International Finance Final Exam

In conversation, interbank foreign exchange traders use a shorthand abbreviation in expressing spot currency quotations. Consider a $/£ bid-ask quote of $1.9072-$1.9077. The "big figure", assumed to be known to all traders is _____.

1.90

Find the hedge ratio for a call option on €12,500 with a strike price of £10,000. The current exchange rate is the same as the strike price. In the next period, the euro can strengthen against the pound by 25% or weaken by 20% (i.e. u = 1.25 and d = 0.8).

5/9

Consider the graph of a call option shown at right. The option is a three-month American call option on €125,000 with a strike price of $1.40 = €1.00 and an option premium of $7,500. What are the values of A, B, and C, respectively?

A = -$7,500 (or -$.06 depending on your scale); B = $1.40; C = $1.46

Privatilization refers to the process of

A country divesting itself of the ownership and operation of a business venture by turning it over to the free market system

The Fisher effect states that

an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.

If the $/€ bid and ask prices are $1.50/€ and $1.51/€, respectively, the corresponding €/$ bid and ask prices are

bid €0.6623 and ask €0.6667.

The difference between a broker and a dealer is

brokers bring together buyers and sellers, but carry no inventory; dealers stand ready to buy and sell from their inventory.

Which of the following equation can be used to calculate the "no-arbitrage" forward rate?

$/Euro

When a currency trades at a discount in the forward market

the forward rate is less than the spot rate.

The most popular reserve currency is now the

$$$

One potential drawback of the gold standard is

The world economy can be subject to deflationary pressure due to the limited supply of monetary gold

What is the most current spot exchange rate shown for British pounds? Use an indirect quote from a U.S. perspective. Country US $ equiv. Currency per US $ Britain (Pound) £62,500 1.6000 0.6250 1 Month Forward 1.6100 0.6211 3 Months Forward 1.6300 0.6173 6 Months Forward 1.6600 0.6024 12 Months Forward 1.7200 0.5814

$1.00 = £0.6250

Yesterday, you entered into a futures contract to sell €62,500 at $1.4/€. Your initial margin was $6,125. Your maintenance margin is $3,600. At what settlement price (exchange rate) do you get a margin call?

$1.4404/€

Yesterday, you entered into a futures contract to buy €62,500 at $1.6/€. Your initial margin was $7,000. Your maintenance margin is $4,000. At what settlement price (exchange rate) do you get a margin call?

$1.5520/€

The current spot exchange rate is $1.60 = €1.00 and the three-month forward rate is $1.55 = €1.00. Consider a three-month American call option on €62,500. For this option to be considered at-the-money right now, the strike price must be

$1.60 = €1.00

Suppose that Britian pegs the pound to gold at six pounds per oz, whereas the exchange rate between pounds and US dollars is $4=1 pound. What should an oz of gold be worth in US $

$24

Under the Bretton Woods system, each country established a par value for its currency in relation to the dollar. And the US dollar was pegged to gold at

$35/oz

You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.20 how much money can an astute trader make?

$41,667

You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.20 = €1.00 and the dollar-pound exchange rate is quoted at $1.80 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.50 how much money can an astute trader make?

$500,000

Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, and that the spot exchange rate is $1.60/€ and the forward exchange rate, with one-year maturity, is $1.58/€. Assume that an arbitrager can borrow up to $1,000,000 or €625,000. If an astute trader finds an arbitrage, what is the net cash flow in one year? $238.65

$7,000

Suppose that the one-year interest rate is 6% in the United States. The spot exchange rate is $1.00 = ¥100, and the one year forward rate is $1.00 = ¥96. What must the interest rate be in Japan (on an investment of comparable risk) to avoid arbitrage?

1.76%

The emergence of global financial markets is due in small part to

Advances in computer and telecommunications technology

The capital account includes

All purchases and sales of assets such as stocks, bonds, bank accounts, real estate, and businesses

Which of the following is not a benefit of classic gold standard

Almost no deflation

Forward expectations parity (FEP) states that

Any forward premium or discount is equal to the expected change in the exchange rate

Consider the supply-demand framework for the pound relative to the $ shown in the nearby chart. The exchange rate is currently $1.8= 1 pound.

