Question 1

Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current nominal one-year interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate forward exchange rate for 360 days?

Accepted Answer

The formula for calculating the approximate forward exchange rate is:

Forward Rate = Spot Rate × (1 + Home Interest Rate) ÷ (1 + Foreign Interest Rate)

In this case, the forward rate would be:

Forward Rate = £0.6993/$ × (1 + 0.05) ÷ (1 + 0.06) = £0.7060/$

Therefore, the answer is D: £0.7060/$.

Question 2

A ________ is an exchange rate quoted today for settlement at some time in the future.

Accepted Answer

A forward rate is an exchange rate quoted today for settlement at some time in the future. A spot rate, on the other hand, is an exchange rate quoted for immediate settlement. Currency rate is too general of a term and yield curve is not related to exchange rates.

Question 3

The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as ________.

Accepted Answer

The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as the international Fisher Effect. This theory suggests that changes in exchange rates will be equal to the difference between the nominal interest rates in two countries. In other words, the international Fisher Effect links interest rates and exchange rates.

Question 4

Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate?

Accepted Answer

If the UK pound appreciates against the USD to an exchange rate of $2.15/£, then the price of the S-type sedan in USD will decrease to $55,000/2.15 = $25,581.39.

To convert this to pounds, we need to multiply the result by the new exchange rate:

£25,581.39 x 2.15/1 = £55,000.

Therefore, at the new exchange rate, Jaguar will receive £25,581, which is the best answer choice.

Question 5

Assume a nominal interest rate on one-year U.S. Treasury Bills of 4.60% and a real rate of interest of 2.50%. Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the U.S. over the next year?

Accepted Answer

The answer of Assume a nominal interest rate on one-year...

Question 6

Empirical studies show that the Fisher Effect works best for short-term securities.

Accepted Answer

Empirical studies have found that the Fisher Effect holds true for short-term securities, while long-term securities may not fully reflect changes in inflation.

Question 7

Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year?

Accepted Answer

The answer of Assume a nominal interest rate on one-year...

Question 8

Consider the price elasticity of demand. If a product has price elasticity less than one it is considered to have relatively elastic demand.

Accepted Answer

If a product has price elasticity less than one it is considered to have relatively inelastic demand.

Question 9

According to the international Fisher Effect, if an investor purchases a five-year U.S. bond that has an annual interest rate of 5% rather than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at least 1% per year over the next 5 years.

Accepted Answer

The international Fisher Effect suggests that the currency of the country with the lower interest rate (in this case, the U.S. dollar) is expected to appreciate relative to the currency of the country with the higher interest rate (the British pound) to offset the interest rate differential.

Question 10

________ states that the spot exchange rate should change in an equal amount but in the opposite direction to the difference in interest rates between two countries.

Accepted Answer

The statement refers to the Fisher-open hypothesis, which states that the expected spot exchange rate should adjust in proportion to the difference in interest rates between two countries.

Question 11

Phillips NV produces DVD players and exports them to the United States. Last year the exchange rate was $1.25/euro and Plillips charged 120 euro per player in Euroland and $150 per DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD players?

Accepted Answer

Degree of pass through = (Change in price in local currency / Change in exchange rate) * 100
Initially, Phillips NV charged 120 euro per player, which at the exchange rate of $1.25/euro, translates to $150 per player in the US market. 
Currently, Phillips NV is charging $160 per player, which at the spot exchange rate of $1.45/euro, translates to 110.34 euro per player in the Euroland market.
Therefore, change in price in the Euroland market = (110.34 - 120)/120 * 100 = -7.05%
Change in exchange rate = (1.45 - 1.25)/1.25 * 100 = 16%
Degree of pass through = (-7.05/16) * 100 = -41.7%
Since the degree of pass through is negative, it means that Phillips NV is absorbing some of the cost of the exchange rate change and not passing on the full impact to the customers. The closest choice is C, which is the correct answer.

Question 12

The government just released international exchange rate statistics and reported that the real effective exchange rate index for the U.S. dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year. Other things equal U.S. ________ to/from Japan think this is good news and U.S. ________ to/from Japan think this is bad news.

Accepted Answer

A decrease in the exchange rate index means that the U.S. dollar is becoming weaker against the Japanese yen. This is good news for U.S. exporters to Japan as it makes their goods cheaper and more competitive in the Japanese market. On the other hand, it is bad news for U.S. importers from Japan as they will have to pay more in dollars to purchase the same amount of goods from Japan. Therefore, the correct choice is exporters; importers.

Question 13

The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of return and π = the expected rate of inflation, is often dropped from the equation because the number is simply too large for most Western economies.

Accepted Answer

The final component of the equation (r)(π) is not often dropped from the Fisher Effect equation, as it is a crucial part of the calculation. The Fisher Effect states that the nominal interest rate is equal to the real interest rate plus the expected rate of inflation, which is calculated as (r + π).

Question 14

In its approximate form the Fisher effect may be written as ________. Where: i = the nominal rate of interest, r = the real rate of return and π = the expected rate of inflation.

Accepted Answer

The Fisher effect states that the nominal interest rate (i) is equal to the real interest rate (r) plus the expected rate of inflation (π). Therefore, the correct equation is i = r + π. Option A is incorrect as it only includes the expected inflation rate, but does not add it to the real rate of return. Option B includes an extra term of (r)(π) which is incorrect. Option D adds twice the expected rate of inflation, which is also incorrect.

Question 15

Exchange rate pass-through may be defined as

Accepted Answer

Exchange rate pass-through refers to the degree to which changes in exchange rates affect the prices of imported and exported goods. It is important for understanding how exchange rate fluctuations impact a country's economy, particularly in terms of inflation and competitiveness. The other options do not accurately define exchange rate pass-through.

Question 16

From the viewpoint of a U.S. investor or trader, the indirect quote for a currency exchange rate would be quoted in ________.

Accepted Answer

From the viewpoint of a U.S. investor or trader, the indirect quote for a currency exchange rate would be quoted in terms of foreign currency units per dollar (e.g., £/$). This means that the investor or trader would need to know how many units of the foreign currency are needed to purchase one U.S. dollar.

Question 17

________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.

Accepted Answer

The statement is known as the Fisher Effect, which states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation. Absolute PPP and Relative PPP are related to exchange rates, and The Law of One Price is related to goods prices.

Question 18

Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the percentage margin the company will realize given the new exchange rate?

Accepted Answer

The answer of Jaguar has full manufacturing costs of their...

Question 19

Assume the current U.S. dollar-yen spot rate is 125¥/$. Further, the current nominal 180-day rate of return in Japan is 3% and 4% in the United States. What is the approximate forward exchange rate for 180 days?

Accepted Answer

To calculate the approximate forward exchange rate, we can use the formula:
Forward rate = Spot rate x (1 + interest rate in domestic country / 1 + interest rate in foreign country)^(number of days/360)

Plugging in the given numbers, we get:
Forward rate = 125¥/$ x (1 + 0.04 / 1 + 0.03)^(180/360)
Forward rate = 124.39¥/$

Therefore, the correct choice is C.

Question 20

The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales revenues of Sony DVDs would ________.

Accepted Answer

Since the price elasticity of demand is greater than one, a 10% increase in price would lead to a decrease in total quantity demanded by more than 10%. Therefore, if the price of the Sony DVD players in the US rises by 10%, and the Japanese yen also appreciates by 10%, then the total dollar sales revenues of Sony DVDs would decline.

Quiz 6: International Parity Conditions