Question 1

Which of the following is not true regarding interest rate parity (IRP)?
A) When interest rate parity holds, covered interest arbitrage is not possible.
B) When the interest rate in the foreign country is higher than that in the home country, the forward rate of that country's currency should exhibit a discount.
C) When the interest rate in the foreign country is lower than that in the home country, the forward rate of that country's currency should exhibit a premium.
D) When covered interest arbitrage is not feasible, interest rate parity must hold.
E) All of the above are true.

Accepted Answer

It is not necessarily true that when covered interest arbitrage is not feasible, interest rate parity must hold. In fact, interest rate parity can sometimes be violated in the short term due to market inefficiencies or other factors. However, if covered interest arbitrage is not feasible, it suggests that markets are functioning efficiently and interest rate parity is likely to hold in the long run.

Question 2

The interest rate in South Africa is 8%. The interest rate in the U.S. is 5%. The South African forward rate should exhibit a premium of about 3%.

Accepted Answer

The forward rate should exhibit a discount of about 3% for the South African currency, not a premium, because its interest rate is higher than that of the U.S.

Question 3

Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, the following adjustments must take place.
A) One bank's ask price will rise and the other bank's bid price will fall.
B) One bank's ask price will fall and the other bank's bid price will rise.
C) One bank's bid/ask spread will widen and the other bank's bid/ask spread will fall.
D) A and C

Accepted Answer

As arbitrageurs buy from the bank with the lower ask price and sell to the bank with the higher bid price, the ask price of the bank with the lower ask price will rise, and the bid price of the bank with the higher bid price will fall. This will narrow the bid/ask spread of the bank with the lower ask price and widen the bid/ask spread of the bank with the higher bid price.

Question 4

Hewitt Bank quotes a value for the Japanese yen (¥) of $0.007, and a value for the Canadian Dollar (C$) of $0.821. The cross exchange rate quoted by the bank for the Canadian dollar is ¥118.00. You have $5,000 to conduct triangular arbitrage. How much will you end up with if you conduct triangular arbitrage?
A) $6,053.27
B) $5,030.45
C) $6,090.13
D) Triangular arbitrage is not possible in this case.

Accepted Answer

The answer of Hewitt Bank quotes a value for the...

Question 5

Which of the following is not true regarding covered interest arbitrage?
A) Covered interest arbitrage is a reason for observing interest rate parity (IRP).
B) If the forward rate is equal to the spot rate, conducting covered interest arbitrage will yield a return that is exactly equal to the interest rate in the foreign country.
C) When interest rate parity holds, covered interest arbitrage is not possible.
D) When interest rate disparity exists, covered interest arbitrage may not be profitable.
E) All of the above are true.

Accepted Answer

The answer of Which of the following is not true...

Question 6

Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country.

Accepted Answer

Interest rate parity (IRP) is a theory that suggests that the difference between the forward exchange rate and the spot exchange rate of two currencies should be equal to the difference between their respective interest rates. This theory assumes that there are no restrictions on capital flows and that transaction costs and risks are the same for both currencies. Therefore, in general, if the interest rate differential between the U.S. and the foreign country increases, the foreign currency's forward rate should decrease to compensate for the higher interest rate. Similarly, if the interest rate differential decreases, the foreign currency's forward rate should increase to reflect the lower interest rate. This relationship is known as the interest rate parity condition.

Question 7

For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective.

Accepted Answer

Covered interest arbitrage is possible for foreign investors when the foreign interest rate, adjusted for forward exchange rates, offers a higher return than the domestic rate, which occurs when points lie to the left of the IRP line.

Question 8

Which of the following is not true regarding covered interest arbitrage?
A) Covered interest arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.
B) Covered interest arbitrage involves investing in a foreign country and covering against exchange rate risk.
C) Covered interest arbitrage opportunities only exist when the foreign interest rate is higher than the interest rate in the home country.
D) If covered interest arbitrage is possible, you can guarantee a return on your funds that exceeds the returns you could achieve domestically.
E) All of the above are true regarding covered interest arbitrage.

Accepted Answer

Covered interest arbitrage opportunities can exist when the foreign interest rate is either higher or lower than the interest rate in the home country. Therefore, statement C is not true regarding covered interest arbitrage.

Question 9

Which of the following is not mentioned in the text as a form of international arbitrage?
A) Locational arbitrage
B) Triangular arbitrage
C) Transactional arbitrage
D) Covered interest arbitrage
E) All of the above are mentioned in the text as forms of international arbitrage.