At an exchange rate 1.8 = 1, demand for pounds exceeds supply

Nestle, a well-known Swiss corporation

At one time placed restrictions on foreign ownership of its stock. When it relaxed these restrictions, there was a major transfer of wealth from foreign shareholders to swiss shareholders.

The balance of payments identify is given by BCA + BKA + BRA = 0. Rearrange the identity for a country with pure flexible exchange rate regime

BCA = -BKA

Gresham's Law states that

Bad money drives good money out of circulation

The current exchange rate is £1.00 = $1.50. Compute the correct balances in Bank A's correspondent account(s) with Bank B if a currency trader employed at Bank A buys £100,000 from a currency trader at Bank B for $150,000 using its correspondent relationship with Bank B.

Bank A's dollar-denominated account at B will fall by $150,000.

The international monetary system went through several distinct stages of evolution. These stages are summarized, in alphabetic order as follows

Bimetallism Classical Gold Standard Interwar Period Bretton Woods System Flexible Exchange Rate Regime

A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is 2% and in the euro zone the one-year interest rate is 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain profit via covered interest arbitrage.

Borrow €800,000 at 6%. Trade €800,000 for $1,000,000 at the spot exchange rate ($1.25 = €1.00). Invest in the U.S. at 2% for one year. Sign a forward contract to translate proceeds back into euro at the forward rate of $1.20 = €1.00 in one year.

If the interest rate rises in the US while other variables remain constant

Capital inflows into the US will increase

Which of the following exchange rate arrangements is hard peg?

Currency board

The main approaches to forecasting exchange rates are

Efficient market, Fundamental, and Technical approaches.

A European option is different from an American option in that

European options can only be exercised at maturity; American options can be exercised prior to maturity.

Which of the following is not a lesson from the Mexican Peso Crisis

Even a currency board arrangement cannot be completely safe from all possible collapse

Suppose you start with $100 and buy stock for 50 pounds when the exchange rate is 1 pound = $2. One year later, the stock rises to 60 pound. You are happy with you 20% return on the stock, but when you sell the stock and exchange your 60 pounds for dollars, you only get $45 since the pound has fallen to 1 pound = $.75. This loss of value is an example of

Exchange risk

During the period between WW1 and WW2, which of the following statements is correct

Failure to restore the gold standard Political instabilities and bank failures Panicky flights of capital across borders

What major dimension sets apart international finance from domestic finance?

Foreign exchange and political risks Market imperfections Expanded opportunity set

The balance of payments summarizes the transactions that occur during a given time period between

Individuals, firms, and gov of one country and individuals, firms, and govs throughout the rest of the world

The forward market

Involves contracting today for the future purchase or sale of foreign exchange at a price agreed upon today

If Interest Rate Parity (IRP) fails to hold

It may be due to transactions costs or due to government-imposed capital controls

If the US $ appreciates relative to the pound

It will take fewer dollars to purchase a pound

Which factors are related to the collapse of the Argentine currency board system and ensuring economic crisis

Labor market inflexibility

Which of the following is not advantage of Anglo-Saxon capitalism

Less inequality and poverty at the lowest margins of society

A 'good' (or ideal) international monetary system should provide

Liquidity, adjustments, and confidence

The current account is divided into four finer categories

Merchandise trade, services, factor income, and unilateral transfers

Advantages of a flexible exchange rate include which of the following

National policy autonomy The government can use monetary and fiscal policies to pursue whatever economic goals it chooses Easier external adjustments

If Japan exports more than it imports, then

One can infer that the yen would be likely to appreciate against other currencies

Under the gold standard, international imbalances of payment will be corrected automatically under the

Price-specie-flow mechanism

Which of the following is not main criteria of Optimal Currency Area?

Reduce political risk

The Singapore dollar—U.S. dollar (S$/$) spot exchange rate is S$1.60/$, and the Canadian dollar—U.S. dollar (CD/$) spot rate is CD1.80/$. What is the no-arbitrage cross exchange rate between Singapore dollar and Canadian dollar (S$/CD)?

S$0.8889/CD

Which of the follow statements is not correct

SDR is a claim on the IMF

The SF/$ spot exchange rate is SF1.8/$ and the 180-day forward premium is 9 percent. What is the 180-day forward exchange rate?

SF1.8810/$

Suppose that the pound is pegged to gold at 20 pound per ounce and the dollar is pegged to gold at $35 per ounce. This implies an exchange rate of $1.75 per pound. If the current market exchange rate is $1.60 per pound, how would take advantage of this situation?

