FIN 475, Exam 2 Study Questions

The bid price

price a dealer is willing to pay you for something.

Assume the following quotes: -Citibank quotes US dollars per pound at $1.8500/£ -National Westminster quotes euro per pound at €1.5000/£ -Deutsche Bank quotes dollars per euro at $1.2400/€ Calculate how a market trader with $1,000,000 can make an intermarket arbitrage profit.

$/€ cross rate between Citibank and National Westminster = $1.2333 / €, which is less than the direct rate at Deutsche Bank. So the trader would want to buy euros through the cross rate transaction. First, buy pounds at Citibank: £540,540.50 Second, buy euros at National Westminster: €810,810.81 Third, buy dollars at Deutsche Bank: $1,005,405.40. The result is a profit of $5,405.40.

Interest Rate Parity Equation

(Forward Rate - Spot Rate) / Spot Rate = IntRef - IntDen

Percent Premium/Discount

(Forward Rate - Spot Rate)/Spot Rate x (360/N) x 100

Percent spread

(ask price - bid price)/bid price x 100

International Fisher Effect Approximation

(spot exchange 1) - (spot exchange 0) / (spot exchange 0) = IntRef - IntDen

Using the excerpt below, calculate the one-, three-, and six-month forward premium or discount for the Canadian dollar versus the U.S. dollar using American term quotations (see definition in the book). For simplicity, assume each moth has 30 days. in US $ per US $ Canada dollar 0.9629 1.0385 -1-month forward 0.9628 1.0386 -3-months forward 0.9624 1.0391 -6-months forward 0.9614 1.0401 What is the interpretation of your results?

1 month forward= [(.9628 - .9629)/.9629] * (360/30) = -.0012 = 0.12% discount 3 month forward= [(.9624 - .9629)/.9629] * (360/90) = -.0021 = 0.21% discount 6 month forward= [(.9614 - .9629)/.9629] * (360/180) = -.0031 = 0.31% discount The Canadian dollar sells forward at a discount that becomes deeper over time. The implication is that the Canadian dollar is expected to depreciate against the U.S. dollar.

Credit Suisse First Boston (CSFB) quotes the following rates for the U.S. dollar. Round to 4 decimal places in your work. Bid (€/$) Ask (€/$) Spot rate 0.8894 0.8898 1-month forward 0.8938 0.8942 3-month forward 0.9028 0.9032 6-month forward 0.9164 0.9168 12-month forward 0.9443 0.9447 What is the annualized 6-month forward premium or discount on the euro?

5.91% discount

Credit Suisse First Boston (CSFB) quotes the following rates for the U.S. dollar. Round to 4 decimal places in your work. Bid (€/$) Ask (€/$) Spot rate 0.8894 0.8898 1-month forward 0.8938 0.8942 3-month forward 0.9028 0.9032 6-month forward 0.9164 0.9168 12-month forward 0.9443 0.9447 What is the annualized 3-month forward premium or discount on the dollar?

6.02% premium

Arbitrage

A trading strategy based on the purchase of a commodity, including foreign exchange, in one market at one price while simultaneously selling it in another market at a more advantageous price, in order to obtain a risk free profit on the price differential.

A bank is quoting the following exchange rates against the dollar for the Swiss franc and the Australian dollar: - SFr/$ = 1.5960-70 - A$/$ = 1.7225-35 An Australian firm asks the bank for an A$/SFr quote. What cross-rate would the bank quote?

AUD/CHF = 1.0786-99 The bank bids CHF 1.596 per USD and asks AUD 1.7235 per USDo - So it asks AUD 1.7235 / CHF 1.596 = AUD/CHF ask of 1.0799 The bank bids 1.7225 AUD per USD and asks CHF 1.5970 per USDo - So it bids AUD 1.7225 / 1.5970 = AUD/CHF bid of 1.0786 Additional explanation: Suppose the FIRM has AUD and wants CHF. We can use its transactions to find the Bank's ask on the CHF. First, the Firm buys USD at the bank's ask on the US dollar of AUD1.7235/USD. So it has $0.5802/AUD. Next, the Firm buys CHF at the bank's bid on the US dollar (CHF 1.5960/$).So the Firm gets ($0.5802/AUD)*(CHF1.596/$) = CHF09256/AUD. That is, the bank asks AUD1.0799/CHF. Now suppose the FIRM has CHF and wants AUD. We can use its transactions to find the Bank's bid on the CHF. First the firm pays the bank's ask rate on the USD of CHF1.597/$. So it has $0.6262/CHF. Then it receives the bank's bid rate on the USD, so it has ($0.6262/CHF)*(AUD1.7225/$) = AUD1.0786/CHF, the bank's bid on the CHF.

