Question 1

Assume you can exchange $1 for either £1.0 or €0.50 in the U.S. In the London market, you can exchange £1 for €0.52. This situation creates an opportunity to profit immediately from which one of the following?

Accepted Answer

This situation presents an opportunity for triangle arbitrage. By exchanging $1 for £1 in the U.S. and then exchanging the £1 for €0.52 in London, you can effectively exchange $1 for €0.52, which is higher than the exchange rate of $1 for €0.50 in the U.S. This can be a profitable trade, although it must be executed quickly as exchange rates can change rapidly. The other choices listed do not apply to this situation.

Question 2

35. Which one of the following formulas illustrates the mechanics of covered interest arbitrage? Assume the  is borrowed and  =  spot rate;  =  one-year forward rate;  =  foreign country risk-free rate; and  risk-free rate.

Accepted Answer

Covered interest arbitrage involves borrowing a currency, converting it into another currency, investing it in a risk-free security, and then converting the proceeds back into the original currency at a forward rate to repay the loan. The formula for covered interest arbitrage is:
((1+RF)/(1+RB)) x (S/(1+F)) = 1
where RF is the foreign risk-free interest rate, RB is the domestic risk-free interest rate, S is the spot exchange rate, and F is the forward exchange rate. Choice B is the closest formula to this formula.

Question 3

You have just agreed to a forward trade that will be settled six months from now. When will the exchange rate for this transaction be determined?

Accepted Answer

The exchange rate for a forward trade is agreed upon at the time of the trade, which is today in this case. It is a contract where a buyer and seller agree to exchange currencies at a predetermined rate on a future date (in this case, six months from now). The exchange rate may fluctuate over time, but the parties involved have locked in their rate at the time of the trade.

Question 4

Which one of the following is an example of long-run exposure to exchange rate risk? Ignore all fees and transaction costs.

Accepted Answer

Building a factory in another country requires a long-term commitment and investment, and changes in exchange rates can affect the cost advantage of doing so. This is a long-run exposure to exchange rate risk. The other options are short-run exposures to exchange rate risk.

Question 5

Which one of the following must be significantly eliminated if interest rate parity is to exist?

Accepted Answer

Interest rate parity exists when the interest rate differential between two currencies is equal to the differential that would be expected due to exchange rate movements over the same period. Covered interest arbitrage opportunities refer to situations where an investor can take advantage of differences in interest rates between two countries by simultaneously entering into forward contracts to purchase and sell the same currencies. If these opportunities exist, interest rate parity does not hold. Therefore, covered interest arbitrage opportunities must be significantly eliminated in order for interest rate parity to exist. The other options (absolute and relative purchasing power parity, short-run exposure to exchange rate risk, and translation exposure) are not directly related to interest rate parity.

Question 6

Suppose you could buy 1,320 South Korea won or 78 Pakistan rupees last year for $1. Today, $1 will buy you 1,318 won or 80 rupees. Which one of the following occurred over the past year?

Accepted Answer

The rupee depreciated against the dollar because you can now buy more rupees (80 instead of 78) for the same $1, indicating the rupee's value has decreased relative to the dollar.

Question 7

Which one of the following best describes an agreement you make today to exchange U.S. dollars for British pounds three months from now?

Accepted Answer

A forward trade is an agreement made today to exchange currencies at a predetermined rate and date in the future. In this case, the agreement is to exchange U.S. dollars for British pounds in three months' time, which falls under the definition of a forward trade.

Question 8

Later this week, you are traveling from the U.S. to Canada for a week's vacation. This morning, you exchanged some U.S. dollars for Canadian dollars in preparation for that trip. Which one of the following best describes this exchange?

Accepted Answer

This transaction is a spot trade, which involves the immediate exchange of one currency for another at the current market rate. There is no agreement to exchange currencies at a future date, so it is not a forward trade. Arbitrage transactions involve taking advantage of price differences between markets, which is not the case here. Cross-rate exchange involves the calculation of exchange rates between two currencies that are not typically traded together, and eurocurrency transactions involve the use of currencies deposited outside of their home country's borders, which are also not applicable here.

Question 9

Which one of the following statements is correct?

Accepted Answer

The statement "The foreign exchange market is the largest financial market in the world" is correct. Statement A is incorrect because exchange rates are constantly fluctuating throughout the day. Statement B is incorrect because the franc is not one of the four most common currencies traded in the foreign exchange market. Statement C is incorrect because not all countries in South America use the peso as their currency. Statement D is incorrect because New Zealand uses its own currency, the New Zealand dollar (NZD), while Australia uses the Australian dollar (AUD or A$).

