Chapter 7

Graph of IRP

- Straight line through (0,0) slope of 1

Assume that the spot rate of the Brazilian real is $0.34. The annual U.S. interest rate is currently 2 percent and Brazilian annual interest rate is currently 6 percent. Assume that interest rate parity exists. Determine the one-year forward rate of the Brazilian real. Do not round intermediate calculations. Round your answer to the nearest cent.

1. Forward rate prem: (1+US IR)/(1+foreign IR)-1 (1+2%)/(1+6%)-1= -3.77% 2. Derive FR : Brazilian real spot*(1+FR Prem) .34* (1 +(-.3.77%)) = .33

Locational Arbitrage Process:

1. Start with using $ to purchase currency at LOWER ask price ($/price) 2.Then sell to bank with HIGHER bid price (ANS^*bid price) 3. Subtract answers for profit (No profit if lower ask and higher bid prices are the same)

Interest rate parity exists between the United States and Poland (its currency is the zloty). The one-year risk-free CD (deposit) rate in the United States is 7 percent. The one-year risk-free CD rate in Poland is 5 percent and deposit is denominated in zloty. Assume that there is zero probability of any financial or political problem such as a bank default or government restrictions on bank deposits or currencies in either country. Myron is from Poland and plans to invest in the United States. What is Myron's return if he invests in the United States and covers the risk of his investment with a forward contract? Round your answers to the nearest whole number. His return is __%. The forward premium on the zloty will be about __%. He will earn __% on the U.S. investment but will pay about __% more when he buys zloty forward to close out his position than what he exchanged zloty for to obtain dollars when initiating the investment.

5, 2, 7, 2

As of now, the nominal interest rate is 6 percent in the United States and 6 percent in Australia. The spot rate of the Australian dollar is $0.58, while the one-year forward rate of the Australian dollar exhibits a discount of 2 percent. Assume that as covered interest arbitrage occurred this morning, the interest rates were not affected, the spot rate of the Australian dollar was not affected, but the forward rate of the Australian dollar was affected. Consequently interest rate parity now exists. Explain the forces that caused the forward rate of the Australian dollar to change. The (Australian/U.S.) investors could benefit from engaging in covered interest arbitrage; their arbitrage would involve (buying/selling) Australian dollars forward, which would cause the forward rate of the Australian dollar to (increase/decrease).

Australian, buying, increase

Assume that cross exchange rates are always proper such that triangular arbitrage is not feasible. While at the Miami airport today, you notice that a U.S. dollar can be exchanged for 125 Japanese yen, or 4 Argentine pesos at the foreign exchange booth. Last year, the Japanese yen was valued at $0.01, and the Argentine peso was valued at $0.29. Based on this information, the Argentine peso has changed by what percent against the Japanese yen over the last year? Round your answer to two decimal places.

Convert peso to direct exchange rate: 1/4 =.25 Convert yen to direct exchange rate: 1/125 = .008 Cross rate now: .25/.008= 31.25 yen Cross rate last year .29/.01= 29 yen Change: (31.25-29)/29= +7.76%

You go to a bank and are given these quotes: You can buy a euro for 12 pesos.The bank will pay you 11 pesos for a euro.You can buy a U.S. dollar for 0.84 euros.The bank will pay you 0.74 euros for a U.S. dollar.You can buy a U.S. dollar for 8 pesos.The bank will pay you 7 pesos for a U.S. dollar. Compute Profit that you would earn using triangular arbitrage.

Covert info to direct Quotes: Euro in $ Bid: 1/ price you can buy Ask: 1/ price bank pays Peso in $ Bid: 1/ price you can buy Ask: 1/ price bank pays Euro in Peso Bid and Ask: From problem Use $ to buy euros: 2,000/ euro in $ ask Convert euros to buy pesos ANS^*euro in peso bid convert peso to $: ANS^*peso in dollar bid Compute profit

Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the United States is 8 percent, while the one-year nominal interest rate in Australia is 11 percent. The spot rate of the Australian dollar is $0.62. You will need 9 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many U.S. dollars will you need in one year to fulfill your forward contract? Do not round intermediate calculations. Round your answer to the nearest dollar.

