francs = 10% 1-year forward rate of Swiss francs = $) 62 Spot rate of Swiss franc = $) 60 ​ Given this information:

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:​

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts ____ pressure on the pound's spot rate and ____ pressure on the pound's forward rate.​

When using ____, funds are typically tied up for a significant period of time.

According to interest rate parity (IRP) :​

If interest rate parity exists, then ____ is not feasible.​

Assume that the interest rate in the home country of Currency X is much higher than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X:

Due to ____, market forces should realign the spot rate of a currency among banks.

Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 12% 1-year deposit rate offered on Swiss francs = 10% 1-year forward rate of Swiss francs = $) 62 Spot rate of Swiss franc = $) 60 Given this information:

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts pressure on the pound's spot rate and pressure on the pound's forward rate.

According to interest rate parity (IRP) :

If interest rate parity exists, then ____ is not feasible.