Question 10

Which of the following are participants in the foreign exchange market? I. U.S. importers
II) U.S. exporters
III) U.S. travelers to Europe
IV) U.S. portfolio manager who purchases foreign securities

Accepted Answer

All of the options listed are participants in the foreign exchange market. U.S. importers and exporters engage in foreign exchange transactions to pay for goods or receive payments for exported goods. U.S. travelers to Europe exchange U.S. dollars for euros to use as currency during their travels. U.S. portfolio managers who purchase foreign securities must exchange U.S. dollars for the foreign currency in order to make the purchase.

Question 11

Short-run exposure to exchange rate risk is best illustrated by which one of the following?

Accepted Answer

Short-run exposure to exchange rate risk is typically associated with daily fluctuations in the spot rate. This refers to the risk that arises from the possibility of an adverse change in exchange rates over a short time frame, such as a day or a week. Factors like political events, economic data releases, and market sentiment can all cause sudden shifts in currency values, which can have a significant impact on the cash flows and profitability of businesses with international operations.

Question 12

Assume a canned soft drink costs $1 in the U.S. and $1.30 in Canada. At the same time, the currency per U.S. dollar is C$1.30. Which one of the following conditions exists in this situation?

Accepted Answer

The answer of Assume a canned soft drink costs $1...

Question 13

Interest rate parity defines the relationships among which of the following?

Accepted Answer

Interest rate parity defines the relationship between forward exchange rates, relative interest rates, and spot exchange rates. It states that the difference in interest rates between two countries should be reflected in the forward exchange rate between those countries' currencies. Therefore, investors cannot earn excessive profits by borrowing in a low-interest-rate country and investing in a high-interest-rate country, as the forward exchange rate will adjust accordingly.

Question 14

Assume you can currently exchange one U.S. dollar for one hundred Japanese yen. Also assume the inflation rate will be 2.5 percent annually in the U.S. and 2 percent in Japan. Given these assumptions, how many yen should you expect in exchange for one U.S. dollar next year?

Accepted Answer

Since the inflation rate in Japan is lower than in the U.S., the Japanese yen is expected to strengthen against the U.S. dollar. Therefore, next year one U.S. dollar is expected to be able to buy less than 100 Japanese yen.

Question 15

Assume that  is the euro price of a product,  is the U.S. price of the identical
product, and  is the spot exchange rate, quoted as the amount of foreign currency per dollar.
Given this, which one of the following correctly expresses absolute purchasing power parity?

Accepted Answer

The answer of Assume that  is the euro price...

Question 16

Which one of the following occurs when interest rate parity exists between countries A and B?

Accepted Answer

Interest rate parity implies that the return on risk-free investments in different countries, when adjusted for exchange rates, is equal, making investors indifferent.

Question 17

Currently, you can exchange $1 for Sf1.14. Assume that the average inflation rate in the U.S. over the next two years will be 2.5 percent annually as compared to 3 percent in Switzerland. Based on this information and relative purchasing power parity, which one of the following assumptions can you make regarding the next two years?

Accepted Answer

Based on the information given, the U.S. inflation rate is lower than Switzerland's inflation rate. This means that the U.S. dollar will appreciate against the Swiss franc, as it will have relatively more purchasing power compared to the Swiss franc in two years' time. Therefore, the correct answer is D: the U.S. dollar will appreciate against the Swiss franc.

Question 18

Relative purchasing power parity is based on the principle that the expected percentage change in the exchange rate between two countries is equal to which one of the following?

Accepted Answer

Relative purchasing power parity theory states that the exchange rate between two countries should be determined by the difference in their inflation rates. If the inflation rate in one country is higher than the other, its currency will depreciate relative to the other country's currency to preserve the balance of the purchasing power of the currencies. Therefore, the expected percentage change in the exchange rate between two countries is equal to the difference in the inflation rates of the two countries.

Question 19

You are given the following exchange rates for the Canadian dollar versus the U.S. dollar:  Which one of the following statements is correct given this information?

Accepted Answer

The answer of You are given the following exchange rates...

Question 20

The U.S. dollar equivalent is 0.4502 for the Brazilian real and 1.4729 for the U.K. pound. Which one of the following statements is correct given this information?

Accepted Answer

One U.K. pound will buy 1.4729 U.S. dollars, as the exchange rate given is the U.S. dollar equivalent for one U.K. pound.

Quiz 18: International Aspects of Financial Management