FINA 4500: Chapter 6

Calculation of interest rate parity is done using the interest rates of U.S. Treasury notes and their equivalents because they are considered

default-free risk-free

If a country's currency Blank______ by more than is warranted by PPP, the competitiveness of the country's industries will Blank______ because the real exchange rate has changed.

depreciates; increase appreciates:decrease

The interest rate will be higher in the United States than in the U.K. when the dollar is at a forward Blank______, that is, when the dollar is expected to Blank______ against the pound.

discount;depreciate

When no profitable arbitrage opportunities exist, the market is said to be in

equilibrium

That any forward premium or discount is equal to the expected change in the exchange rate between two currencies is predicted by

forward expectations

If (1 + i$) > FS�� (1 + i£), then a profitable arbitrage opportunity is to Blank______ in the United States and Blank______ in the U.K.

lend;borrow

The currency carry trade involves being Blank______ a high-yielding currency, being Blank______ a low-yielding currency and Blank______ hedging exchange rate risk.

long; short; not

Purchasing power parity can be thought of as

the law of one price applied to the standard consumption basket an application of arbitrage equilibrium

The idea that the nominal interest rate differential between two countries reflects the expected change in exchange rates is the

International fisher effect

Which currencies have been popular for funding currency carry trades?

Swiss franc; Japanese Yen

When the interest rate parity equation does not hold and it is possible to earn profits without exchange-rate risk, there is a(n) *blank* interest arbitrage opportunity

covered

The interest rate parity condition is given by which formula(s)? Define S and F as the spot and forward rates and i as the interest rate.

(1 + i$) = FS�� (1 + i£) S = [1+i£1+i$]1+�£1+�$ F

When the same (or equivalent) things are trading at the same price across different locations or markets, then what is true?

- The law of one price holds - There is no arbitrage opportunity

The equation for the quantity theory of money is Blank______, where M denotes the money supply, P the general price level, V the velocity of money that measures the speed at which money is being circulated in the economy, and Y the national aggregate output.

MV=PY

Why might interest rate parity not hold?

There are transaction costs in buying and selling currency. There are bid-ask spreads in capital markets.

The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making certain, guaranteed profits is referred to as

arbitrage

When people's expectations for an exchange rate to go up in the future actually cause it to go up, it is referred to as ______ expectations.

self-fulfilling

According to the monetary approach, which factors determine exchange rates?

the relative velocities of money the relative money supplies the relative national outputs

If the interest rate in two countries is the same, then the forward rate should be Blank______ the spot rate

the same as