Nominal Exchange Rate

Actual exchange rate at S(t). No adjustments

Suppose an investor has $2,000,000 and can choose to invest in U.S. securities for six months or make a covered interest arbitrage investment in the Swiss franc. She faces the following rates: Spot exchange rate CHF1.1520/$ 6-month forward rate CHF1.1472/$ 6-month U.S. interest rate 4.5% per annum 6-month Swiss interest rate 3.2% per annum Which is the better investment? Explain why (assume interest is compounded annually so adjust the annual rates to 6 month rates).

After investing in the U.S, the investor has $2,000,000 * (1.0225) = $2,045,000. To make a CIA investment she coverts the $2million to Swiss francs at the spot rate of CHF1.1520/$ for CHF 2,304,000. She invests for 6 months at a 3.2% annual rate, knowing she will have a total of exactly CHF 2,304,000 * (1.016) = CHF 2,340,864. She simultaneously sells the CHF 2,340,864 forward at a rate of CHF1.1472/$ (or, following rule number two, $0.8717/CHF), for a total of $2,040,502 So, the U.S. market is the better investment.

Covered Interest Arbitrage

Buying or selling assets internationally and using the forward market to eliminate exchange risk in order to take advantage of return differentials

Suppose a currency trader sees the following quotes at Banks A, J, S. Bank A: $0.009411/¥ Bank J: CHF 0.016459 / ¥ Bank S: CHF 1.7125 /$ How much profit can a trader who starts with $1,000,000 make through arbitrage (round to the nearest hundred)?

CHF/USD cross rate between Bank J and Bank A = CHF 1.7489/$ Buy Swiss francs at Bank J. First, exchange $1,000,000 into ¥ 106,258,633.50 at Bank A. Second, exchange ¥ 106,258,633.50 into CHF 1,748,910.85 at Bank J. Third, exchange CHF 1,748,910.85 into $1,021,261.81 at Bank S. Profit of $21,261.81

How does the risk of an uncovered interest arbitrage investment differ from the risk of a covered interest arbitrage investment?

Covered interest arbitrage is secure in that there is no risk for the arbitrager because the forward rate is "locked in." Uncovered interest arbitrage basically involves speculating on the spot rate, and there is a risk of losing money because the spot rate could change unfavorably for the speculator.

PPP Prediction Exact Form

Exchange Rate (t) = Initial exchange rate x (1+IntRef)^t / (1+IntDen)^t

Law of one price

If the identical product or service can be sold in two different markets, and no restrictions exist on the sale or transportation costs of moving the product between markets, the product's price should be the same in both markets.

Real Exchange Rate

Indicates the real purchasing of one currency relative to another q(t) = S(t) x (1+IntDen)^t / (1+IntRef)^t

Suppose 3-year deposit rates on Eurodollars and Eurofrancs (Swiss) are 12% and 7% respectively. If the current spot rate for the Swiss franc is $0.3985, what is the spot rate implied by these interest rates for the franc 3 years from now?

Intuition: After 3 years you have X(1.12)3 eurodollars from investing in Eurodollars (X/.3985)*(1.07)3 *($/CHF) dollars from: converting to francs, investing in Euro francs, and converting back to dollars Equating these: 1.4049 = 3.0741 ($/CHF)3So, 0.4570 = ($/CHF)3

Uncovered Interest Arbitrage

Investors borrow in countries and currencies exhibiting relatively low interest rates, convert the currencies to one that has much higher interest rates, then repay the loan betting that the low-interest currency will not have significantly appreciated.

International Fisher Effect

Is a similar relationship between the percent change and in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets.