Dollars needed in one year (1.08/1.11)-1 = -2.70% 1 yr Fwd Rate: .62* (1-(-.0270)) =.6032 You need 9,000,000 * .6032= 5,429,189(final)

Covered Interest Arbitrage Process:

Exchange dollars to Euro (dollars / spot) Deposit in bank as they grow (Euro value *1+Eurozone) Exchange Euro to dollars (ANS^* fwd rate) Find difference and profit

Triangular Arbitrage Process: (multiple currencies)

Find real cross exchange rate: (Euro/peso)= rate in peso Exchange dollars for larger spot rate: ($/rate) Exchange euros for pesos: (ANS^ *cross exch rate) Exchange pesos for dollars: (ANS(*other spot rate) Subtract answers for profit

Interest Rate Parity (IRP)

Forward Rate Premium = (1+US Rate)/(1+Foreign Rate)-1 6 month Fwd Rate = Spot Rate (1+ FRP^) Find profit when converting pesos back to dollars and for accrued interest Accrued Int = $ *(1+rate) Under interest rate parity, if the difference in profits is small, it illustrates investing domestically could produce same results.

Covered Interest Arbitrage (Yield %)

Investment/spot rate * (1+int rate) ANS^* Fwd Rate Yield = (ANS^-Investment)/Investment

Earlier this morning, the annual U.S. interest rate was 6 percent and Mexico's annual interest rate was 8 percent. The spot rate of the Mexican peso was $0.16. The one-year forward rate of the peso was $0.15. Assume that as covered interest arbitrage occurred this morning, the interest rates were not affected, and the spot rate was not affected, but the forward rate was affected, and consequently interest rate parity now exists. Explain which type of investor (Mexican or U.S.) engaged in covered interest arbitrage, whether they were buying or selling pesos forward, and how that affected the forward rate of the peso. (Mexican/U.S.) investors engaged in covered interest arbitrage by exchanging (pesos for dollars/dollars for pesos) today and then (buying/selling) pesos forward. It placed (downward/upward) 4 pressure on the forward rate of the peso.

Mexican, peso for dollar, buying, upward

Locational Arbitrage

Purchasing a currency at a location where it is cheaply priced and immediately selling it at another location where the price is higher

Assume that the annual U.S. interest rate is currently 7 percent and Japan's annual interest rate is currently 8 percent. The spot rate of the Japanese yen is $0.01. The one-year forward rate of the Japanese yen is $0.01. Assume that as covered interest arbitrage occurs, the interest rates are not affected, and the spot rate is not affected. Explain how the one-year forward rate of the yen will change in order to restore interest rate parity, and why it will change. [Your explanation should specify which type of investor (Japanese or U.S.) would be engaging in covered interest arbitrage and whether these investors are buying or selling yen forward, and how that affects the forward rate of the yen.] (Japanese/U.S.) investors will be able to engage in covered interest rate arbitrage. They will exchange (yen for dollars/dollars for yen) and also (buy/sell) one-year yen forward contracts. This will cause a (upward/downward) pressure on the one-year forward yen rate.

U.S. , dollars for yen, sell, downward

According to interest rate parity (IRP) a. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies. b. the future spot rate differs from the current spot rate by a sufficient amount to offset the inflation differential between two currencies. c. the future spot rate differs from the current spot rate by a sufficient amount to offset the interest rate differential between two currencies. d. the forward rate differs from the spot rate by a sufficient amount to offset the inflation rate differential between two currencies.

a

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 National Bank at the ask rate and selling them to American Bank at the bid rate. b. buying rupees from American Bank at the bid rate and selling them to National Bank at the ask 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.

a

If the U.S. interest rate is close to zero, while the interest rate of Russia was very high, what would interest rate parity suggest about the forward rate of the Russian ruble? Explain. a. The forward rate of the Russian ruble should exhibit a discount. If not, a U.S. investor could have conducted covered interest arbitrage by converting dollars to rubles, investing in Russia, and simultaneously selling rubles forward. b. The forward rate of the Russian ruble should exhibit a discount. If not, a Russian investor could have conducted covered interest arbitrage by converting rubles to dollars, investing in the U.S., and simultaneously selling dollars forward. c. The forward rate of the Russian ruble should exhibit a premium. If not, a U.S. investor could have conducted covered interest arbitrage by converting dollars to rubles, investing in Russia, and simultaneously selling rubles forward.

