Multinational Exam 1

Under a fixed exchange rate system:

central bank intervention in the foreign exchange market is often necessary.

A strong dollar is normally expected to cause:

high unemployment and low inflation in the U.S.

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts _______ pressure on the pound's spot rate, and _______ pressure on the pound's forward rate.

upward; downward

Assume that a bank's bid rate on Swiss francs is $.45 and its ask rate is $.47. Its bid ask percentage spread is:

Bid‑ask percentage spread = ($.47 ‑ $.45)/$.47 = 4.26%

T/F: Every month, the U.S. trade deficit figures are announced. Foreign exchange traders ALWAYS react to this announcement by selling U.S. dollars when the announced deficit is very large.

False

Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the U.S. is 7%, while the one-year nominal interest rate in Australia is 11%. The spot rate of the Australian dollar is $.60. You will need 10 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?

[(1.07)/(1.11)] - 1 = -3.60%. So the one-year forward rate is $.60 × [1 + (-.036)] = $.5784. You will need 10,000,000 × $.5784 = $5,784,000.

High national income in the U.K. could cause ___________ in the demand for U.S. goods.

an increase

T/F: The ask quote is the price for which a bank offers to sell a currency.

True

A high level of supply of a currency generally ____________ the currency's value, while a high level of demand for a currency ___________ its value.

decreases; increases

According to interest rate parity (IRP):

the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.

Assume U.S. interest rates fall relative to British interest rates. Other things being equal, how should this affect the supply of pounds for sale?

the supply of pounds for sale will decrease

Due to _______, market forces should realign the cross exchange rate between two foreign currencies based on the spot exchange rates of the two currencies against the U.S. dollar.

triangular arbitrage

Assume the Canadian dollar is equal to $.88 and the Peruvian Sol is equal to $.35. The value of the Peruvian Sol in Canadian dollars is:

$.35/$.88 = .3977

Assume the British pound is worth $1.60, and the Canadian dollar is worth $.80. What is the value of the Canadian dollar in pounds?

$.80/$1.60 = 0.50

Assume the following information: Spot rate today of Swiss franc = $.60 1-year forward rate as of today for Swiss franc = $.63 Expected spot rate 1 year from now = $.64 Rate on 1 year deposits denominated in Swiss francs = 7% Rate on 1 year deposits denominated in U.S. dollars = 9% From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of _______%.

$1,000,000/$.60 = SF1,666,667 × (1.07) = SF1,783,333 × $.63 = $1,123,500 Yield = ($1,123,500 - $1,000,000)/$1,000,000 = 12.35%

The value of euro was $1.30 last week. During last week the euro depreciated by 5%. What is the value of euro today?

$1.3 * (1 - .05) = $1.235

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 want to use covered interest arbitrage for a 90 day investment, you will buy pound at ______, and sell pound forward at ___________.

$1.30; $1.28

Assume that the spot exchange rate of the British pound is $1.73. This spot rate will adjust to ___________ according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 2 percent.

$1.649

Today's spot rate of the Mexican peso is $.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7%, while the Mexican inflation over this year is expected to be 3%. Wake Forest Co. plans to import from Mexico and will need 20 million Mexican pesos in one year. What is the expected amount of dollars to be paid by the Wake Forest Co. for the pesos in one year? Hint, there are 3 steps: 1. find the expected % change of peso using PPP- please use the exact formula instead of the simplified one ;2. find the spot rate one year from now using the current spot rate and the result from step 1; 3. using the result from 2, find how much $ is 20 million Mexican peso in one year.

$2,077,710

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:

(1.05/1.07) (1.50) = $1.47.

The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is quoted at $1.63. The forward _______ is _______ percent.

(F/S) - 1 = ($1.60/$1.63) - 1 = -1.8 percent discount

The one-year risk-free interest rate in Mexico is 10%. The one-year risk-free rate in the U.S. is 2%. Assume that interest rate parity exists. The spot rate of the Mexican peso is $.14. What is the forward rate premium?

- .07273

Assume a simple world in which the U.S. exports beverage to France and imports wine from France. If the U.S. imposes large tariffs on the French wine, what is the likely impact on the values of the U.S. beverage firms, U.S. wine producers, the French beverage firms, and the French wine producers (assuming that French government will retaliate)?

Both French wine producers and U.S. beverage firms will be adversely affected

If the direct exchange rate of the euro is worth $1.40, what is the indirect rate of the euro?

1/1.4=0.71

You invested in a stock denominated in euro. Over the investment period, the stock has appreciated by 8.0%, and euro has appreciated by 5.0%. What is your total return?

13.4%

When inflation is high in a particular country, foreign demand for goods in that country will ______________. In addition, that country's demand for foreign goods should ____________. Thus, the home currency of that country will ________________. (note: #1 asks the same question:))

Decrease; increase; weaken

T/F: If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

False

T/F:There is no exchange rate risk involved in carry trade, because it is the same as covered interest arbitrage.

False

Chinese Yuan (CNY) was quoted at about 8 CNY for $1 when I left China in 2001. Right now, it is quoted as 6.15 CNY for $1. Chinese Yuan has _____ by approximately _______ since 2001.

Indirect-->direct: 1/8=.125; 1/6.15=.1626 % change=(.1626-.125)/.125=30.08%appreciation

Assume that the level of capital flows between the U.S. and the country of Krendo is negligible (close to zero) and will continue to be negligible. There is a substantial amount of trade between the U.S. and the country of Krendo and no capital flows. Thus, the inflation effect will be _____ than the interest rate effect in influencing the exchanger rate of Krendo against U.S. dollar.

stronger

According to the IFE, if British interest rates exceed U.S. interest rates:

the British pound will depreciate against the dollar.

