IBS Exam 2
A forecast of a currency one year in advance is typically more accurate than a forecast one week in advance since the currency reverts to equilibrium over a longer term period. Select one: True False
False
A futures hedge involves taking a money market position to cover a future payables or receivables position. Select one: True False
False
A set of currency cash inflows is more volatile if the correlations are low. Select one: True False
False
Hedging the position of individual subsidiaries is generally necessary, even if the overall performance of the MNC is already insulated by the offsetting positions between subsidiaries. Select one: True False
False
If interest rate parity (IRP) exists, then triangular arbitrage will not be possible. Select one: True False
False
If the pattern of currency values over time appears random, then technical forecasting is appropriate. Select one: True False
False
Market-based forecasting is based on fundamental relationships between economic variables and exchange rates. Select one: True False
False
The interest rate on euros is 8%. The interest rate in the U.S. is 5%. The euro's forward rate should exhibit a premium of about 3%. Select one: True False
False
The maximum one-day loss estimated using the value-at-risk (VAR) method is independent of the confidence level used. Select one: True False
False
To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an MNC would buy futures. Select one: True False
False
Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. Select one: True False
False
Usually, fundamental forecasting is used for short-term forecasts, while technical forecasting is used for longer-term forecasts. Select one: True False
False
When comparing the forward hedge to the options hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty. Select one: True False
False
here is much evidence to suggest that Japanese investors invest in U.S. Treasury securities when U.S. interest rates are higher than Japanese interest rates. These investors most likely believe in the international Fisher effect. Select one: True False
False
Which of the following operations benefit(s) from depreciation of the firm's local currency? Select one: a. investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency. b. A and B c. purchasing foreign supplies. d. borrowing in a foreign country and converting the funds to the local currency prior to the depreciation.
a. investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency.
When using ____, funds are typically tied up for a significant period of time. Select one: a. triangular arbitrage b. B and C c. covered interest arbitrage d. locational arbitrage
c. covered interest arbitrage
A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast. Select one: True False
True
An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it. Select one: True False
True
Cross-hedging may involve taking a forward position in a currency that is highly correlated with the currency an MNC needs to hedge. Select one: True False
True
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. Select one: True False
True
If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis indicates that remaining unhedged will probably be less costly than hedging. Select one: True False
True
If the functional currencies for reporting purposes are highly correlated, translation exposure is magnified. Select one: True False
True
Inflation and interest rate differentials between the U.S. and foreign countries are examples of variables that could be used in fundamental forecasting. Select one: True False
True
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. Select one: True False
True
Lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate. Select one: True False
True
Some MNCs are subject to economic exposure without being subject to transaction exposure. Select one: True False
True
The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP). Select one: True False
True
The hedging of a foreign currency for which no forward contract is available with a highly correlated currency for which a forward contract is available is referred to as cross-hedging. Select one: True False
True
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. Select one: True False
True
U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margin. Select one: True False
True
The inflation rate in the U.S. is 3%, while the inflation rate in Japan is 10%. The current exchange rate for the Japanese yen (¥) is $0.0075. After supply and demand for the Japanese yen has adjusted in the manner suggested by purchasing power parity, the new exchange rate for the yen will be: Select one: a. $0.0070. b. $0.0073. c. $0.0066. d. $0.0076.
a. $0.0070. SOLUTION: (1.03/1.10) ´ $.0075 = $.0070
The one-year forward rate of the British pound is $1.55, while the current spot rate is $1.60. Based on the forward rate, what is the expected percentage change in the British pound over the next year? Select one: a. -3.1% b. +3.2% c. +3.1% d. +5.0% e. None of the above
a. -3.1%
Exhibit 7-1 Assume the following information: You have $300,000 to invest: The spot bid rate for the euro (€) is $1.08 The spot ask quote for the euro is $1.10 The 180-day forward rate (bid) of the euro is $1.08 The 180-day forward rate (ask) of the euro is $1.10 The 180-day interest rate in the U.S. is 6% The 180-day interest rate in Europe is 8% Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what is your percentage return after 180 days? Is covered interest arbitrage feasible in this situation? Select one: a. 6.04%; feasible SOLUTION: $318,109.10/$300,000 - 1 = 6.04%. Since this rate is slightly higher than the U.S. interest rate of 6%, covered interest arbitrage is feasible. b. 10.00%; feasible c. 7.96%; feasible d. 6.04%; not feasible e. 4.07%; not feasible
a. 6.04%; feasible SOLUTION: $318,109.10/$300,000 - 1 = 6.04%. Since this rate is slightly higher than the U.S. interest rate of 6%, covered interest arbitrage is feasible.
