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 price discrepancies between three currencies in the foreign exchange market, not interest rates or forward exchange rate premiums/discounts.

Question 2

Points above the IRP line represent situations where:

Accepted Answer

The answer of Points above the IRP line represent situations...

Question 3

The yield curve of every country has its own unique shape.

Accepted Answer

The yield curve of every country is influenced by its economic conditions, political factors, and monetary policy, among other factors. As a result, the shape of the yield curve may vary significantly from one country to another, reflecting the unique characteristics of their financial systems and economic structures. For example, some countries may have steep yield curves, indicating higher long-term interest rates compared to short-term rates, while others may have flat or inverted yield curves, where short-term rates are higher than long-term rates.

Question 4

The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).

Accepted Answer

Interest rate parity refers to the condition in which the interest rate differential between two countries is equal to the expected depreciation of the higher-interest-rate country's currency. When IRP holds, covered interest arbitrage is no longer possible because there are no more profitable opportunities for investors to exploit. Therefore, the statement is true.

Question 5

Assume the following information:
$$\begin{array} { l l r } 
\text { Exchange rate of Japanese yen in U.S. \$ } & = & \$ .011 \
\text { Exchange rate of euro in U.S. \$ } & = & \$ 1.40 \
\text { Exchange rate of euro in Japanese yen } & = & 140 \text { yen }
\end{array}$$
What will be the yield for an investor who has $1,000,000 available to conduct triangular arbitrage?

Accepted Answer

The answer of Assume the following information:
\[\begin{array} { l l...

Question 6

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 at one bank and sell high at another.

Question 7

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

Accepted Answer

Even if interest rate parity does not exist, covered interest arbitrage may still not be profitable due to various factors such as transaction costs, political risk, and differential tax laws. These additional costs and risks may offset any potential gains from the arbitrage, making it unattractive or unfeasible.

Question 8

The interest rate on pounds in the U.K. is 8%. The interest rate in the U.S. is 5%. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

Accepted Answer

According to interest rate parity, the return on foreign investment should be equal to the return on domestic investment adjusted for the exchange rate. In this case, if the interest rate on pounds is 8% and the interest rate on dollars is 5%, U.S. investors will need to earn an additional return of 3% from the exchange rate in order to achieve parity with British investors. Therefore, U.S. investors will have a lower return domestically than British investors.

Question 9

The interest rate on yen is 7%. The interest rate in the U.S. is 9%. The yen's forward rate should exhibit a premium of about 2%.

Accepted Answer

The forward rate should exhibit a premium when the interest rate in the foreign country is higher than the interest rate in the domestic country. In this case, the interest rate in the U.S. is higher than the interest rate in Japan, so the yen's forward rate should exhibit a premium.

Question 10

Assume that interest rate parity holds. U.S. interest rate is 13% and British interest rate is 10%. The forward rate on British pounds exhibits a ____ of ____ percent.

Accepted Answer

The answer of Assume that interest rate parity holds. U.S....

Question 11

Assume the following information:
$\begin{array}{ll}
&\text { Quoted Bid Price } & \text {Quoted Ask Price }  \
\text {Value of an Australian dollar (AS) in $\$$ } & \text { \$ 0.67 }&\text { \$ 0.69 } \
\text {Value of Mexican peso in $\$$ } &\text { \$ .074 }&\text { \$ .077 }  \
\text {Value of an Australian dollar in } && \
\text {Mexican pesos } &\text {  8.2 }&\text {8.5 }  \
\end{array}$
Assume you have $100,000 to conduct triangular arbitrage. What will be your profit from implementing this strategy?

Accepted Answer

The answer of Assume the following information:
\(\begin{array}{ll}
&\text { Quoted Bid...

Question 12

Assume the following information:
U.S. investors have $1,000,000 to invest:
$\begin{array} { l l r } 
1 \text {-year deposit rate affered by U.S. Gariks } & = & 10 \% \
1 \text {-year deposit rate affered an British pounds } & = & 13.5 \% \
1 \text {-year forward rate of Suriss francs } & = & \$ 1.26 \
\text { Spot rate of Swriss franc } & = & \$ 1.30
\end{array}$
Given this information:

Accepted Answer

SOLUTION:
$\begin{array} { l } 
\$ 1,000,000 / \$ 1.30 = 793,651 \text { pounds } \times ( 1.135 ) = 900,794 \times \$ 1.26 = \
\$ 1,100,076 \
\text { Yield: } ( \$ 1,100,076 - \$ 1,000,000 ) / ( \$ 1,000,000 ) = 10 \% .
\end{array}$

Question 13

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 14

Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.

Accepted Answer

Technology allows for real-time updates and connectivity, leading to more consistent and accurate foreign exchange rates across different locations and banks.

Question 15

Cross exchange rates are used to determine the relationship between the dollar and two nondollar currencies.

Accepted Answer

Cross exchange rates are used to determine the exchange rate between two nondollar currencies by using a common third currency, often the dollar, as a reference.

Question 16

Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount.

Accepted Answer

Locational arbitrage involves taking advantage of price differences in different locations, which leads to market forces that quickly eliminate these discrepancies, ensuring prices remain similar across locations.

Question 17

Assume that the real interest rate in the U.S. and in the U.K. is 3%. The expected annual inflation in the U.S. is 3%, while in the U.K. it is 4%. The forward rate on the pound should exhibit a premium of about 1%.

Accepted Answer

The forward rate on the pound should exhibit a discount of about 1% due to the higher expected inflation in the U.K. compared to the U.S.

Question 18

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 refers to the process of taking advantage of price or rate differences in different geographic locations. If the arbitrage opportunity exists between two different banks, then it means there is a price or rate difference between them. Market forces would work to eliminate this difference, which would result in an increase in the bank's ask rate with higher rates and a decrease in the bid rate at lower rates, making it possible to profit from the price differential. Therefore, the statement is true.

Question 19

Points below the IRP line represent situations where:

Accepted Answer

Points below the IRP (Interest Rate Parity) line indicate that the foreign interest rate, adjusted for the forward exchange rate, offers a higher yield than the domestic rate, making covered interest arbitrage profitable for domestic investors.

Question 20

If quoted exchange rates are the same across different locations, then ____ is not feasible.

Accepted Answer

If exchange rates are the same across different locations, locational arbitrage is not feasible because there is no price discrepancy to exploit. Similarly, triangular arbitrage is not feasible because there are no differences in cross rates to take advantage of.

Quiz 7: International Arbitrage and Interest Rate Parity