a

What market forces would occur to eliminate any further possibilities of covered interest arbitrage? a.The Canadian dollar's spot rate should rise, and its forward rate should fall; in addition, the Canadian interest rate may fall and the U.S. interest rate may rise. b.The Canadian dollar's spot rate should fall, and its forward rate should rise; in addition, the Canadian interest rate may rise and the U.S. interest rate may fall. c.The Canadian dollar's spot rate should rise, and its forward rate should rise; in addition, the Canadian interest rate may fall and the U.S. interest rate may fall.

a

Assume that interest rate parity (IRP) exists, along with the following information: Spot rate of British pound = $1.80 6-month forward rate of pound = $1.82 12-month forward rate of pound = $1.78 Is the annualized 6-month U.S. risk-free interest rate above, below, or equal to the British risk-free interest rate? a. The 6-month U.S. risk-free interest rate must be (above/below/equal to) the 6-month British risk-free interest rate. Is the 12-month U.S. risk-free interest rate above, below, or equal to the British risk-free interest rate? b The 12-month U.S. risk-free interest rate must be (above/below/equal to) the 12-month British risk-free interest rate.

above, equal to

Assume that interest rate parity does not hold, and Japanese investors are benefiting from covered interest arbitrage due to high interest rates in the U.S. Which of the following forces should result from this covered interest arbitrage activity? a. downward pressure on the yen's forward rate b. downward pressure on the yen's spot rate c. downward pressure on the yen's interest rate d. upward pressure on the U.S. interest rate

b

Assume that the Swiss interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the following is true? a. Americans who invest in the United States earn the same rate of return as Swiss investors who attempt covered interest arbitrage. b. Americans using covered interest arbitrage earn the same rate of return as Swiss investors who attempt covered interest arbitrage. c. Swiss investors who attempt covered interest arbitrage earn a higher return than American investors who attempt covered interest arbitrage. d. Americans who invest in the United States earn the same rate of return as Swiss investors who invest in Switzerland.

c

Assume that the annual U.S. interest rate is currently 6 percent and Germany's annual interest rate is currently 8 percent. The spot rate of the euro is $1.10 and the one-year forward rate of the euro is $1.10. Assume that as covered interest arbitrage occurs, the interest rates are not affected, and the spot rate is not affected. Explain how the one-year forward rate of the euro will change in order to restore interest rate parity, and why it will change. Your explanation should specify which type of investor (German or U.S.) would be engaging in covered interest arbitrage, whether they are buying or selling euros forward, and how that affects the forward rate of the euro. a. U.S. investors will engage in covered interest arbitrage, which involves forward purchases of euros, and will place upward pressure on the one-year forward rate. b. U.S. investors will engage in covered interest arbitrage, which involves forward sales of euros, and will place downward pressure on the one-year forward rate. c. German investors will engage in covered interest arbitrage, which involves forward sales of euros, and will place downward pressure on the one-year forward rate. d. German investors will engage in covered interest arbitrage, which involves forward purchases of euros, and will place upward pressure on the one-year forward rate.

b

Assume that the interest rate in the home country of Currency X is much lower than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X a. should exhibit a discount. b. should exhibit a premium. c. should be zero d. the information provided is not sufficient to select any answer.

b

Due to ____, market forces should realign the spot rate of a currency among banks. a. quadratic arbitrage b. locational arbitrage c. triangular arbitrage d. covered interest arbitrage

b

What market forces would occur to eliminate any further possibilities of triangular arbitrage? a. The value of the Canadian dollar with respect to the U.S. dollar would rise. The value of the Canadian dollar with respect to the New Zealand dollar would rise. The value of the New Zealand dollar with respect to the U.S. dollar would fall. b. The value of the Canadian dollar with respect to the U.S. dollar would rise. The value of the Canadian dollar with respect to the New Zealand dollar would decline. The value of the New Zealand dollar with respect to the U.S. dollar would fall. c. The value of the New Zeland dollars with respect to the U.S. dollar would rise. The value of the Canadian dollar with respect to the New Zeland dollar would rise. The value of the Canadian dollar with respect to the U.S. dollar would fall.

