Scenario: Sam Dearing, Budding International Financier
Sam Dearing is a summer intern in the arbitrage department at a prestigious Wall Street firm. Sam is hoping to be offered a full-time position at the firm after he graduates from college, and therefore, Sam knows that he must demonstrate a strong understanding of how exchange rates work.
-Sam has been studying the price of wheat across markets.If a kilogram of wheat costs €1.5 in France and $1 in the United States,the law of one price would tell us ________.
A) the expected exchange rate between the euro and the dollar is €1.5/$
B) wheat is overpriced in France
C) wheat is underpriced in France
D) an arbitrage opportunity does not exist in the international wheat market

Question

Quizplus · Accepted Answer

The law of one price suggests that in the absence of transportation costs and barriers to trade, identical goods should have the same price when expressed in the same currency. The statement that a kilogram of wheat costs €1.5 in France and $1 in the United States implies that the expected exchange rate to equalize the prices would be €1.5 per $1, according to the law of one price.