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.
-Suppose Sam then noticed that the actual euro/dollar exchange rate on currency markets is €1.2/$,and that a kilogram of wheat still costs $1 in the U.S.and €1.5 in France.Sam then knows that ________.

Question

Quizplus · Accepted Answer

If a kilogram of wheat costs $1 in the U.S. and €1.5 in France, and the exchange rate is €1.2/$, then the price of wheat in France is higher. This is because if we convert the price of wheat in France from euros to dollars, it would be $1.8, which is higher than the price in the U.S. Therefore, Sam knows that wheat is priced higher in France. Option A is incorrect because the expected exchange rate cannot be determined from the given information. Option C is incorrect because we already established that wheat is priced higher in France. Option D is incorrect because an arbitrage opportunity does exist in the international wheat market. A trader could buy wheat in the U.S. for $1, sell it in France for €1.5, and then convert the euros back to dollars at the favorable exchange rate of €1.2/$, resulting in a profit.