Start with $350. Exchange the dollars for pound at the current rate of $1.60 per pound pound. Buy gold with pounds at 20 pounds per ounce. Convert the gold to dollars at $35 per ounce

Suppose you observe the following exchange rates: €1 = $0.85; £1 = $1.60; and €2.00 = £1.00. Starting with $1,000,000, how can you make money?

Start with dollars, exchange for pounds at £1 = $1.60; exchange pounds for euros at €2.00 = £1.00; exchange euros for dollars at €1 = $0.85.

Under a purely flexible exchange rate system

Supply and demand set the exchange rates

The current spot exchange rate is $1.45/€ and the three-month forward rate is $1.55/€. Based upon your economic forecast, you are pretty confident that the spot exchange rate will be $1.50/€ in three months. Assume that you would like to buy or sell €100,000. What actions would you take to speculate in the forward market? How much will you make if your prediction is correct?

Take a short position in a forward contract on euro. If you're right you will make $5,000.

The common monetary policy for the euro zone is now formulated by

The European Central Bank

The Bretton Woods agreement resulted in the creation of

The World Bank

When a country's currency appreciates against the currencies of major trading partners

The country's exports tend to fall and imports rise

Which of the following is not an element of currency board

The currency of another country circulates as the sole legal tender

Under a flexible exchange rate regime, governments can retain monetary policy independence because the external balance will be achieved by

The exchange rate adjustments

The J curve effect shows

The initial deterioration and the eventual improvement of a country's trade balance following a currency depreciation

Consider a trader who takes a long position in a six-month forward contract on the euro. The forward rate is $1.75 = €1.00; the contract size is €62,500. At the maturity of the contract the spot exchange rate is $1.65 = €1.00.

The trader has lost $6,250.

Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the one-year forward exchange rate, is $1.16/€. Assume that an arbitrageur can borrow up to $1,000,000.

This is an example of an arbitrage opportunity; Interest Rate Parity does NOT hold.

Foreign direct investment FDI occurs

When an investor acquires a measure of control of a foreign business AND when there is an acquisition, by a foreign entity, of 10% or more of the voting shares of a business in the US

An "option" is

a contract giving the buyer (owner) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future.

When money can move freely across borders, policy makers must choose between

a fixed exchange rate and an independent monetary policy

The Efficient Markets Hypothesis states

current asset prices (e.g. exchange rates) fully reflect all the available and relevant information.

Gold was officially abandoned as an international reserve asset

in jan 1976 Jamaica agreement

The spot market

involves the almost-immediate purchase or sale of foreign exchange.

The Bid price

is the price that a dealer stands ready to pay.

When a Honda, a Japanese auto maker, built a factory in Ohio

it was engaged in foreign direct investment

The forward price

may be higher, lower or the same as the spot price.

A dealer in British pounds who thinks that the pound is about to depreciate

may want to lower both his bid price and his ask price.

An arbitrage is best defined as

the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making guaranteed profits.

If one country is twice the size of another country and is better at making almost everything than the smaller country

the bigger country enjoys an absolute advantage

Purchasing Power Parity (PPP) theory states that

the exchange rate between currencies of two countries should be equal to the ratio of the countries' price levels

The current account includes

the export and import of goods and services

The International Fisher Effect suggests that

the nominal interest rate differential reflects the expected change in the exchange rate.

Indirect exchange rate quotations from the U.S. perspective are

the price of one U.S. dollar in the foreign currency.

When Interest Rate Parity (IRP) does not hold

there are opportunities for covered interest arbitrage

Comparing "forward" and "futures" exchange contracts, which of the following is incorrect

they are both "marked-to-market" daily.

If one has agreed to buy foreign exchange forward

you have a long position in the forward contract.

Find the no-arbitrage cross exchange rate between euro and yen. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-yen exchange rate is quoted at $1.00 = ¥110.

¥176/€1.00

Suppose a bank customer with €1,000,000 wishes to trade out of euro and into Japanese yen. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-yen exchange rate is quoted at $1.00 = ¥120. How many yen will the customer get?

¥192,000,000

Suppose that the current exchange rate is €1.00 = $1.60. The indirect quote, from the U.S. perspective is

€0.6250 = $1.00