According to the international Fisher effect, if U.S. investors expect a 5% rate of domestic inflation over one year, and a 2% rate of inflation in European countries that use the euro, and require a 3% real return on investments over one year, the nominal interest rate on one-year U.S. Treasury securities would be: Select one: a. 8%. b. -2%. c. 5%. d. 3%. e. 2%.
a. 8%. Correct SOLUTION: 5% + 3% = 8%
Which of the following theories suggests the percentage change in spot exchange rate of a currency should be equal to the interest rate differential between two countries? Select one: a. international Fisher effect (IFE). b. relative form of PPP. c. interest rate parity (IRP). d. absolute form of PPP.
a. international Fisher effect (IFE).
Assume a forecasting model uses inflation differentials and interest rate differentials to forecast the exchange rate. Assume the regression coefficient of the interest rate differential variable is -.5, and the coefficient of the inflation differential variable is .4. Which of the following is true? Select one: a. The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly related to the exchange rate. b. The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the interest rate variable. c. The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly (positively) related to the interest rate variable. d. The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the exchange rate.
a. The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly related to the exchange rate.
____ is (are) not a determinant of translation exposure. Select one: a. The local (domestic) earnings of the MNC b. The MNC's degree of foreign involvement c. The locations of foreign subsidiaries d. The accounting methods used
a. The local (domestic) earnings of the MNC
Generally, MNCs with less foreign revenues than foreign costs will be ____ affected by a ____ foreign currency. Select one: a. favorably; weaker b. favorably; stronger c. not; stronger d. not; weaker
a. favorably; weaker
If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield the same result as the ____ hedge. Select one: a. forward b. call option c. none of the above d. put option
a. forward
Factors such as economic growth, inflation, and interest rates are an integral part of ____ forecasting. Select one: a. fundamental b. technical c. none of the above d. market-based
a. fundamental
If an MNC has a net inflow in one currency and a net outflow of about the same amount in another currency, then the MNCs' transaction exposure is ____ if the two currencies are ____ correlated. Select one: a. high; negatively b. low; negatively c. none of the above d. high; positively
a. high; negatively
If a particular currency is consistently declining substantially over time, then a market-based forecast will usually have: Select one: a. overestimated the future exchange rates over time. b. underestimated the future exchange rates over time. c. forecasted future exchange rates accurately. d. forecasted future exchange rates inaccurately but without any bias toward consistent underestimating or overestimating.
a. overestimated the future exchange rates over time.
A ____ involves an exchange of currencies between two parties, with a promise to re-exchange currencies at a specified exchange rate and future date. Select one: a. parallel loan b. money market hedge c. long-term forward contract d. currency option contract
a. parallel loan
Assume zero transaction costs. If the 180-day forward rate overestimates the spot rate 180 days from now, then the real cost of hedging payables will be: Select one: a. positive. b. negative. c. zero. d. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
a. positive.
Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar is $.80. If you use a forward hedge, you will: Select one: a. receive $480,000 in 90 days. c. receive $480,000 today. d. receive $750,000 today. e. pay $750,000 in 90 days.
a. receive $480,000 in 90 days. SOLUTION: C$600,000 ´ $0.80 = $480,000 b. receive $750,000 in 90 days.
Assume that the interest rate in the home country of Currency X is a much higher interest rate than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X: Select one: a. should exhibit a discount. b. B or C c. should be zero (i.e., it should equal its spot rate). d. should exhibit a premium.
a. should exhibit a discount.