b

Which of these statements is true? a. If interest rate parity exists, then the return for British investors who use covered interest arbitrage will be higher than the return for British investors who invest in British Treasury bills. b. If interest rate parity exists, then the return for British investors who use covered interest arbitrage will be the same as the return for British investors who invest in British Treasury bills. c. If interest rate parity exists, then the return for British investors who use covered interest arbitrage will be lower than the return for British investors who invest in British Treasury bills.

b

Which of these statements is true? a. If interest rate parity exists, then the return for U.S. investors who use covered interest arbitrage will be higher than the return for U.S. investors who invest in U.S. Treasury bills. b. If interest rate parity exists, then the return for U.S. investors who use covered interest arbitrage will be the same as the return for U.S. investors who invest in U.S. Treasury bills. c. If interest rate parity exists, then the return for U.S. investors who use covered interest arbitrage will be lower than the return for U.S. investors who invest in U.S. Treasury bills.

b

The one-year interest rate in Singapore is 13 percent. The one-year interest rate in the United States is 5 percent. The spot rate of the Singapore dollar (S$) is $0.52 and the forward rate of the S$ is $0.47. Assume zero transactions costs. Does interest rate parity exist? a. Yes, because the discount is equal to the interest rate differential. b. No, because the discount is larger than the interest rate differential. c. No, because the discount is smaller than the interest rate differential. Can a U.S. firm benefit from investing funds in Singapore using covered interest arbitrage? a. No, because of the interest rate parity. b. Yes, because the discount on a forward sale does not offset the interest rate advantage of investing in Singapore. c. No, because the discount on a forward sale exceeds the interest rate advantage of investing in Singapore.

b, c

Assume that the annual U.S. interest rate is currently 9 percent and Germany's annual interest rate is currently 8 percent. The euro's one-year forward rate currently exhibits a premium of 2 percent. Does interest rate parity exist? a. Yes, interest rate parity exists. b. No, interest rate parity does not exist. Can a U.S. firm benefit from investing funds in Germany using covered interest arbitrage? a. No, because of interest rate parity. b. No, because the U.S. interest rate is higher than the German interest rate. c. Yes, because even though it would earn 1 percent less interest over the year by investing in euros, it would be able to sell euro for 2 percent more than it paid for them. Can a German subsidiary of a U.S. firm benefit by investing funds in the United States through covered interest arbitrage? a. No, because of interest rate parity. b. No, because the premium on a forward sale exceeds the interest rate advantage of investing in the U.S. c. Yes, because the German interest rate is lower than the U.S. interest rate.

b, c, b

Assume that the 30-day forward premium of the euro is 1 percent, while the 90-day forward premium of the euro is 2 percent. Explain the likely interest rate conditions that would cause these premiums. Does this ensure that covered interest arbitrage is worthwhile? These premiums could occur when the euro's 30-day interest rate is (above/below) the U.S. 30-day interest rate, and the euro's 90-day interest rate is (above/below) the U.S. 90-day interest rate. This (does not ensure/ensures) that covered interest arbitrage is worthwhile.

below, below, does not ensure

Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP7. Given this information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the Mexican peso (MXP) should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____. a. depreciate; appreciate b. remain stable; appreciate c. appreciate; appreciate d. appreciate; depreciate e. depreciate; depreciate

c

If U.S. firms attempt to use covered interest arbitrage to capitalize on the high Argentine peso interest rate, what forces should occur? a. Spot rate of peso decreases; forward rate of peso increases. b. Spot rate of peso increases; forward rate of peso increases. c. Spot rate of peso increases; forward rate of peso decreases. d. Spot rate of peso decreases; forward rate of peso decreases.

c

If the relationship that is specified by interest rate parity does not exist at any period but does exist on average, then covered interest arbitrage should not be considered by U.S. firms. Do you agree or disagree with this statement? Explain. a. Agree. If interest rate parity does exist on average, it proves that covered interest arbitrage is eliminated. b. Agree. If at any point in time, interest rate parity does not exist, transactions costs and tax differences completely offset the excess returns. c. Disagree. If at any point in time, interest rate parity does not exist, covered interest arbitrage could earn excess returns.

