Question 1

Which of the following represents the Fisher effect?

Accepted Answer

The Fisher effect states that the nominal interest rate is equal to the real interest rate plus the expected inflation rate. Therefore, option C correctly represents the Fisher effect. Option A represents the cross rate formula, while option B represents the relationship between real interest rate, nominal interest rate, and spot rate, which is not related to the Fisher effect. Option D represents an incorrect relationship between real interest rate and unemployment rate.

Question 2

The principle that a difference in nominal interest rates supported by two countries' currencies will cause an equal but opposite change in their spot exchange rates is called the ________.

Accepted Answer

The principle described in the question is known as the international Fisher effect, which suggests that the difference in nominal interest rates will result in an equal but opposite change in the spot exchange rates. The other options listed are unrelated to this principle.

Question 3

Color-Me-Green Inc.
Color-Me-Green Inc. ,a U.S.-based clothing merchant,has started doing business internationally.Having subsidiaries in several countries,the company must integrate financial information from all its subsidiaries with the U.S.home office at the end of the year.
-Suppose Country A has a currency called the Pulse (P).At the beginning of the year,the exchange rate between the Pulse and the U.S.dollar was P150/$.The inflation rate in Country A is running at an annual rate of 250 percent,whereas inflation in the U.S.is running at 2 percent.Which of the following would most likely be the new exchange rate that Color-Me-Green can expect at the end of the year?

Accepted Answer

The new exchange rate can be estimated using the concept of purchasing power parity (PPP), which suggests that the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. Given the high inflation rate in Country A compared to the U.S., the Pulse is expected to depreciate. The calculation involves adjusting the initial exchange rate by the inflation differential. The option that closely matches the expected depreciation due to the high inflation differential, without doing the exact math, is P514.70/$, as it reflects a significant depreciation of the Pulse relative to the dollar, which is consistent with the high inflation rate in Country A.

Question 4

Purchasing power parity does not hold for single products,it is meaningful only when applied to a basket of goods.

Accepted Answer

Purchasing power parity compares the cost of a basket of goods and services across different countries. It cannot be applied to single products as their prices may be influenced by various factors like local taxes, transportation costs, etc.

Question 5

The principle that nominal interest rate is the sum of the real interest rate and the expected rate of inflation over a specific period of time is called ________.

Accepted Answer

This principle is known as the Fisher effect, named after economist Irving Fisher. It states that the nominal interest rate equals the real interest rate plus expected inflation over a given period of time.

Question 6

Purchasing power parity is better at predicting ________ exchange rates.

Accepted Answer

Purchasing power parity (PPP) is a long-term oriented concept that suggests exchange rates should adjust to equalize the price of a basket of goods and services across countries. Therefore, it is better at predicting long-term exchange rates rather than short-term or spot rates. Cross exchange rates, which refer to rates between two non-U.S. currencies, are not directly related to PPP.

Question 7

An exchange rate system in which the exchange rate for converting one currency into another is set by international governmental agreement is called a ________ system.

Accepted Answer

A fixed exchange-rate system is one in which the exchange rate for converting one currency into another is set by international governmental agreement. In this system, the exchange rate is fixed and does not fluctuate based on market forces. This system was prevalent before the 1970s but has since been largely replaced by floating exchange-rate systems.

Question 8

Which of the following is a reason for the failure of PPP to predict exchange rates accurately?

Accepted Answer

PPP assumes that there are no barriers to international trade, which is often not the case in reality. Trade barriers such as tariffs, quotas, and regulations can impact exchange rates, and PPP does not take these into account, leading to inaccurate predictions.

Question 9

If the law of one price is applied and upheld,an arbitrage opportunity arises.

Accepted Answer

The law of one price states that identical goods should sell for the same price in different markets when there are no transportation costs and no differential taxes applied in the two markets. If this law is upheld, there would be no arbitrage opportunity, as arbitrage relies on price differences between markets.

Question 10

If money were free from all controls when transferred internationally,the real rate of interest would ________.