When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are ____ affected by translation exposure. When the dollar weakens, the reported consolidated earnings are ____ affected. Select one: a. unfavorably; favorably affected b. favorably; unfavorably affected c. favorably; favorably affected by a higher degree d. favorably; favorably affected but by a smaller degree
a. unfavorably; favorably affected
A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. During ____ dollar cycles, cash outflows are ____. Select one: a. weak; somewhat stable b. weak; favorably affected c. none of the above d. weak; adversely affected
a. weak; somewhat stable
Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL). 30% of the MNC's funds are lev and 70% are leu. The standard deviation of exchange movements is 10% for lev and 15% for leu. The correlation coefficient between movements in the value of the lev and the leu is .85. Based on this information, the standard deviation of this two-currency portfolio is approximately: Select one: a. 17.28%. b. 13.15%. c. 12.04%. d. 14.50%.
b. 13.15%. =sqrt((.30)^(.10)^2+(.70)^2(.15)^2+2(.30)(.70)(.10)(.15)(.85)
National Bank quotes the following for the British pound and the New Zealand dollar: Quoted Bid Price Quoted Ask Price Value of a British pound (£) in $ $1.61 $1.62 Value of a New Zealand dollar (NZ$) in $ $.55 $.56 Value of a British pound in New Zealand dollars NZ$2.95 NZ$2.96 Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy? Select one: a. $77.64. b. $15.43. c. $197.53. d. $111.80.
b. 15.43 SOLUTION: $10,000/$1.62 = £6,172.84 ´ 2.95 = NZ$18,209.88 ´ $.55 = $10,015.43. Thus, the profit is
The following regression model was estimated to forecast the percentage change in the Australian Dollar (AUD): AUDt = a0 + a1INTt + a2INFt - 1 + mt, where AUD is the quarterly change in the Australian Dollar, INT is the real interest rate differential in period t between the U.S. and Australia, and INF is the inflation rate differential between the U.S. and Australia in the previous period. Regression results indicate coefficients of a0 = .001; a1 = -.8; and a2 = .5. Assume that INFt - 1 = 4%. However, the interest rate differential is not known at the beginning of period t and must be estimated. You have developed the following probability distribution: Probability Possible Outcome 20% -3% 80% -4% There is a 20% probability that the Australian dollar will change by ____, and an 80% probability it will change by ____. Select one: a. None of the above b. 4.5%; 5.3% c. 6.1%; 4.5% d. 4.5%; 6.1%;
b. 4.5%; 5.3% SOLUTION: Probability 20% = .001 + (-.8)(-.03) + (.5)(.04) = 4.5% Probability 80% = .001 + (-.8)(-.04) + (.5)(.04) = 5.3%
Exhibit 10-2 Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30. Refer to Exhibit 10-2. What is the portfolio standard deviation? Select one: a. none of the above b. 5.44%. c. 17.98%. d. 3.00%.
b. 5.44%. =sqrt((.625)^2(.08)^2+(.375)^2(.03)^2+2(.625)(.375)(.30)(.08)(.03)
You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate of the Australian dollar in 180 days is: Future Spot Rate Probability $.46 20% $.48 30% $.52 50% The 90-day forward rate of the Australian dollar is $.50. What is the probability that the put option will be exercised (assuming Arizona purchased it)? Select one: a. 0%. b. 50%. c. none of the above d. 80%.
b. 50%. SOLUTION: Arizona will exercise when the exercise price is greater than the future spot (20% + 30% = 50%).
Which of the following is not true regarding IRP, PPP, and the IFE? Select one: a. All of the above are true. b. IRP suggests that a currency's spot rate will change according to interest rate differentials. c. The IFE suggests that a currency's spot rate will change according to interest rate differentials. d. PPP suggests that a currency's spot rate will change according to inflation differentials.
b. IRP suggests that a currency's spot rate will change according to interest rate differentials.
Assume the following information for a bank quoting on spot exchange rates: Exchange rate of Singapore dollar in U.S. $ = $.60 Exchange rate of pound in U.S. $ = $1.50 Exchange rate of pound in Singapore dollars = S$2.6 Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot exchange rates? Select one: a. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should appreciate. b. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. c. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should depreciate, and the pound value in Singapore dollars should appreciate. d. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate.
b. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate.
Which of the following is not true regarding interest rate parity (IRP)? Select one: a. 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. b. When covered interest arbitrage is not feasible, interest rate parity must hold. c. All of the above are true. d. When interest rate parity holds, covered interest arbitrage is not possible. e. 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.
b. When covered interest arbitrage is not feasible, interest rate parity must hold.
Among the reasons that purchasing power parity (PPP) does not consistently occur are: Select one: a. exchange rates are affected by interest rate differentials. b. all of the above are reasons that PPP does not consistently occur. c. supply and demand may not adjust if no substitutable goods are available. d. exchange rates are affected by national income differentials and government controls.
b. all of the above are reasons that PPP does not consistently occur.