c

Assume zero transactions costs. As of now, the Japanese one-year interest rate is 2 percent, and the U.S. one-year interest rate is 8 percent. The spot rate of the Japanese yen is $0.0090 and the one-year forward rate of the Japanese yen is $0.0092. Determine whether interest rate parity exists, or whether the quoted forward rate is quoted too high or too low. a. Interest rate parity exists. b. The quoted forward rate is too high. IRP does not exist. c. The quoted forward rate is too low. IRP does not exist. Based on the information provided in (a), is covered interest arbitrage feasible for U.S. investors, for Japanese investors, for both types of investors, or for neither type of investor? a. U.S. investors could engage in covered interest arbitrage by exchanging dollars for yen today and then selling yen forward. b. Japanese investors could engage in covered interest arbitrage by exchanging yen for dollars today and then selling dollar forward. c. Covered interest arbitrage is feasible for neither type of investor. d. Covered interest arbitrage is feasible for both types of investors.

c, b

Assume that interest rate parity exists and will continue to exist. The U.S. interest rate was 4% while the Singapore interest rate was 5% at the beginning of the month. Assume the Singapore interest rate rises while the U.S. interest rate declines over the month. Based on this information, the forward rate of the Singapore dollar exhibited a______ at the beginning of the month, and _______by the end of the month. a. discount; discount changed to a premium b. premium; the size of the premium increased c. premium; changed to a discount d. discount; the size of the discount increased

d

Assume the following information: 1 yr deposit rate on US $: 12% 1 yr deposit rate on Singapore dollars: 10% 1 yr forward rate on Singapore dollars: $.412 Spot rate on Singapore dollar: $.400 a. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. b. interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically. c. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically. d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically.

d

Today, the annualized interest rate in the United States is 4 percent for any debt maturity. The annualized interest rate in Australia is 4 percent for debt maturities of three months or less, 5 percent for debt maturities between three months and six months, and 6 percent for debt maturities more than six months. Assume that interest rate parity exists. Does the forward rate quoted today for the Australian dollar exhibit a premium or a discount, or does your answer vary with specific conditions? Briefly explain. a. The forward rate of the Australian dollar exhibits a discount for maturities less than 3 months (since interest rates are the same), and no discount or premium for any maturities beyond 3 months since the Australian interest rates are higher than U.S. interest rates for those maturities. b. The forward rate of the Australian dollar exhibits a premium for maturities less than 3 months (since interest rates are the same), and no discount or premium for any maturities beyond 3 months since the Australian interest rates are higher than U.S. interest rates for those maturities. c. The forward rate of the Australian dollar exhibits no discount or premium for maturities less than 3 months (since interest rates are the same), and a premium for any maturities beyond 3 months since the Australian interest rates are higher than U.S. interest rates for those maturities. d. The forward rate of the Australian dollar exhibits no discount or premium for maturities less than 3 months (since interest rates are the same), and a discount for any maturities beyond 3 months since the Australian interest rates are higher than U.S. interest rates for those maturities.

d

Which of the following best describes covered interest arbitrage? a. Using forward contracts to mitigate default risk, while attempting to capitalize on higher interest rates in a particular country b. Using forward contracts to mitigate interest rate risk, while attempting to capitalize on equal interest rates across countries c. Using forward contracts to mitigate default risk, while attempting to capitalize on equal interest rates across countries d. Using forward contracts to mitigate exchange rate risk, while attempting to capitalize on higher interest rates in a particular country

d

The expectations of a weaker U.S. economy resulted in a (decline/rise) of short-term interest rates. The U.S. interest rate was (reduced/increased) while foreign interest rates were not. Therefore, the forward premium on foreign currencies (decreased/increased), or the forward discount became (more/less) pronounced.

decline, reduced, decreased, more

Assume that the Japanese yen's forward rate currently exhibits a premium of 6 percent and that interest rate parity exists. If U.S. interest rates decrease, how must this premium change to maintain interest rate parity? Why might we expect the premium to change? The premium will (decrease/increase) in order to maintain IRP, because the difference between the interest rates is (reduced/increased). We would expect the premium to change because as U.S. interest rates decrease, (U.S. investors/Japanese investors) could benefit from covered interest arbitrage if the forward premium stays the same.