The spot market a. involves the almost-immediate purchase or sale of foreign exchange. b. involves the sale of futures, forwards, and options on foreign exchange. c. takes place only on the floor of a physical exchange. d. all of the above. e. none of the above

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

Define and give examples of an Outright Forward Transaction:

Outright Forward Transaction - An outright forward is a forward currency contract that locks in an exchange rate for a specific delivery date and a specific amount. An outright forward contract protects an investor, importer or exporter from changes in the exchange rates. Companies that buy, sell or borrow from foreign businesses can use outright forward contracts to cover their exchange rate risk. Examples: -An American company that buys materials from a French supplier may be required to provide payment for half of the total value of the euro payment now and the other half in six months. The first payment can be paid for with a spot trade, but in order to reduce currency risk from the possible appreciation of the euro vs. the U.S. dollar, the American company can lock in the exchange rate with an outright forward purchase of euros.

Comparing Prices in 2 different countries

P(A) = Spot Exchange Rate (A/B) x P(B)

Using Exhibit 5.4 calculate the one-, three-, and six-months forward premium or discount for the U.S. dollar versus the British pound using European term quotations

Solution: The formula we want to use is: fN,$ = [(FN (£/$) - S(£/$))/S(£/$)] x 360/N f1,$ = [(.6943 - .6944)/.6944] x 360/30 = -.0017 f3,$ = [(.6941 - .6944)/.6944] x 360/90 = -.0017 f6,$ = [(.6937 - .6944)/.6944] x 360/180 = -.0020 The pattern of forward premiums indicates that the dollar is trading at a premium versus the British pound. The one-month premium is larger than the either the three-month or six-month premium in percentage but not absolute terms.

Define and give examples of a Spot Exchange Transaction:

Spot Exchange Transaction - the two parties involved in the transaction agree on the price, which is the number of units of currency A that will be exchanged for currency B. The parties also agree on the value of the transaction in both currencies and the settlement date (1-2 Business Days). If both currencies are to be delivered, the parties also exchange bank information Example: -The exchange can be made directly between two parties, eliminating the need for a third party. -Electronic broking systems may also be used, where dealers can make their trades through an automated order matching system. -Traders can also use electronic trading systems through a single or multibank dealing system. -Trades can be made through a voice broker, or over the phone with a foreign exchange broker.

Steps to preform Arbitrage

Step 1: Get a cross rate Step 2: Is there an arbitrage opportunity? Step 3: Transactions for arbitrage

Interest Rate Parity

The absolute difference in national nominal interest rates for securities of similar risk and maturity should be equal to the forward rate discount or premium for foreign currencies, except for transaction costs

Relative Purchasing Power Parity

The percent change in the exchange rate will be equal to the inflation differential between two nations

PPP prediction approximation:

The percent change in the spot exchange rate will approximately equal the inflation differential between two currencies (exchange rate in one year) - (initial exchange rate) / (initial exchange rate) = Interest(refrence) - Interest(denominator)

Fisher Effect: (approximation)

The real interest rate, r, is approximately equal to the nominal interest rate, i, less expected inflation, E[π]. r ≈i-E[π] or i ≈r+ E[π]

Foreign Exchange Swap Transactions

The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. The purchase and sale are between the same parties.

Absolute Purchasing Power Parity

The spot exchange rate is determined by the relative prices of a similar basket of goods

Credit Suisse First Boston (CSFB) quotes the following rates for the U.S. dollar. Round to 4 decimal places in your work. Bid (€/$) Ask (€/$) Spot rate 0.8894 0.8898 1-month forward 0.8938 0.8942 3-month forward 0.9028 0.9032 6-month forward 0.9164 0.9168 12-month forward 0.9443 0.9447 What is expected to happen to the value of the dollar?

The value of the $ is expected to increase against the Euro

List three reasons why deviations from PPP might occur; then carefully explain how each causes such deviations.

Transactions costs—Transactions costs (such as shipping costs or tariffs) are positive and can prevent prices from being driven to equality. Non-traded goods—Non-traded goods such as local labor, real estate, and utilities, are cannot get directed toward equality through arbitrage. Time lags—Often exchange rates are different at the time orders are placed and contracts arranged from the rates when the goods are exchanged.