Points below the IRP line represent situations where: Select one: a. covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets. b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically. c. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically. d. covered interest arbitrage is not feasible for neither domestic nor foreign investors.
b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically.
The ____ does not represent an obligation. Select one: a. long-term forward contract b. currency option c. currency swap d. parallel loan
b. currency option
Assume that Mill Corporation, a U.S.-based MNC, has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements: PCFt = a0 + a1et + mt where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression model estimates a coefficient of a1 of 2. This indicates that: Select one: a. if the foreign currency depreciates by 1%, Mill's cash flows will increase by 2%. b. if the foreign currency appreciates by 1%, Mill's cash flows will decline by .2%. c. none of the above d. if the foreign currency appreciates by 1%, Mill's cash flows will decline by 2%. e. if the foreign currency depreciates by 1%, Mill's cash flows will decline by 2%.
b. if the foreign currency appreciates by 1%, Mill's cash flows will decline by .2%.
Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered on U.S. dollars = 12% 1-year deposit rate offered on Singapore dollars = 10% 1-year forward rate of Singapore dollars = $.412 Spot rate of Singapore dollar = $.400 Given this information: Select one: a. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically. b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. d. interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically.
b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. SOLUTION: $1,000,000/$.400 = S$2,500,000 ´ (1.1) = S$2,750,000 ´ $.412 = $1,133,000 Yield = ($1,133,000 - $1,000,000)/$1,000,000 = 13.3% This yield exceeds what is possible domestically.
One argument for exchange rate irrelevance is that: Select one: a. MNCs are typically not diversified across numerous countries. b. investors can invest in a diversified stock portfolio of MNCs that have different exposures to exchange rates. c. MNCs can hedge exchange rate exposure much more effectively than individual investors. d. purchasing power parity does not hold very well.
b. investors can invest in a diversified stock portfolio of MNCs that have different exposures to exchange rates.
Assume that the U.S. and Chile nominal interest rates are equal. Then, the U.S. nominal interest rate decreases while the Chilean nominal interest rate remains stable. According to the international Fisher effect, this implies expectations of ____ than before, and that the Chilean peso should ____ against the dollar. Select one: a. lower U.S. inflation; appreciate b. lower U.S. inflation; depreciated c. higher U.S. inflation; appreciate d. higher U.S. inflation; depreciate
b. lower U.S. inflation; depreciated
Which of the following forecasting techniques would best represent sole use of today's spot exchange rate of the euro to forecast the euro's future exchange rate? Select one: a. fundamental forecasting. b. market-based forecasting. c. mixed forecasting. d. technical forecasting.
b. market-based forecasting.
Given a home country and a foreign country, the international Fisher effect (IFE) suggests that: Select one: a. the exchange rates of both countries will move in a similar direction against other currencies. b. none of the above c. the inflation rates of both countries are the same. d. the nominal interest rates of both countries are the same.
b. none of the above
If it was determined that the movement of exchange rates was not related to previous exchange rate values, this implies that a ____ is not valuable for speculating on expected exchange rate movements. Select one: a. all of the above b. technical forecast technique c. fundamental forecast technique d. none of the above
b. technical forecast technique
Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest rates: U.S. Switzerland 360-day borrowing rate 7% 5% 360-day deposit rate 6% 4% Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If Parker Company uses a money market hedge, it will receive ____ in 360 days. Select one: a. $92,307 b. $98,769 c. $96,914 d. $101,923 e. $101,904
c. $96,914 SOLUTION: 1. Borrow SF190,476 (SF200,000/1.05) = SF190,476. 2. Convert SF190,476 to $91,428 (SF190,476 ´ $.48) = $91,428. 3. Invest $91,428 at 6% to accumulate $96,914 ($91,428 ´ 1.06) = $96,914.