decrease, reduced, US Investors

Assume that interest rate parity (IRP) exists, along with the following information: Spot rate of Swiss franc = $0.80 6-month forward rate of Swiss franc = $0.78 12-month forward rate of Swiss franc = $0.81 Assume that the annualized U.S. interest rate is 7 percent for a 6-month maturity and a 12-month maturity. Do you think the Swiss interest rate for a 6-month maturity is greater than, equal to, or less than the U.S. interest rate for a 6-month maturity? Explain. Since the 6-month forward rate contains a (discount/premium) , the Swiss 6-month interest rate must be (higher/lower) than the U.S. 6-month interest rate.

discount, higher

Suppose you observe that 90-day interest rate across the eurozone is 7%, while the interest rate in the U.S. over the same time period is 3%. Further, the spot rate and the 90-day forward rate on the euro are both $1.25. You have $800,000 that you wish to use in order to engage in covered interest arbitrage. If many individuals recognize the same arbitrage opportunity, and sell euros forward just as you did, this would place (upward, downward) pressure on the forward rate. This would continue until the (premium, discount) on the forward rate (relative to the current spot rate) was approximately (1%,2%,3%,4%,5%)

downward, discount, 4%

Assume that the forward rate premium of the euro was lower last month than it is today. What does this imply about interest rate differentials between the United States and Europe today compared to those last month? The interest rate differential is (smaller/greater) now than it was last month.

greater

Why do you think currencies of countries with high inflation rates tend to have forward discounts? These currencies have (high/low) interest rates, which cause forward rates to have discounts as a result of interest rate parity.

high

What market forces would occur to eliminate any further possibilities of locational arbitrage? The large demand for New Zealand dollars at Yardley Bank will force this bank's ask price on New Zealand dollars to (increase/decrease). The large sales of New Zealand dollars to Beal Bank will force its bid price (up/down).

increase, down

Assume that interest rate parity holds and will continue to hold in the future. At the beginning of the month, the spot rate of the British pound is $1.60, while the one-year forward rate is $1.50. Assume that U.S. annual interest rate remains steady over the month. At the end of the month, the one-year forward rate of the British pound exhibits a discount of 1 percent. Explain how the British annual interest rate changed over the month, and whether it is higher, lower, or equal to the U.S. rate at the end of the month. For interest parity to hold, the forward discount at the beginning of the month implies that the U.S. interest rate is much (higher/lower) than the British interest rate. During the month, the British interest rate must have (decreased/increased). By the end of the month, the gap between the U.S. and British interest rates must have (narrowed/widened) because the forward discount has (increased/declined), but the British interest rate must still be (higher/lower) than the U.S. interest rate.

lower, decreased, narrowed, decline, higher

Assume that interest rate parity holds. At the beginning of the month, the spot rate of the Canadian dollar is $0.70, while the one-year forward rate is $0.68. Assume that U.S. interest rates increase steadily over the month. At the end of the month, the one-year forward rate is lower than it was at the beginning of the month. Yet, the one-year forward discount is larger (the one-year premium is more negative) at the end of the month than it was at the beginning of the month. Explain how the relationship between the U.S. interest rate and the Canadian interest rate changed from the beginning of the month until the end of the month. The forward discount at the beginning of the month implies that the U.S. interest rate is (lower/higher) than the Canadian interest rate. During the month, the Canadian interest rate must have increased by a (greater/lower) degree than the U.S. interest rate. At the end of the month, the gap between the Canadian dollar and the U.S. dollar is (greater/smaller) than it was at the beginning of the month. This results in a more pronounced forward discount.

lower, greater, greater

Assume that interest rate parity exists. The 6-month forward rate of the Swiss franc has a premium while the 12-month forward rate of the Swiss franc has a discount. What does this tell you about the relative level of Swiss interest rates versus U.S. interest rates? The 6-month Swiss interest rate must be (lower/higher) than the 6-month U.S. interest rate. The 12-month Swiss interest rate must be (lower/higher) than the 12-month U.S. interest rate.

lower, higher

The South African rand has a one-year forward premium of 2 percent. One-year interest rates in the U.S. are 3 percentage points higher than in South Africa. Based on this information, is covered interest arbitrage possible for a U.S. investor if interest rate parity holds? (No/Yes) , covered interest arbitrage (is not/is) possible for a U.S. investor because the interest rate differential is (higher/lower) than the forward premium.