Suppose the spot rate on the British pound is $1.8410/£ and the one-month and three-month forward rates are given below -One-month $1.8360/£ -Six-month$1.8120/£ a.Calculate the one-month forward discount or premium on the pound. b.Calculate the six-month forward discount or premium on the dollar (hint: first convert to a direct quote on the dollar).

a. 3.26% discount b. 3.2% premium

Suppose five-year deposit rates on dollar securities and yen securities are 1% and 4%, respectively. If the current spot rate for the dollar is 83 yen, then according to the IFE, what is the spot rate for the dollar five years from now implied by these interest rates? Use the exact form. a.96 yen / $ b.86 yen / $ c.72 yen / $ d.81 yen/ $ e.none of the above

a. 96 yen / $

An economic analysis firm has just published projected inflation rates for the U.S. and Germany for the next 5 years. U.S. inflation is expected to be 10% per year, and German inflation is expected to be 4% per year. a.If the current exchange rate is $0.95/€, use PPP to forecast the exchange rates for the next 5 years. b.Suppose that U.S. inflation over the next five years turns out to average 3.2%, German inflation averages 1.5%, and the exchange rate in 5 years is $0.99/€. What has happened to the real value of the euro over this 5-year period?

a. According to PPP, the exchange rate for the euro at the end of year t should equal 0.95(1.10/1.04)t. Hence, projected exchange rates for the next five years are $1.0048, $1.0628, $1.1241, $1.1889, $1.2575. b. Recall that we are using purchasing power parity to ADJUST an observed nominal exchange rate to a real exchange rate. Review that formula and explanation. With average annual inflation in Germany of 1.5% and in the US of 3.2%, and a nominal rate of $0.99/Є, the real value of the euro, q5($/€) = $0.99*(1.015/1.032)5 = $0.9111/Є.Hence, even though the euro has appreciated in nominal terms over this five-year period, it has fallen in real terms by 4.09% [(0.9111 - 0.95)/0.95].

Use the following information to answer the next question. The dollar-euro exchange rate is quoted at Bank A as $1.00= €0.8334 and the dollar-pound exchange rate is quoted at Bank B as $1.00 = £0.5556. Bank C quotes you a rate of £1.00 = €1.503. How much money can an astute trader with $1,000,000 make from triangular arbitrage between Banks A, B, and C above? a. No triangular arbitrage is possible at the above rates. b. $1,600,000 c. $41,667 d. $40,000 e. none of the above is correct

a. No triangular arbitrage is possible at the above rates.

Use the table below to answer the question U.S.-dollar foreign-exchange rates in late New York trading In US $ Per US $ Australian Dollar 0.8778 1.1392 - 1-months forward 0.8759 1.1417 - 3-months forward 0.8721 1.1467 - 6 months forward 0.8665 1.1540 China Yaun 0.1635 6.1160 Hong Kong dollar 0.1289 7.7572 India rupee 0.01634 61.19995 Indonesia rupiah 0.0000832 12018 UK pound 1.6050 0.6231 - 1 months forward 1.6046 0.6232 - 3 months forward 1.6038 0.6235 - 6 months forward 1.6024 0.6241 Which of the following can you infer from the table above? a. The US dollar is expected to appreciate against the UK pound. b. The Australian dollar is expected to appreciate against the US dollar. c. The US dollar is expected to depreciate against the UK pound. d. The UK pound is expected to appreciate against the Indian rupee.e. none of the above

a. The US dollar is expected to appreciate against the UK pound.

Suppose the one-year interest rate on euros is 4 percent, the dollar interest rate is 6 percent, and the current $/€ spot rate is $1.30. a.What does the International Fisher Effect predict the spot rate will be in one year? USE the approximation. b.Why can we not observe the expected future spot rate?

a. The euro should appreciate by the percent difference in inflation—2%. That is, one euro should buy 2% more dollars. So it should appreciate to $1.326/euro. b. Expectations are not the same across all people and they are not observable.

Suppose an investor has $10,000 and is deciding whether to invest in U.S. securities for one year or make an uncovered interest arbitrage investment in the Mexican peso. He faces the following rates. Spot exchange rate - Ps10/$ U.S. interest rate - 3% per annum Mexican interest rate - 6% per annum a. What is the investor's return from uncovered interest arbitrage if the spot rate remains at Ps10/$ FOR B-D: Suppose, after making a profit on uncovered interest arbitrage, the investor decides to try again, this time borrowing $1,000,000. b. What is his profit if the spot rate remains the same? c. What is his profit if the dollar appreciates to Ps10.5/$ d. What happens if the dollar appreciates to Ps12/$?

a. The investor converts $10,000 to PS100,000 and invests in Mexican securities at 6% to end up with PS106,000 which convert to $10,600. Therefore the return is $600. b. He converts his $1 million to 10 million pesos. After investing in the Mexican securities he has Ps10, 600,000 which converts back to $1,060,000. He owes $1,030,000 on his U.S. loan, so he makes a profit of $30,000. c-d. Follow the same steps as in (b) so that after investing in pesos the investor has Ps 10,600,000. The answers to the remaining steps are in the table below. He takes a large loss in part (d).