Samson Inc. needs €1,000,000 in 30 days. Samson can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Samson can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Samson uses a money market hedge, how much should it borrow in the U.S.? Select one: a. $943,396. b. $995,025. c. $995,851. d. $952,381.
c. $995,851. SOLUTION: 1,000,000/[1 + (5% ´ 30/360) = $995,851
Assume that the U.S. one-year interest rate is 3% and the one-year interest rate on Australian dollars is 6%. The U.S. expected annual inflation is 5%, while the Australian inflation is expected to be 7%. You have $100,000 to invest for one year and you believe that PPP holds. The spot exchange rate of an Australian dollar is $0.689. What will be the yield on your investment if you invest in the Australian market? Select one: a. 6% b. 3% c. 4% d. 2%
c. 4% SOLUTION: (1 + .05)/(1 + .07) ´ $0.689 = $0.676. ($100,000/A$0.689) ´ (1 + .06) = A$153,846 ´ $0.676 = $104,000. ($104,000 - $100,000)/$100,000 = 4%
Which of the following is not a forecasting technique mentioned in your text? Select one: a. Mixed forecasting b. Market-based forecasting c. Accounting-based forecasting d. Fundamental forecasting e. Technical forecasting
c. Accounting-based forecasting
Which of the following is indicated by research regarding purchasing power parity (PPP)? Select one: a. There is no relationship between inflation differentials and exchange rate movements in the short run or long run. b. PPP clearly holds in the short run. c. Deviations from PPP are reduced in the long run. d. PPP clearly holds in the long run.
c. Deviations from PPP are reduced in the long run.
Which of the following is not mentioned in the text as a form of international arbitrage? Select one: a. Covered interest arbitrage b. Triangular arbitrage c. Transactional arbitrage d. All of the above are mentioned in the text as forms of international arbitrage. e. Locational arbitrage
c. Transactional arbitrage
Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then: Select one: a. British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the U.S. b. U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the U.S. c. U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S. d. U.S. investors will earn 15% whether they use covered interest arbitrage or invest in the U.S
c. U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S.
Given a home country and a foreign country, purchasing power parity (PPP) suggests that: Select one: a. a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate. b. a home currency will depreciate if the current home inflation rate exceeds the current foreign interest rate. c. a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate. d. a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate
c. a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.
If the foreign exchange market is ____ efficient, then technical analysis is not useful in forecasting exchange rate movements. Select one: a. semistrong-form b. weak-form c. all of the above d. strong form
c. all of the above
Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%. Select one: a. appreciate; 3.11 b. depreciate; 4.85 c. appreciate; 4.85 d. depreciate; 3,11
c. appreciate; 4.85 SOLUTION: (1.08/1.03) - 1 = 4.85%.
Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro: eurot = b0 + b1INFt - 1 + b2INCt - 1 = .005 + .9INFt - 1 + 1.1INCt - 1 The most recent quarterly percentage change in the inflation differential between the U.S. and Europe was 2 percent, while the most recent quarterly percentage change in the income growth differential between the U.S. and Europe was -1 percent. Based on this information, the forecast for the euro is a(n) ____ of ____%. Select one: a. appreciation; 3.4 b. depreciation; 3.4 c. appreciation; 1.2 d. appreciation; 0.7
c. appreciation; 1.2 SOLUTION: eurot = .005 + .9(.02) + 1.1(-.01) = 1.2%
Assume that the U.S. interest rate is 11 percent, while Australia's one-year interest rate is 12 percent. Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to forecast the future spot rate, the forecast would reflect an expectation of: Select one: a. appreciation in the Australian dollar's value over the next year. b. information on future interest rates is needed to answer this question. c. depreciation in the Australian dollar's value over the next year. d. no change in the Australian dollar's value over the next year.
c. depreciation in the Australian dollar's value over the next year.
The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the percentage of a given financial statement item that is susceptible to translation exposure. Select one: a. smaller; greater b. greater; smaller c. greater; greater d. none of the above
c. greater; greater
Which of the following theories suggests that the percentage change in spot exchange rate of a currency should be equal to the inflation differential between two countries? Select one: a. triangular arbitrage. b. interest rate parity (IRP). c. purchasing power parity (PPP). d. international Fisher effect (IFE).
c. purchasing power parity (PPP).
The Fisher effect is used to determine the: Select one: a. real inflation rate. b. real forward rate. c. real interest rate. d. real spot rate.
c. real interest rate.
Assume that the international Fisher effect (IFE) holds between the U.S. and the U.K. The U.S. inflation is expected to be 5%, while British inflation is expected to be 3%. The interest rates offered on pounds are 7% and U.S. interest rates are 7%. What does this say about real interest rates expected by British investors? Select one: a. real interest rates expected by British investors are equal to the interest rates expected by U.S. investors. b. IFE doesn't hold in this case because the U.S. inflation is higher than the British inflation, but the interest rates offered in both countries are equal. c. real interest rates expected by British investors are 2 percentage points above the real interest rates expected by U.S. investors. d. real interest rates expected by British investors are 2 percentage points lower than the real interest rates expected by U.S. investors.
c. real interest rates expected by British investors are 2 percentage points above the real interest rates expected by U.S. investors.