Accepted Answer

If money could be freely transferred internationally without any controls, arbitrage opportunities would ensure that the real rate of interest would equalize across countries, as investors would move funds to take advantage of higher real rates until the rates converge.

Question 11

Sam's mentor is excited about the wheat prices in France and the U.S.because he sees an opportunity to buy wheat in the U.S.and sell it in France,which is known as a(n)________.

Accepted Answer

An arbitrage opportunity is a situation where an investor can take advantage of price differences in different markets by buying and selling the same asset simultaneously to make a profit. In this scenario, the mentor sees an opportunity to buy wheat in the U.S. at a lower price and sell it in France at a higher price. This is an example of cross-border arbitrage. Therefore, the best answer is B.

Question 12

According to the efficient market view,future exchange rates are most accurately forecasted by ________.

Accepted Answer

The efficient market view suggests that all publicly available information is immediately reflected in current exchange rates, making it impossible to forecast future exchange rates. However, forward exchange rates are based on current exchange rates and expectations of future changes, and therefore, are the most accurate forecast of future exchange rates according to this view.

Question 13

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 ________.

Accepted Answer

The answer of Sam Dearing,Budding International Financier
Sam Dearing is a...

Question 14

Which of the following is true of the techniques used for forecasting exchange rates?

Accepted Answer

Forecasting exchange rates is a difficult task as unexpected events can occur at any time, making it difficult to accurately predict future exchange rates. It is not possible to have completely accurate forecasts, but instead, forecasts provide an estimate of how the exchange rate might behave in the future.

Question 15

The efficient market view holds that ________.

Accepted Answer

The efficient market view suggests that financial instrument prices reflect all publicly available information at any given time, meaning that it is difficult to consistently outperform the market by analyzing or selecting individual securities.

Question 16

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 ________.

Accepted Answer

If a kilogram of wheat costs $1 in the U.S. and €1.5 in France, and the actual euro/dollar exchange rate is €1.2/$, then it means that the cost of one euro is equivalent to $1.2. Therefore, the cost of one kilogram of wheat in France in dollars would be €1.5/$1.2 = $1.25, which is higher than the price of $1 in the U.S. So, wheat is priced higher in France. Option A cannot be true as the expected exchange rate cannot be calculated based on the information given. Option D cannot be confirmed based on the information given, and hence it cannot be the answer.

Question 17

It is the nature of arbitrage to even out excessive fluctuation by destroying its own profitability.

Accepted Answer

Arbitrage involves taking advantage of market inefficiencies to make a profit, but as more traders engage in arbitrage, the inefficiencies are reduced or eliminated, causing prices to even out and reducing profitability for arbitrageurs. Therefore, arbitrage tends to even out excessive fluctuations in the market.

Question 18

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

Accepted Answer

To find the price of a kilogram of wheat in France in dollars, divide the cost in euros (€1.5) by the exchange rate (€1.2/$), which equals $1.25.

Question 19

Color-Me-Green Inc.
Color-Me-Green Inc. ,a U.S.-based clothing merchant,has started doing business internationally.Having subsidiaries in several countries,the company must integrate financial information from all its subsidiaries with the U.S.home office at the end of the year.
-In an attempt to raise money in Country B,Color-Me-Green was quoted an interest rate of 14 percent by a local bank.This quoted rate is called the ________ rate.

Accepted Answer

The quoted rate of 14 percent is the nominal rate, which is the stated rate without any adjustment for inflation or other factors.

Question 20

Color-Me-Green Inc.
Color-Me-Green Inc. ,a U.S.-based clothing merchant,has started doing business internationally.Having subsidiaries in several countries,the company must integrate financial information from all its subsidiaries with the U.S.home office at the end of the year.
-In Country B,Color-Me-Green is faced with a tight labor market and a low unemployment rate.This low unemployment rate will most likely result in ________.

Accepted Answer

The answer of Color-Me-Green Inc.
Color-Me-Green Inc. ,a U.S.-based clothing merchant,has...

Quiz 10: International Monetary System