Suppose the spot rate on the Korean won is $0.39 and the 180-day forward rate is $0.40. According to the parity conditions covered in class, the difference between the spot and forward rates would imply a.interest rates are higher in the U.S. than in South Korea b.the won has risen in relation to the dollar c.the inflation rate in South Korea is declining d.the won is expected to fall in value relative to the dollar e .there is a high inflation rate in the U.S.

a. interest rates are higher in the U.S. than in South Korea

Assume that the cost of a particular basket of goods is equal to $108 in the U.S. and ¥14,000 in Japan a. What should the ¥/$ exchange rate be according to absolute purchasing power parity? b.If the actual exchange rate were equal to 120, would the dollar be considered undervalued or overvalued? c.Suppose that three months later the exchange rate changes to $0.0085/yen. Did the exchange rate move in the direction predicted by purchasing power parity? d.Is purchasing power parity a good measure of what exchange rates should be?

a.¥14,000/$108 = ¥129.63/$ b.Undervalued c.no—PPP would predict that the dollar would buy more than 120 yen, but the rate changed to 117 yen— in the opposite direction. d.Not of a specific rate at a point in time, no. However it is a good indicator of the direction in which exchange rates will be changing over time.

The ask price

amount a dealer wants you to pay for something.

Cross rate

an exchange rate between two currencies derived from each currency's exchange rate with a third currency.

Use the table below to answer the question U.S.-dollar foreign-exchange rates in late New York trading In US $ Per US $ Australian Dollar 0.8778 1.1392 - 1-months forward 0.8759 1.1417 - 3-months forward 0.8721 1.1467 - 6 months forward 0.8665 1.1540 China Yaun 0.1635 6.1160 Hong Kong dollar 0.1289 7.7572 India rupee 0.01634 61.19995 Indonesia rupiah 0.0000832 12018 UK pound 1.6050 0.6231 - 1 months forward 1.6046 0.6232 - 3 months forward 1.6038 0.6235 - 6 months forward 1.6024 0.6241 You owe 5 million UK pounds in 6 months and are considering a forward contract to cover your payable. What is the ANNUALIZED 6-month forward premium or discount on the UK pound? a. 0.32% discount b. 0.32% premium c. 0.16% discount d. 0.16% premium e. none of the above

b. 0.32% premium

Use the following information to answer the next question: Suppose that inflation is expected to be 1% in the U.S. and 7% in Mexico and the current exchange rate between the dollar and the Mexican peso (MXN) is 13.56MXN = 1 US dollar. After a year of the relative inflation rates above, the exchange rate should be approximately ___ MXN = 1 USD a. 12.75 b. 14.37 c. 10.00 d. 14.65 e. none of the above

b. 14.37

Use the following information to answer the next question: Suppose that inflation is expected to be 1% in the U.S. and 7% in Mexico and the current exchange rate between the dollar and the Mexican peso (MXN) is 13.56MXN = 1 US dollar. Use the information above but suppose that the expected inflation rates are expected to be the average annual inflation rates for the next 3 years. What is the exact MXN/USD exchange rate predicted by purchasing power parity (at the end of 3 years)? a. MXN 14.37/ $ b. MXN 16.12/$ c. MXN 12.80/$ d. MXN 11.40/$ e. None of the above

b. MXN 16.12/$

The forward market a. involves contracting today for the future purchase or sale of foreign exchange at the spot rate that will prevail at the maturity of the contract. b. involves contracting today for the future purchase of sale of foreign exchange at a price agreed upon today. c. involves contracting today for the right but not obligation to the future purchase of sale of foreign exchange at a price agreed upon today. d. none of the above

b. involves contracting today for the future purchase of sale of foreign exchange at a price agreed upon today.

