Question 1

Purchasing power parity suggests that the forward rate premium (or discount) should be about equal to the differential in interest rates between the countries of concern.

Accepted Answer

The answer of Purchasing power parity suggests that the forward...

Question 2

The following information refers to Fresno Bank and Champaign Bank.  Based on this information, locational arbitrage would be profitable.

Accepted Answer

Locational arbitrage involves taking advantage of price differences between two markets in different locations. In this case, the given information suggests that Fresno Bank and Champaign Bank have different interest rates for the same product, indicating a price difference. Therefore, locational arbitrage would be profitable.

Question 3

The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements.

Accepted Answer

The potential benefits from using foreign exchange derivatives, such as hedging against currency risk, are highly dependent on the expected exchange rate movements. These financial instruments are used to lock in exchange rates or speculate on future changes, making their benefits closely tied to how the exchange rates are anticipated to move.

Question 4

A speculator who expects a foreign currency to appreciate could purchase the currency forward and, when received, sell it in the spot market.

Accepted Answer

By purchasing the currency forward, the speculator can lock in the exchange rate and then sell it in the spot market when the exchange rate has appreciated, earning a profit.

Question 5

A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates.

Accepted Answer

When a country pegs its exchange rate to another currency, it is essentially agreeing to maintain the value of its currency relative to the other currency. As a result, changes in the value of the pegged currency can impact the country's own domestic interest rates, which can limit the country's ability to control its monetary policy. This is because changes in interest rates can impact the demand for the currency, which in turn can impact its value relative to the pegged currency.

Question 6

The forward rate premium is dictated by the inflation rate differential of the two currencies.

Accepted Answer

The forward rate premium is determined by the interest rate differential between two currencies, not the inflation rate differential.

Question 7

When countries experience substantial net outflows of funds, they commonly use indirect intervention by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency.

Accepted Answer

This is known as "interest rate defense" and is a common tool used by countries to maintain the value of their currency.

Question 8

Central bank intervention can be overwhelmed by market forces and may not always succeed in reversing exchange rate movements.

Accepted Answer

Central banks can intervene in foreign exchange markets by buying or selling currencies in order to influence exchange rates. However, market forces such as supply and demand for currencies can sometimes be stronger than central bank interventions, making it difficult or impossible for the central bank to reverse exchange rate movements.

Question 9

The indirect exchange rate specifies the value of the currency in U.S.dollars.

Accepted Answer

The indirect exchange rate specifies the amount of foreign currency needed to buy one unit of the domestic currency, not the value of the currency in U.S. dollars.

Question 10

Financial institutions rarely use the forward market.

Accepted Answer

Financial institutions commonly use the forward market to manage their currency risk by locking in a specific exchange rate for future transactions.

Question 11

The Smithsonian Agreement allowed for a devaluation of the dollar and for a widening of the boundaries within which currencies were allowed to fluctuate.

Accepted Answer

The Smithsonian Agreement was signed in 1971 and allowed for a devaluation of the dollar by 8% and for a widening of the boundaries within which currencies were allowed to fluctuate.

Question 12

The forward rate is the exchange rate for immediate delivery.

Accepted Answer

The forward rate is the exchange rate for delivery at a specified future date, not immediate delivery.

Question 13

If the quoted cross rate between two foreign currencies is not aligned with the two corresponding exchange rates, investors can profit from triangular arbitrage.

Accepted Answer

Triangular arbitrage involves using the cross rate between two foreign currencies and comparing it to the two corresponding exchange rates in order to identify a potential profit opportunity. If the quoted cross rate does not align with the two exchange rates, there may be an opportunity for investors to take advantage of the discrepancy and make a profit.

Question 14

Assume the following information.  If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is

Accepted Answer

The answer of Assume the following information.  If Fabrizio...

Question 15

A country that pegs its currency does not have complete control over its local interest rates, as its interest rates must be aligned with the interest rates of the currency to which it is tied.

Accepted Answer

When a country pegs its currency, it commits to maintaining a fixed exchange rate between its currency and the currency it is pegged to. As a result, the country's interest rates must be aligned with those of the currency it is tied to in order to maintain the exchange rate. Therefore, the country does not have complete control over its local interest rates.

Question 16

If British interest rates suddenly increase substantially relative to U.S.interest rates, the demand by U.S.investors for British pounds ____, the supply of British pounds to be sold in exchange for dollars ____, and the British pound will ____.

Accepted Answer

The answer of If British interest rates suddenly increase substantially...

Question 17

The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on an annualized basis.

Accepted Answer

The forward rate premium reflects the percentage by which the forward rate exceeds the spot rate on an annualized basis.

Question 18

In July 2005, China implemented a new system in which the yuan could float within narrow boundaries based on a set of major currencies.

Accepted Answer

This statement is true. In July 2005, China abandoned its fixed exchange rate system and implemented a new system where the yuan could float within narrow boundaries based on a set of major currencies, such as the US dollar, euro, and Japanese yen. This system is known as a managed float or a dirty float.

Question 19

The primary advantage of currency options over forward and futures contracts is that they provide a right rather than an obligation to purchase or sell a particular currency at a specified price within a given period.

Accepted Answer

Currency options give the holder the right, but not the obligation, to purchase or sell a particular currency at a specified price within a given period, which is an advantage over the obligation to buy or sell that comes with forward and futures contracts.

Question 20

Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory.

Accepted Answer

Exchange rates do not always change precisely according to PPP theory, as there are many factors that can affect exchange rates beyond just the relative price levels of two countries. Other factors like inflation, interest rates, political instability, and market speculation can all impact exchange rates.

Quiz 16: Foreign Exchange Derivative Markets