Assume that the Japanese government relaxes its controls on imports by Japanese companies. Other things being equal, how should this affect the U.S. demand for Japanese yen?

the U.S. demand for Japanese yen will not be affected

T/F: Currencies of countries with high inflation rates tend to have forward discounts because these currencies tend to have high interest rates.

True

T/F: The potential effectiveness of a central bank's direct intervention depends on the amount of reserves it can use.

True

T/F:To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward.

True

Assume that the U.S. inflation rate becomes high relative to Canadian inflation. Other things being equal, how should this affect the U.S. demand for Canadian dollars?

U.S. demand for Canadian dollars will increase

The equilibrium exchange rate of pounds is $1.70. At an exchange rate of $1.72 per pound:

U.S. demand for pounds would be less than the supply of pounds for sale and there would be a surplus of pounds in the foreign exchange market.

Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then:

U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S.

Currencies in countries with high inflation will be ______ according to PPP, causing the purchasing power of goods in the home country versus these countries to be similar.

Weak

Assume there is concern that the United States may experience a recession. How should the Federal Reserve influence the dollar to prevent a recession?

Weaken the dollar

The demand for U.S. exports tends to increase when:

the currencies of foreign countries strengthen against the dollar.

Assume that the U.S. income level rises at a much higher rate than does the Canadian income level. Other things being equal, how should this affect the equilibrium value of the Canadian dollar?

the equilibrium value of the Canadian dollar will increase

A U.S. firm that exports products to Latin American countries will be _____________ affected by the central bank intervention that causes Latin American currencies to depreciate (Assume the exports are denominated in the corresponding Latin American currency for each country).

adversely

ssume that you have a subsidiary in Australia. The subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from local banks. Your subsidiary purchases all of its materials from Hong Kong and pays Hong Kong dollar. The Hong Kong dollar is tied to the U.S. dollar. Your subsidiary borrowed funds from the U.S. parent, and must pay the parent $100,000 in interest each month. Australia has just raised its interest rate in order to boost the value of its currency (Australian dollar). The Australian dollar will ____________ in value as a result of the interest rate raise.

appreciate

Assume U.S. and Swiss investors require a real rate of return of 3%. Assume the nominal U.S. interest rate is 6% and the nominal Swiss rate is 4%. According to the international Fisher effect, the franc will _______ by about _______.

appreciate; 2%

The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian dollar was $0.69. The Australian dollar ________ by _______%.

appreciated; 5.80 =>($0.73 - $0.69)/$0.69 = 5.80%

Direct foreign investment into the U.S. represents a ________.

capital inflow

Due to _______, market forces should realign the relation¬ship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.

covered interest arbitrage

If interest rate parity exists, then _______ is not feasible.

covered interest arbitrage

Assume that you have a subsidiary in Australia. The subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from local banks. Your subsidiary purchases all of its materials from Hong Kong and pays Hong Kong dollar. The Hong Kong dollar is tied to the U.S. dollar. Your subsidiary borrowed funds from the U.S. parent, and must pay the parent $100,000 in interest each month. Australia has just raised its interest rate in order to boost the value of its currency (Australian dollar). The subsidiary's cost of purchasing materials measured in Australian dollar will ____________.

decrease

Assume that U.S. interest rates have increased substantially, while Country P's interest rates remain low. Investors of both countries are attracted to high interest rates. Other things being equal, this should ____________ U.S. demand for krank, ______________ supply of krank for sale, and ________________ the equilibrium value of krank.

decrease, increase, decrease

If investors in the United States and Canada require the same real interest rate, and the nominal rate of interest is 2 percent higher in Canada, the value of the Canadian dollar should _______________ against the U.S. dollar according to PPP.(Recall the Fisher Effect: inflation rate=nominal rate-real rate)

depreciate by 2 percent

To boost the value of Thai Baht, Thai central bank sell U.S. dollar to buy Thai Baht in the foreign exchange market. The intervention effort by the Thai government constitutes _____________.

direct intervention

The high inflation in Mexico places ___________ pressure on the value of the peso.

downward

If interest rate parity holds, then the one-year forward rate of a currency will ______ the predicted spot rate of the currency in one year according to the international Fisher effect.

equal to

T/F: A weakening of the U.S. dollar with respect to the British pound would likely reduce the U.S. exports to Britain and increase U.S. imports from Britain.

false

Consider two countries that trade with each other, called X and Y. According to the text, inflation in Country X will have a greater impact on inflation in Country Y under the _______ system. Now, consider two other countries that trade with each other, called A and B. Unemployment in Country A will have a greater impact on unemployment in Country B under the _______ system.

fixed rate; fixed rate

Assume that the inflation rate in Brazil is expected to increase substantially. Brazil's nominal interest rate would likely ________, and the Brazilian real would be expected to ___________.(recall the Fisher Effect, Nominal interest rate=inflation+real interest rate)

increase; depreciate

According to the international Fisher effect, if investors in all countries require the same real rate of return, the differential in nominal interest rates between any two countries:

is due to their inflation differentials

Due to _______, market forces should realign the spot rate of a currency among banks.

locational arbitrage

The currency of country X is pegged to the currency of country Y. Assume that county Y's currency depreciates against the currency of country Z. It is likely that country X will export _______ to country Z and import _______ from country Z.

more; less

Latin American countries have historically experienced relatively high inflation, and their currencies have weakened. This information is somewhat consistent with the concept of:

purchasing power parity.

Because there are sometimes no substitutes for traded goods, this will:

reduce the probability that PPP shall hold.