How does the risk of an uncovered interest arbitrage investment differ from the risk of a covered interest arbitrage investment? a.With covered interest arbitrage the investor knows the interest rate in both markets but with uncovered interest arbitrage the nominal interest rate in the foreign market is variable. b.Nominal interest rates are known under both covered and uncovered interest arbitrage but the exchange rate at which the foreign investment is converted is known under covered interest arbitrage and unknown under uncovered interest arbitrage. c.The risks are actually very similar, so it depends on the situation d.With uncovered interest arbitrage the investor hedges her investment in the spot market versus covered interest arbitrage which is unhedged. e.None of the above is correct.

b.Nominal interest rates are known under both covered and uncovered interest arbitrage but the exchange rate at which the foreign investment is converted is known under covered interest arbitrage and unknown under uncovered interest arbitrage.

Annual inflation rates in the U.S. and Brazil are expected to be 2% and 5%, respectively. If the current spot rate is $.6043/real, then the expected spot rate in two years is how much? Use the exact form of relative PPP. a.$.6404 b.$.5922 c.$.5702 d.$.5862 e. none of the above

c. $.5702

Use the table below to answer the question U.S.-dollar foreign-exchange rates in late New York trading In US $ Per US $ Australian Dollar 0.8778 1.1392 - 1-months forward 0.8759 1.1417 - 3-months forward 0.8721 1.1467 - 6 months forward 0.8665 1.1540 China Yaun 0.1635 6.1160 Hong Kong dollar 0.1289 7.7572 India rupee 0.01634 61.19995 Indonesia rupiah 0.0000832 12018 UK pound 1.6050 0.6231 - 1 months forward 1.6046 0.6232 - 3 months forward 1.6038 0.6235 - 6 months forward 1.6024 0.6241 You are receiving a payment of 2 million Australian dollars in 3 months and would like to lock in the dollar amount of your receipt using the forward market. How much will you receive in US dollars if you enter into the 3 month forward contract? a. $1,755,600 b. $2,278,400 c. $1,744,200 d. $2,293,400 e. None of the above

c. $1,744,200

The AUD/$ spot exchange rate is AUD1.60/$ and the CHF/$ is CHF1.25/$. The AUD/CHF cross exchange rate is _____. a. AUD 0.7813/CHF b. AUD 2.0000/CHF c. AUD 1.2800/CHF d. AUD 0.3500/CHF e. None of the above

c. AUD 1.2800/CHF

Use the following information to answer the next question: Suppose that inflation is expected to be 1% in the U.S. and 7% in Mexico and the current exchange rate between the dollar and the Mexican peso (MXN) is 13.56MXN = 1 US dollar. After 3 years, the actual spot exchange rate is 15MXN = 1 USD. The actual average inflation rates per year over the three year period were 2% in the US and 10% in Mexico. What is the real exchange rate in MXN/$ in 3 years? a. MXN 18.31/ $ b. MXN 9.78/ $ c. MXN 11.96/ $ d. MXN 16.02/ $ e. None of the above

c. MXN 11.96/ $

Use the following information to answer the next question: Suppose that inflation is expected to be 1% in the U.S. and 7% in Mexico and the current exchange rate between the dollar and the Mexican peso (MXN) is 13.56MXN = 1 US dollar. The US dollar is expected to _______________ (choose one: appreciate or depreciate) against the Mexican peso by approximately ___________%. a. appreciate; 8% b. depreciate; 6% c. appreciate; 6% d. appreciate; about 14 times its current value e. depreciate; about 8%

c. appreciate; 6%

If the $/€ bid and ask prices are $1.50/€ and $1.51/€, respectively, what are the corresponding bid and ask prices on the dollar? a. bid: $1.5; ask: $1.50 b. bid: €0.6667; ask: €0.6623 c. bid: €0.6623; ask: €0.6667 d. Cannot be determined with the information give. e. None of the above.

c. bid: €0.6623; ask: €0.6667

The direct spot quote for the Canadian dollar is $.76 and the 180-day forward rate is $.74. The difference between the two rates is likely to mean that a.inflation in the U.S. during the past year was lower than in Canada b.interest rates are rising faster in Canada than in the U.S. c.prices in Canada are expected to rise more rapidly than in the U.S. d.the Canadian dollar's spot rate is expected to rise in terms of the U.S. dollar e.none of the above

c. prices in Canada are expected to rise more rapidly than in the U.S.

