Question 1

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 tied up for a significant period. Locational and triangular arbitrage, on the other hand, are more focused on exploiting price differences in different markets or currencies and are usually executed quickly.

Question 2

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

Accepted Answer

Locational and triangular arbitrage involve taking advantage of price differences in different markets or currencies without the funds being tied up for a significant period. Covered interest arbitrage, on the other hand, involves investing in foreign interest-bearing assets, which ties up funds for the duration of the investment.

Question 3

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

Accepted Answer

Triangular arbitrage involves taking advantage of discrepancies between three currencies in the foreign exchange market, not directly influencing the relationship between interest rates of two countries and their forward exchange rate premium or discount.

Question 4

Assume that British interest rates are higher than US 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

The answer of Assume that British interest rates are higher...

Question 5

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Accepted Answer

The answer of For locational arbitrage to be possible, one...

Question 6

Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.

Accepted Answer

Interest rate parity is a theory that explains the relationship between interest rates and currency exchange rates, ensuring that arbitrage opportunities due to interest rate differentials are minimized or eliminated. Capitalizing on discrepancies in quoted prices with no risk and no investment is referred to as arbitrage, not interest rate parity.

Question 7

According to interest rate parity (IRP):

Accepted Answer

According to interest rate parity (IRP), the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies. This means that the difference between the forward rate and the spot rate reflects the interest rate differential between two currencies. IRP assumes that there are no restrictions on capital flows between countries and that investors have access to the same investment opportunities in all countries.

Question 8

Assume the bid rate of a New Zealand dollar is £0.183 while the ask rate is £0.185 at Bank X. Assume the bid rate of the New Zealand dollar is £0.179 while the ask rate is £0.182 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 answer of Assume the bid rate of a New...

Question 9

Assume the bid rate of an Australian dollar is £0.40 while the ask rate is £0.42 at Bank Q. Assume the bid rate of an Australian dollar is £0.415 while the ask rate is £0.419 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 10

Assume the bid rate of a Singapore dollar is £0.20 while the ask rate is £0.21 at Bank X. Assume the bid rate of a Singapore dollar is £0.22 while the ask rate is £0.23 at Bank Z. 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 a Singapore...

Question 11

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. When locational arbitrage occurs and banks buy and sell currencies in different locations, it creates an imbalance in the exchange rates. Market forces will eventually cause the ask rate of the bank that sold the currency to increase and the bid rate of the bank that bought the currency to decrease, eventually eliminating the opportunity for locational arbitrage.

Question 12

Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the UK interest rate, the:

Accepted Answer

Interest rate parity suggests that if the foreign interest rate is higher than the UK interest rate, the foreign currency will trade at a forward discount to offset the interest rate differential.

Question 13

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

Accepted Answer

Locational arbitrage refers to the process of profiting from buying and selling a currency at different locations in order to take advantage of price differentials. This process helps to balance the market and realign the spot rate of a currency among banks. Therefore, locational arbitrage is the best choice for this question.

Question 14

If the interest rate is lower in the US than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate:

Accepted Answer

If the interest rate is lower in the US than in the UK, and if the forward rate of the British pound is the same as its spot rate, then the US dollar is considered to be "cheaper" than the pound. US investors can borrow US dollars at a lower interest rate and invest in the UK at a higher interest rate, earning a profit. This is a form of covered interest arbitrage. British investors, on the other hand, would not benefit as they would have to borrow pounds at a higher rate and invest in the US at a lower rate, resulting in a loss.

Question 15

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 16

Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.

Accepted Answer

Locational arbitrage involves taking advantage of discrepancies in exchange rates between different locations. If this is possible, market forces will eventually lead to a realignment of exchange rates, such that the ask rate of the bank with the lower rate will increase and the bid rate of the bank with the higher rate will decrease. This is the process of realignment that eliminates the possibility of arbitrage profits.

Question 17

If the cross exchange rate of two noneuro currencies implied by their individual spot rates with respect to the euro 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 18

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

Accepted Answer

According to interest rate parity, if the home country's interest rate is higher than the foreign country's (UK in this case), the forward rate of the home currency (Currency X) should exhibit a discount to offset the interest rate differential.

Question 19

In which case will locational arbitrage most likely be feasible?

Accepted Answer

Locational arbitrage is the process of taking advantage of price differences in different locations. In this case, if one bank's bid price for a currency is greater than another bank's ask price for the same currency, an investor can buy the currency from the bank with the lower ask price and sell it to the bank with the higher bid price, earning a profit from the price difference. This is known as locational arbitrage and is feasible in this scenario.

Question 20

Based on interest rate parity, the larger the degree by which the UK interest rate exceeds the foreign interest rate, the:

Accepted Answer

The answer of Based on interest rate parity, the larger...

Quiz 7: International Arbitrage and Interest Rate Parity