Question 1

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

The answer of Assume you discovered an opportunity for locational...

Question 2

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 3

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

When covered interest arbitrage is not feasible, it means that the forward rate does not provide an opportunity to lock in a riskless profit, and in this case, interest rate parity must hold. This is because the absence of covered interest arbitrage implies that there are no arbitrage opportunities to exploit, which consequently means that the foreign exchange markets are efficient and the exchange rates reflect the relative interest rates between the two countries. A, B, and C are true statements regarding interest rate parity.

Question 4

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 discrepancies between three currencies. In option C, the implied rate from the given exchange rates allows for a profit by converting currencies in a loop, starting and ending with the same currency.

Question 5

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 $500,000 / $0.305 = 1,639,344.26 MYR. Selling this at $0.306 gives $501,639.34, resulting in a profit of $501,639.34 - $500,000 = $1,639.34, approximately $1,639.

Question 6

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 other factors such as transaction costs, currency restrictions, and differential tax laws.

Question 7

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, not a premium, because the interest rate in South Africa is higher than in the U.S.

Question 8

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 forward exchange rate between two currencies should be equal to the ratio of the two countries' interest rates. This implies that the forward rate premium or discount on a foreign currency should be roughly equal to the interest rate differential between the United States and the foreign country. Therefore, option A is correct.

Question 9

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 10

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 lower than the interest rate in the home country as well. In this case, an investor would borrow in the home currency, convert to the foreign currency, invest at the lower foreign interest rate, and then convert back to the home currency at the end of the investment period. The profit would come from the difference between the two interest rates, minus any transaction costs.

Question 11

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 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 exchange rate should incorporate the difference in interest rates between two countries. The larger the difference in interest rates, the larger will be the forward discount of the foreign currency relative to the home currency. So, the statement is true.

Question 13

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 14

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 15

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

The text mentions locational, triangular, and covered interest arbitrage as forms of international arbitrage, but does not mention transactional arbitrage.

Question 16

National Bank quotes the following for the British pound and the New Zealand dollar:  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 17

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

This statement is true. Points to the left of the IRP line indicate that the foreign currency is priced at a premium to its expected future spot rate, making it more expensive to hedge currency risk. Therefore, a U.S. investor would not be able to profitably engage in covered interest arbitrage. However, a foreign investor could potentially take advantage of the favorable exchange rate and earn a profit through covered interest arbitrage.

Quiz 7: International Arbitrage and Interest Rate Parity

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?

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

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

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?