According to a 2015 article in The Economist, a Big Mac costs ¥378, or about $3.60 in Japan and, on average, $4.56 in the U.S. According to the Big Mac Index . . . a. the yen is overvalued against the dollar by about 21% b. the yen is overvalued against the dollar by more than 100% c. the yen is undervalued against the dollar by about 21% d. the yen is due for an appreciation nearly 100% e. none of the above

c. the yen is undervalued against the dollar by about 21%

When Interest Rate Parity (IRP) does not hold a. there is usually a high degree of inflation in at least one country b. the financial markets are in equilibrium c. there are opportunities for covered interest arbitrage d. both b and c e. none of the above

c. there are opportunities for covered interest arbitrage

Use the following information to answer the next question. The dollar-euro exchange rate is quoted at Bank A as $1.00= €0.8334 and the dollar-pound exchange rate is quoted at Bank B as $1.00 = £0.5556. Bank C quotes you a rate of £1.00 = €1.503. What is the euro/pound cross rate computed from the first two quotes in the information above? a. £1.50/€ b. €1.20/£ c. €1.50/£ d. €1.80/£ e. None of the above

c. €1.50/£

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. a.Fisher b. Herstatt c.Unbiased forward rate d.International Fisher e.None of the above

c.Unbiased forward rate

Suppose you observe a spot exchange rate of $1.50/€. If interest rates are 3% APR in the U.S. and 5% APR in the euro zone, what is the no-arbitrage 1-year forward rate (that is, what is the IRP prediction)? Use the exact form of IRP. a. €1.5291/$ b. $1.5291/€ c. €1.4714/$ d. $1.4714/€ e. none of the above.

d. $1.4714/€

Use the table below to answer the question U.S.-dollar foreign-exchange rates in late New York trading In US $ Per US $ Australian Dollar 0.8778 1.1392 - 1-months forward 0.8759 1.1417 - 3-months forward 0.8721 1.1467 - 6 months forward 0.8665 1.1540 China Yaun 0.1635 6.1160 Hong Kong dollar 0.1289 7.7572 India rupee 0.01634 61.19995 Indonesia rupiah 0.0000832 12018 UK pound 1.6050 0.6231 - 1 months forward 1.6046 0.6232 - 3 months forward 1.6038 0.6235 - 6 months forward 1.6024 0.6241 You are receiving a payment of 2 million Australian dollars in 3 months and would like to lock in the dollar amount of your receipt using the forward market (with a 3 month forward contract). What is the ANNUALIZED forward discount or premium on the US dollar? Round to 4 decimal places in your work. a. 0.65% forward premium b. 0.66% forward premium c. 2.60% forward premium d. 2.64% forward premium e. none of the above

d. 2.64% forward premium

According to a recent Wall Street Journal article, the key South African interest rate is 5.75%, while the comparable interest rate in the US is 0.75% and the current South African rand (ZAR) to US dollar exchange rate is ZAR 11.40 / USD. According to the International Fisher Effect, approximately what should the ZAR/USD exchange rate be in 1 year? a. ZAR 12.08 / USD b.ZAR 10.83 / USD c. ZAR 11.17 / USD d. ZAR 11.97 / USD e. None of the above.

d. ZAR 11.97 / USD

Use the following information to answer the next question: Suppose that inflation is expected to be 1% in the U.S. and 7% in Mexico and the current exchange rate between the dollar and the Mexican peso (MXN) is 13.56MXN = 1 US dollar. Which of the following best describes what happened to the value of MX against the dollar? a. the nominal value of the peso appreciated; and the real value of the peso appreciated. b. the nominal value of the peso appreciated; and the real value of the peso depreciated. c. the nominal value of the peso depreciated; and the real value of the peso depreciated. d. the nominal value of the peso depreciated; and the real value of the peso appreciated. e. none of the above

d. the nominal value of the peso depreciated; and the real value of the peso appreciated.

Fisher Effect Exact Form

i = r +E(r)

Foreign currency is overvalued against $ if:

the price for the same basket of goods is higher in the foreign currency or a dollar buys less of a foreign currency than PPP predicts

Foreign currency is undervalued against $ if:

the price for the same basket of goods is lower in the foreign currency or a dollar buys more of a foreign currency than PPP predicts

Given the following exchange rates Mexican peso: MXN 10.974/$ Japanese yen: ¥117.29/$ Calculate the cross rate between the peso and the yen.

¥ 10.69/MXN