Because there are a variety of factors in addition to inflation that affect exchange rates, this will: Select one: a. increase the probability that PPP shall hold. b. B and C c. reduce the probability that PPP shall hold. d. increase the probability the IFE will hold.
c. reduce the probability that PPP shall hold.
According to interest rate parity (IRP): Select one: a. the forward rate differs from the spot rate by a sufficient amount to offset the inflation differential between two currencies. b. the future spot rate differs from the current spot rate by a sufficient amount to offset the interest rate differential between two currencies. c. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies. d. the future spot rate differs from the current spot rate by a sufficient amount to offset the inflation differential between two currencies.
c. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.
Gamma Corporation has incurred large losses over the last ten years due to exchange rate fluctuations of the Egyptian pound (EGP), even though the company has used a market-based forecast based on the forward rate. Consequently, management believes its forecasts to be biased. The following regression model was estimated to determine if the forecasts over the last ten years were biased: St = a0 + a1Ft - 1 + mt, where St is the spot rate of the pound in year t and Ft - 1 is the forward rate of the pound in year t - 1. Regression results reveal coefficients of a0 = 0 and a1 = 1.3. Thus, Gamma has reason to believe that its past forecasts have ____ the realized spot rate. Select one: a. none of the above b. correctly estimated c. underestimated d. overestimated
c. underestimated
A firm produces goods for which substitute goods are produced in all countries. Depreciation of the firm's local currency should: Select one: a. decrease local sales as foreign competition in local markets is reduced. b. decrease the firm's cash outflow required to pay for imported supplies denominated in a foreign currency. c. decrease the returns earned on the firm's foreign bank deposits. d. none of the above e. decrease the firm's exports denominated in the local currency.
d. none of the above
Assume the following information: You have $1,000,000 to invest: Current spot rate of pound = $1.30 90-day forward rate of pound = $1.28 3-month deposit rate in U.S. = 3% 3-month deposit rate in Great Britain = 4% If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days? Select one: a. none of the above b. $1,034,000. c. $1,040,000. d. $1,024,000. e. $1,030,000.
d. $1,024,000. Correct SOLUTION: $1,000,000/$1.30 = 769,231 pounds ´ (1.04) = 800,000 pounds ´ 1.28 = $1,024,000
The interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The spot rate for the British pound is $1.50. According to the international Fisher effect (IFE), the British pound should adjust to a new level of: Select one: a. $1.57. b. $1.53. c. $1.43. d. $1.47.
d. $1.47. SOLUTION: (1.05/1.07) ´ (1.50) = $1.47.
Dubas Co. is a U.S.-based MNC that has a subsidiary in Germany and another subsidiary in Greece. Both subsidiaries frequently remit their earnings back to the parent company. The German subsidiary generated a net outflow of €2,000,000 this year, while the Greek subsidiary generated a net inflow of €1,500,000. What is the net inflow or outflow as measured in U.S. dollars this year? The exchange rate for the euro is $1.05. Select one: a. $525,000 inflow b. $210,000 outflow c. $3,675,000 outflow d. $525,000 outflow
d. $525,000 outflow SOLUTION: -€2,000,000 + €1,500,000 = -€500,000 ´ $1.05 = -$525,000
Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate of the Swiss franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with? Select one: a. $10,114. b. $8,556. c. $12,238. d. $7,067.
d. $7,067. SOLUTION: $1,000,000/$.566 = SF1,766,784 ´ $.57 = $1,007,067. Thus, the profit is $7,067.
Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $.23. Furthermore, Money's financial center has indicated that the possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30 and .70, respectively. Based on this information, the revenue from hedging minus the revenue from not hedging receivables is____. Select one: a. $0. b. -$7,500. c. none of the above d. $7,500.
d. $7,500. SOLUTION: RCH(1) = (MYR1,500,000 ´ $0.20) - (MYR1,500,000 ´ $0.23) = -$45,000 RCH(2) = (MYR1,500,000 ´ $0.25) - (MYR1,500,000 ´ $0.23) = $30,000 E[RCH] = (.30)(-45,000) + (.7)(30,000) = 7,5000
You are the treasurer of Montana Corporation and must decide how to hedge (if at all) future payables of 1,000,000 Japanese yen 90 days from now. Call options are available with a premium of $.01 per unit and an exercise price of $.01031 per Japanese yen. The forecasted spot rate of the Japanese yen in 90 days is: Future Spot Rate Probability $.01035 20% $.01032 20% $.01030 30% $.01029 30% The 90-day forward rate of the Japanese yen is $.01033. What is the probability that the call option will be exercised (assuming Montana purchased it)? Select one: a. 60% b. 30% c. 20% d. 40%
d. 40%
If quoted exchange rates are the same across different locations, then ____ is not feasible. Select one: a. covered interest arbitrage b. triangular arbitrage c. locational arbitrage d. A and C
d. A and C
If the interest rate is higher in the U.S. than in the United Kingdom, and if the forward rate of the British pound (in U.S. dollars) is the same as the pound's spot rate, then: Select one: a. neither U.S. nor British investors could benefit from covered interest arbitrage. b. A and B c. U.S. investors could possibly benefit from covered interest arbitrage. d. British investors could possibly benefit from covered interest arbitrage.
d. British investors could possibly benefit from covered interest arbitrage.
Which of the following is true according to the text? Select one: a. Use of the absolute forecast error as a percent of the realized value is a good measure to use in detecting a forecast bias. b. Forecasts in recent years have been very accurate. c. Forecasting errors are smaller when focused on longer term periods. d. None of the above.
d. None of the above.
Sensitivity analysis allows for all of the following except: Select one: a. development of a range of possible future values. b. consideration of alternative scenarios. c. accountability for uncertainty. d. focus on a single point estimate of future exchange rates.
d. focus on a single point estimate of future exchange rates.
If the international Fisher effect (IFE) did not hold based on historical data, then this suggests that: Select one: a. some corporations with excess cash could have generated profits on average from covered interest arbitrage. b. most corporations that consistently invest in foreign short-term investments would have generated the same profits (on average) as from domestic short-term investments. c. some corporations with excess cash can lock in a guaranteed higher return on future foreign short-term investments. d. some corporations with excess cash could have generated higher profits on average from foreign short-term investments than from domestic short-term investments.
d. some corporations with excess cash could have generated higher profits on average from foreign short-term investments than from domestic short-term investments.
Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in Mexico at 14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur? Select one: 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 decreases; forward rate of peso decreases. d. spot rate of peso increases; forward rate of peso decreases.
d. spot rate of peso increases; forward rate of peso decreases.
Jenco Co. imports raw materials from Japan, invoiced in U.S. dollars. The price it pays is not expected to change for the next several years. If the Japanese yen appreciates, its imports from Japan will probably ____ and if the Japanese yen depreciates, its imports from Japan will probably ____. Select one: a. decrease; increase b. increase; stay the same c. increase; decrease d. stay the same; stay the same
d. stay the same; stay the same
Assume the following bid and ask rates of the pound for two banks as shown below: Bid Ask Bank C $1.61 $1.63 Bank D $1.58 $1.60 As locational arbitrage occurs: Select one: a. the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will increase. b. the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will decrease. c. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will decrease. d. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will increase.
d. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will increase.
Translation exposure reflects: Select one: a. the exposure of a firm's cash flows to exchange rate fluctuations. b. the exposure of a firm's international contractual transactions to exchange rate fluctuations. c. the exposure of a firm's local currency value to transactions between foreign exchange traders. d. the exposure of a firm's financial statements to exchange rate fluctuations.
d. the exposure of a firm's financial statements to exchange rate fluctuations.
Assume the following information: Current spot rate of New Zealand dollar = $.41 Forecasted spot rate of New Zealand dollar 1 year from now = $.43 One-year forward rate of the New Zealand dollar = $.42 Annual interest rate on New Zealand dollars = 8% Annual interest rate on U.S. dollars = 9% Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____%. Select one: a. about 11.12 b. about 11.64 c. about 9.63 d. about 11.97 e. about 10.63
e. about 10.63 SOLUTION: $500,000/$.41 = NZ$1,219,512 ´ (1.08) = NZ$1,317,073 ´ .42 = $553,171 Yield = ($553,171 - $500,000)/$500,000 = 10.63%