no, is not, higher

Covered Interest arbitrage is feasible for -no one when point is (above, below, on) IRP line -foreign investors when point is (above, below, on) IRP line -domestic investors when point is (above, below, on) IRP line

on, above, below

Why would U.S. investors consider covered interest arbitrage in France when the interest rate on euros in France is lower than the U.S. interest rate? If the forward (premium/discount) more than offsets the lower interest rate, investors could use covered interest arbitrage by investing in euros and achieve higher returns than in the U.S.

premium

Assume that interest rate parity exists and will continue to exist. As of this morning, the one-month interest rate in the United States was higher than the one-month interest rate in the eurozone. Assume that as a result of the European Central Bank's monetary policy this afternoon, the one-month interest rate of the euro increased and is now higher than the U.S. one-month interest rate. The one-month interest rate in the United States remained unchanged. Based on the information, do you think the one-month forward rate of the euro exhibited a discount or premium this morning? The one-month forward rate of the euro exhibited a (discount/premium) this morning. How did the forward rate of the euro change this afternoon? a. In the afternoon, the forward rate of the euro should exhibit a lower premium than in the morning. b. In the afternoon, the forward rate of the euro should exhibit a discount instead of a premium. c. In the afternoon, the forward rate of the euro should exhibit a premium instead of a discount. d. In the afternoon, the forward rate of the euro should exhibit a lower discount than in the morning.

premium, b

Assume that interest rate parity exists. As of this morning, the one-month interest rate in Canada was lower than the one-month interest rate in the United States. Assume that as a result of the Fed's monetary policy this afternoon, the one-month interest rate in the United States declined this afternoon, but was still higher than the Canadian one-month interest rate. The one-month interest rate in Canada remained unchanged. Based on the information, the forward rate of the Canadian dollar exhibited a (premium/discount) this morning that (decreased/increased) this afternoon.

premium, decreased

At the end of this month, you (owner of a U.S. firm) are meeting with a Japanese firm to which you will try to sell supplies. If you receive an order from that firm, you will obtain a forward contract to hedge the future receivables in yen. As of this morning, the forward rate of the yen and spot rate are the same. You believe that interest rate parity holds. This afternoon, news occurs that makes you believe that the U.S. interest rates will increase substantially by the end of this month, and that the Japanese interest rate will not change. However, your expectations of the spot rate of the Japanese yen are not affected at all in the future. How will your expected dollar amount of receivables from the Japanese transaction be affected (if at all) by the news that occurred this afternoon? Explain. If U.S. interest rates increase, then the forward rate of the yen will exhibit a (premium/discount). Therefore, if you hedge your receivables at the end of this month, the dollar amount to be received would be (higher/lower).

premium, higher

Assume that interest rate parity exists and will continue to exist. On September 1, the one-year interest rate of Singapore is 4 percent versus 7 percent in the United States. The Singapore central bank is expected to decrease interest rates in the future so that as of December 1, you expect that the one-year interest rate in Singapore will be 2 percent. The U.S. interest rate is not expected to change over time. Based on the information, explain how the forward premium (or discount) is expected to change by December 1. For all situations in which the foreign interest is less than the US, the forward rate should exhibit a (premium/discount) that is the same as the difference in interest rates. The differential is expected to (increase/decrease) over time, so the (premium/discount) will become (larger/smaller).

premium, increase, premium, larger

Assume that the one-year interest rate in the United Kingdom is 9 percent, while the one-year interest in the United States is 4 percent. The spot rate of the pound is $1.50. Assume that interest rate parity exists. The quoted one-year interest in the United Kingdom is expected to decline consistently over the next month. Meanwhile, the quoted one-year interest rate in the United States is expected to rise consistently over the next month. Assume that the spot rate does not change over the month. Based on this information, how will the quoted one-year forward rate change over the next month? It should (decline/rise) consistently over the next month.

rise

Forward Rate price:

spot price (1+ premium) or (1- discount)

Assume that Mexico's economy has expanded significantly, causing a high demand for loanable funds there by local firms. How might these conditions affect the forward discount of the Mexican peso? Expansion in Mexico creates a demand for loanable funds, which places (upward/downward) pressure on Mexican interest rates, which (increases/reduces) the forward discount on the Mexican peso (or (increases/reduces) the premium).

upward, increases, reduces