Question 1

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

Accepted Answer

Triangular arbitrage involves exploiting discrepancies in currency exchange rates across three currencies, not interest rates or forward exchange rate premiums/discounts.

Question 2

Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.

Accepted Answer

Interest rate parity refers to the relationship between interest rates and exchange rates, not risk-free profit opportunities. Arbitrage is the term for capitalizing on price discrepancies without risk or investment.

Question 3

Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso's forward ____ will ____.

Accepted Answer

According to interest rate parity, the forward rate reflects the interest rate differential between two countries. A decrease in the U.S. interest rate reduces the differential, leading to a smaller discount on the peso's forward rate, thus increasing the discount.

Question 4

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

Accepted Answer

Interest rate parity (IRP) relates to the relationship between interest rates and exchange rates, while triangular arbitrage involves exploiting discrepancies between three currencies. They are separate concepts, and the existence of IRP does not necessarily prevent triangular arbitrage opportunities.

Question 5

Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in forward contracts.

Accepted Answer

Locational arbitrage involves exploiting price differences in the same asset across different locations, not necessarily involving forward contracts or exchange rate risk coverage.

Question 6

Forward rates are driven by the government rather than market forces.

Accepted Answer

Forward rates, like other interest rates, are driven by market forces such as supply and demand for credit. While government policy can certainly influence interest rates, it is incorrect to say that forward rates are solely determined by the government.

Question 7

Exhibit 7-1
Assume the following information:
You have $300,000 to invest:
The spot bid rate for the euro (€) is $1.08
The spot ask quote for the euro is $1.10
The 180-day forward rate (bid) of the euro is $1.08
The 180-day forward rate (ask) of the euro is $1.10
The 180-day interest rate in the U.S. is 6%
The 180-day interest rate in Europe is 8%
-Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what amount will you have after 180 days?

Accepted Answer

SOLUTION:
$\begin{aligned}
\$ 300,000 / \$ 1.10 & = € 277,777.80 \times ( 1.08 ) \
& = € 294,444.40 \times \$ 1.08 \
& = \$ 318,109.10
\end{aligned}$

Question 8

The interest rate on euros is 8%. The interest rate in the U.S. is 5%. The euro's forward rate should exhibit a premium of about 3%.

Accepted Answer

The answer of The interest rate on euros is 8%....

Question 9

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Accepted Answer

The answer of If the cross exchange rate of two...

Question 10

If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage should be equal to the rate available in the foreign country.

Accepted Answer

The answer of If interest rate parity (IRP) exists, then...

Question 11

Exhibit 7-1
Assume the following information:
You have $300,000 to invest:
The spot bid rate for the euro (€) is $1.08
The spot ask quote for the euro is $1.10
The 180-day forward rate (bid) of the euro is $1.08
The 180-day forward rate (ask) of the euro is $1.10
The 180-day interest rate in the U.S. is 6%
The 180-day interest rate in Europe is 8%
-Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what is your percentage return after 180 days? Is covered interest arbitrage feasible in this situation?

Accepted Answer

SOLUTION:
$318,109.10/$300,000 -1 = 6.04%. Since this rate is slightly higher than the U.S. interest rate of 6%, covered interest arbitrage is feasible.

Question 12

Assume the following information:
You have $900,000 to invest:
$$\begin{array}{l}
\text { You have } \$ 900,000 \text { to invest: }\
\begin{array} { l l l } 
\text { Current spot rate of Australian dollar (AS) } & = & \$ .62 \
\text { 180-day forward rate of the Australian dollar } & = & \$ .64 \
\text { 180-day interest rate in the U.S. } & = & 3.5 \% \
\text { 180-day interest rate in Australia } & = & 3.0 \%
\end{array}
\end{array}$$
If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days?

Accepted Answer

The correct answer is A.The dollar profit from covered interest arbitrage is the difference between the interest earned on the foreign currency deposit and the interest paid on the domestic currency loan. In this case, the interest earned on the Australian dollar deposit is $900,000 * 3.0% * 180/360 = $45,000. The interest paid on the U.S. dollar loan is $900,000 * 3.5% * 180/360 = $49,500. Therefore, the dollar profit is $45,000 - $49,500 = $56,903.

Question 13

To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward.

Accepted Answer

This statement accurately describes the process of covered interest arbitrage for capitalizing on high foreign interest rates. By investing in a foreign country using the converted currency, the investor can earn a higher return, but also hedges against exchange rate risk by selling the foreign currency forward. This ensures a known exchange rate when converting the foreign currency back to dollars in the future.

Question 14

National Bank quotes the following for the British pound and the New Zealand dollar:
$\begin{array}{lll} 
& \underline{\text { Quoted Bid Price}} & \underline{\text {Quoted Ask Price}} \
\text { Value of a British pound (£) in $\$$ } & \$ 1.61 & \$ 1.62 \
\text { Value of a New Zealand dollar (NZS) in $\$$ } & \$ .55 & \$ .56\
\text {Value of a British pound in} &  & \
\text { New Zealand dollars } & NZ\$2.95 & NZ\$ 2.96\
\end{array}$

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy?

Accepted Answer

The answer of National Bank quotes the following for the...

Question 15

According to interest rate parity (IRP):

Accepted Answer

According to interest rate parity (IRP), the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies. This means that the forward exchange rate should reflect the difference in interest rates between the two currencies. If the interest rate differential between two currencies is expected to be 5%, then the forward rate should be adjusted accordingly to offset this differential, so that investors would receive similar returns regardless of which currency they invest in.

Question 16

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Accepted Answer

For locational arbitrage to be possible, one bank's ask rate must be lower than another bank's bid rate for a currency, allowing a trader to buy low and sell high.

Question 17

Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.

Accepted Answer

Locational arbitrage involves exploiting price differences between different markets in order to make a profit. In doing so, market forces will cause prices to adjust to eliminate the arbitrage opportunity. In this case, if one bank's ask rate is too low relative to the other bank's bid rate, buyers will flock to the first bank to take advantage of the lower rate. This increase in demand will drive up the ask rate at the first bank, while the decrease in demand at the second bank will cause its bid rate to fall. As a result, there will be a realignment of ask and bid rates between the two banks.

Question 18

The foreign exchange market is an over-the-counter market.

Accepted Answer

The answer of The foreign exchange market is an over-the-counter...

Question 19

Assume the following information:
You have $400,000 to invest:
$$\begin{array}{l}
\text { You have } \$ 400,000 \text { to invest: }\
\begin{array} { l l r } 
\text { Current spot rate of Sudanese dinar (SDD) } & = & \$ .00570 \
\text { 90-day forward rate of the dinar } & = & \$ .00569 \
\text { 90-day interest rate in the U.S. } & = & 4.0 \% \
\text { 90-day interest rate in Sudan } & = & 4.2 \%
\end{array}
\end{array}$$
If you conduct covered interest arbitrage, what amount will you have after 90 days?

Accepted Answer

To conduct covered interest arbitrage, convert USD to SDD at the spot rate, invest in Sudan at 4.2% for 90 days, and convert back to USD using the forward rate. The calculation yields approximately $416,068.77.

Question 20

Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage.

Accepted Answer

This statement is true as realignment in exchange rates will make it less profitable to conduct locational arbitrage, leading to an increase in the ask rate of the bank from which the currency was bought and a decrease in the bid rate of the bank to which the currency was sold. This is because the increased demand for currency from the bank with the lower ask rate and the increased supply of currency to the bank with the higher bid rate will ultimately lead to a convergence of exchange rates.

Quiz 7: International Arbitrage and Interest Rate Parity