Accepted Answer

Transactional arbitrage is not a commonly recognized form of international arbitrage, unlike locational, triangular, and covered interest arbitrage.

Question 10

National Bank quotes the following for the British pound and the New Zealand dollar:
$\begin{array}{ll}
&\text { Quoted Bid Price } & \text {Quoted Ask Price }  \
\text {Value of a British pound (£) in $\$$ } & \text { \$ 1.61 }&\text { \$1.62 } \
\text {Value of a New Zealand dollar (NZ\$) in $\$$ } &\text { \$ .55 }&\text { \$ 0.56 }  \
\text {Value of a British pound in } && \
\text {New Zealand dollars } &\text NZ\$2.95&\text NZ\$2.96  \
\end{array}$

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy?
A) $77.64
B) $197.53
C) $15.43
D) $111.80

Accepted Answer

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

Question 11

American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR); National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would involve:
A) buying rupees from American Bank at the bid rate and selling them to National Bank at the ask rate.
B) buying rupees from National Bank at the ask rate and selling them to American Bank at the bid rate.
C) buying rupees from American Bank at the ask rate and selling to National Bank at the bid rate.
D) buying rupees from National Bank at the bid rate and selling them to American Bank at the ask rate.
E) Locational arbitrage is not possible in this case.

Accepted Answer

The answer of American Bank quotes a bid rate of...

Question 12

The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula.

Accepted Answer

According to the interest rate parity formula, the forward discount of a foreign currency will increase as the foreign interest rate exceeds the home interest rate. Therefore, the larger the degree of difference between the two interest rates, the larger will be the forward discount of the foreign currency.

Question 13

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

Accepted Answer

Interest rate parity implies that the rate of return from covered interest arbitrage should be equal to the domestic interest rate, not the foreign interest rate.

Question 14

Which of the following is an example of triangular arbitrage initiation?
A) Buying a currency at one bank's ask and selling at another bank's bid, which is higher than the former bank's ask.
B) Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African rand (ZAR)/Singapore dollar (S$) exchange rate at ZAR2.50 when the spot rate for the South African rand is $0.20.
C) Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African rand/Singapore dollar exchange rate at ZAR3.00 when the spot rate for the South African rand is $0.20.
D) Converting funds to a foreign currency and investing the funds overseas.

Accepted Answer

Triangular arbitrage involves exploiting price discrepancies between three currencies. In option C, the implied rate from the given exchange rates allows for a profit by converting currencies through a sequence of trades.

Question 15

If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax laws.

Accepted Answer

Even if IRP does not hold, covered interest arbitrage may not be profitable due to additional factors such as transaction costs, currency restrictions, and differential tax laws.

Question 16

If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.

Accepted Answer

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

Question 17

Bank A quotes a bid rate of $0.300 and an ask rate of $0.305 for the Malaysian ringgit (MYR). Bank B quotes a bid rate of $0.306 and an ask rate of $0.310 for the ringgit. What will be the profit for an investor that has $500,000 available to conduct locational arbitrage?
A) $2,041,667
B) $9,804
C) $500
D) $1,639

Accepted Answer

The investor can buy MYR from Bank A at $0.305 and sell it to Bank B at $0.306. The profit per MYR is $0.001. With $500,000, the investor can buy 1,639,344 MYR from Bank A and sell it to Bank B for $1,639,344 * $0.306 = $501,639.344, resulting in a profit of $1,639.344.

Quiz 7: International Arbitrage and Interest Rate Parity

Which of the following is not true regarding interest rate parity (IRP) ?

The interest rate in South Africa is 8%. The interest rate in the U.S. is 5%. The South African forward rate should exhibit a premium of about 3%.

Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, the following adjustments must take place.

Which of the following is not true regarding covered interest arbitrage?

Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country.

For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective.

Which of the following is not true regarding covered interest arbitrage?

Which of the following is not mentioned in the text as a form of international arbitrage?

American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR) ; National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would involve:

The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula.

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

Which of the following is an example of triangular arbitrage initiation?

If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax laws.

If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.

Bank A quotes a bid rate of $0.300 and an ask rate of $0.305 for the Malaysian ringgit (MYR) . Bank B quotes a bid rate of $0.306 and an ask rate of $0.310 for the ringgit. What will be the profit for an investor that has $500,000 available to conduct locational arbitrage?