Question 1

A currency is said to be at a forward _________ if the forward rate is below the spot rate.

Accepted Answer

B

Question 2

If the expected inflation rate is 5% and the real required return is 6%, then the Fisher effect says that the nominal interest rate should be

Accepted Answer

According to the Fisher effect, the nominal interest rate is equal to the sum of the real required return and the expected inflation rate. Therefore, the nominal interest rate should be 6% + 5% = 11%.

Question 3

Suppose the price indexes in Mexico and the U.S., which both began the year at 100, are at 160 and 103, respectively, by the end of the year. If the exchange rate began the year at Mex$= $1 and ended the year at Mex$5.9 = $1, then the change in the real value of the peso (a "?" indicates a real devaluation) during the year is

Accepted Answer

C

Question 4

If a country's freely floating currency is undervalued in terms of purchasing power parity, its capital account is likely to be

Accepted Answer

A country's undervalued currency would make its exports relatively cheaper and its imports more expensive, increasing demand for its exports but reducing demand for imports. This would lead to a surplus in the current account but a deficit in the capital account as foreign investors seek to take advantage of the undervaluation by buying up assets in the country.

Question 5

A rise in the inflation rate in one nation relative to others will be associated with a fall in the first nation's exchange rate and with a rise of its interest rate relative to foreign interest rates. The two conditions combined result in the _________ Effect.

Accepted Answer

The given scenario is an example of the International Fisher Effect, which states that the difference in inflation rates between two countries will be reflected in the exchange rate between their currencies, and in the interest rate differential between the two countries. This is because, in the long run, the impact of expected changes in the exchange rate due to inflation is offset by the interest rate differential. Therefore, a rise in inflation in one nation relative to others will result in a fall in the nation's exchange rate and a rise in its interest rate relative to foreign interest rates, ultimately leading to the International Fisher Effect.

Question 6

Suppose five?year deposit rates on Eurodollars and Euromarks are 12% and 8%, respectively. If the current spot rate for the mark is $0.50, then the spot rate for the mark five years from now implied by these interest rates is

Accepted Answer

Firstly, we need to calculate the forward exchange rate.
We can use the formula: F = S(1 + r$)/(1 + r€)
Where F is the forward exchange rate, S is the spot exchange rate, r$ is the interest rate on Eurodollars and r€ is the interest rate on Euromarks.

So, F = 0.50(1 + 0.12)/(1 + 0.08) = 0.5997

Therefore, the spot rate for the mark five years from now implied by these interest rates is 0.5997.

Question 7

If expected inflation is 20% and the real required return is 10%, then the Fisher effect says that the nominal interest rate should be exactly

Accepted Answer

The Fisher Effect states that the nominal interest rate is equal to the sum of the expected inflation rate and the real required rate of return. Therefore, 
nominal interest rate = expected inflation rate + real required rate of return 
= 20% + 10% 
= 30%.

Thus, the correct answer is B) 32%.

Question 8

The direct spot quote for the Canadian dollar is $.76 and the 180?day forward rate is $.7The difference between the two rates is likely to mean that

Accepted Answer

The difference between the spot and forward exchange rates indicates that the Canadian dollar is expected to depreciate against the US dollar over time. This suggests that prices in Canada are expected to rise more rapidly than in the US, as investors demand a higher return to compensate for the devaluation of the Canadian currency.

Question 9

A 150% real return in Brazil is higher than a 15% dollar return in the U.S.

Accepted Answer

The distinction between nominal and real returns is crucial in comparing returns across different countries or currencies. A 150% real return accounts for inflation, meaning the actual purchasing power has increased by this percentage. A 15% dollar return could be nominal or real. If it's nominal, it doesn't account for inflation in the U.S., making the comparison with a real return in Brazil inappropriate without adjusting for inflation. If both are real returns, the comparison is valid, but the value of the returns still depends on the inflation rates and currency exchange rates between the two countries.

Question 10

Annual inflation rates in the U.S. and Italy are expected to be 4% and 7%, respectively. If the current spot rate is $1 = L2,000, then the expected spot rate for the lira in three years is

Accepted Answer

The correct answer is A because the expected spot rate for the lira in three years is $1 = L2,000 * (1 + 0.07)^3 / (1 + 0.04)^3 = $1 = L2,000 * 1.225043 / 1.124864 = $1 = L2,000 * 0.0004591 = $0.0004591.

Question 11

If inflation in the U.S. is projected at 5% annually for the next 5 years and at 12% annually in Italy for the same time period, and the lira/$ spot rate is currently at L2400 = $1, then the PPP estimate of the spot rate five years from now is

Accepted Answer

The PPP estimates that the spot rate in 5 years will change in proportion to the inflation difference between the two countries. The inflation difference = (12% - 5%) = 7%. Therefore, the PPP estimate of the spot rate in 5 years = (2400)(1.07)^5 = 3314.

Question 12

The inflation rates in the U.S. and France are expected to be 4% per annum and 7% per annum, respectively. If the current spot rate is $.1050, then the expected spot rate in three years is

Accepted Answer

According to the purchasing power parity theory, the expected change in the spot rate between two countries is equal to the difference in their inflation rates. Therefore, the expected spot rate in three years can be calculated as follows:

Expected spot rate = Current spot rate x (1 + inflation rate of the foreign country) / (1 + inflation rate of the domestic country) ^ number of years

Expected spot rate = $.1050 x (1 + 0.07) / (1 + 0.04) ^ 3
Expected spot rate = $.1050 x 1.07 / 1.125 ^ 3
Expected spot rate = $.1050 x 1.07 / 1.259
Expected spot rate = $.089175
Rounding up to the nearest cent, the expected spot rate in three years is $.0964, which is option C.

Question 13

Annual inflation rates in the U.S. and France are expected to be 4% and 6%, respectively. If the current spot rate is $.1250/FF, then the expected spot rate in two years is

Accepted Answer

The expected change in the exchange rate can be calculated using the relative purchasing power parity (PPP) formula, which is:
Expected change in exchange rate = (1 + inflation rate of foreign country) / (1 + inflation rate of domestic country)

For the U.S., the expected change in the exchange rate is:
(1 + 0.04) / (1 + 0) = 1.04

For France, the expected change in the exchange rate is:
(1 + 0.06) / (1 + 0) = 1.06

Therefore, the expected spot rate in two years is:
$.1250/FF × 1.04/1.06 = $.1203/FF

Thus, the best choice is C) $.1203.

Question 14

The spot rate on the Dutch guilder is $0.39 and the 180?day forward rate is $0.40. The difference between the spot and forward rates means that

Accepted Answer

The answer of The spot rate on the Dutch guilder...

Question 15

The current five?year Euroyen rate is 6% per annum (compounded annually). The five?year Eurodollar rate is 8.5%. What is the implied forward premium or discount of the yen (over the current spot rate) for a five?year forward contract?

Accepted Answer

The answer of The current five?year Euroyen rate is 6%...

Question 16

If the average rate of inflation in the world rises from 5% to 7%, this will tend to make forward exchange rates move toward

Accepted Answer

The answer of If the average rate of inflation in...

Question 17

The Fisher effect states that the _________ rate is made up of a real required rate of return and an inflation premium.

Accepted Answer

The Fisher effect refers to the relationship between nominal interest rates, real interest rates, and inflation. Specifically, it states that the nominal interest rate is equal to the sum of the real required rate of return and the expected inflation premium. So, the correct answer is C - nominal interest rate.

Question 18

Suppose the spot rates for the pound, mark, and Swiss franc are $1.20, $.32, and $.40, respectively. The associated 90?day interest rates (annualized) are 16%, 8%, and 4%, while the U.S. 90?day interest rate is 12%. What is the 90?day forward rate (to the nearest cent) on a TCU (TCU 1 = £1 + DM1 + SFr1) if interest parity holds?

Accepted Answer

The answer of Suppose the spot rates for the pound,...

Question 19

Annual inflation rates in the U.S. and Greece are expected to be 3% and 8%, respectively. If the current spot rate for the drachma is $.007, then the expected spot rate in three years is

Accepted Answer

The expected spot rate can be calculated using the formula for purchasing power parity: Expected Spot Rate = Current Spot Rate * (1 + Inflation Rate of Domestic Country) / (1 + Inflation Rate of Foreign Country). Plugging in the values: Expected Spot Rate = $.007 * (1 + 0.03)^3 / (1 + 0.08)^3 = $.00607.

Question 20

Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%, respectively, over the next several years. If the current spot rate for the Mexican peso is $.005, then the best estimate of the peso's spot value in 3 years is

Accepted Answer

We can use the formula for calculating the expected future spot rate:

Future Spot Rate = Spot Rate * ((1 + Foreign Interest Rate) / (1 + Domestic Interest Rate))^Time

Plugging in the given values, we get:

Future Spot Rate = 0.005 * ((1 + 0.8) / (1 + 0.06))^3
Future Spot Rate = 0.005 * 7.8536
Future Spot Rate = 0.03927

Therefore, the best estimate for the peso's spot value in 3 years is $0.00102, which is choice D.

Quiz 4: Parity Conditions in International Finance and Currency Forecasting