IBUS TEST 2 multiple choice q's ch 6-12
Assume that U.S. and British investors require a real return of 2%. If the nominal U.S. interest rate is 15%, and the nominal British rate is 13%, then according to the IFE, the British inflation rate is expected to be about ____ the U.S. inflation rate, and the British pound is expected to
2 percentage points below; appreciate by about 2%
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:
8%.
T/F: If the IFE theory holds, that means that covered interest arbitrage is not feasible.
False
T/F: The international Fisher effect (IFE) suggests that the currencies with relatively high interest rates will appreciate because those high rates will attract investment and increase the demand for that currency.
False
Which of the following is not true regarding IRP, PPP, and the IFE?
IRP suggests that a currency's spot rate will change according to interest rate differentials.
T/F: According to the IFE, when the nominal interest rate at home exceeds the nominal interest rate in the foreign country, the home currency should depreciate.
True
T/F: Corporations tend to make only limited use of technical forecasting because it typically focuses on the near future, which is not very helpful for developing corporate policies.
True
T/F: If interest rate parity holds, and the international Fisher effect (IFE) holds, foreign currencies with relatively high interest rates should have forward discounts and those currencies would be expected to depreciate.
True
T/F: If the international Fisher effect (IFE) holds, the local investors are expected to earn the same return from investing internationally as they would from investing in their local markets.
True
Which of the following is not a forecasting technique mentioned in your text? a. accounting-based forecasting. b. technical forecasting. c. fundamental forecasting. d. market-based forecasting.
accounting-based forecasting.
Among the reasons that purchasing power parity (PPP) does not consistently occur: a. exchange rates are affected by interest rate differentials. b. exchange rates are affected by national income differentials and government controls. c. supply and demand may not adjust if no substitutable goods are available. d. all of the above are reasons that PPP does not consistently occur.
all of the above are reasons that PPP does not consistently occur.
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%
If an MNC invests excess cash in a foreign county, it would like the foreign currency to ____; if an MNC issues bonds denominated in a foreign currency, it would like the foreign currency to ____.
appreciate; depreciate
Assume that the dollar has been consistently depreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using sterilized intervention. The Fed would
buy dollars with foreign currency and simultaneously buy Treasury securities with dollars.
To strengthen the dollar using sterilized intervention, the Fed would ____ dollars and simultaneously ____ Treasury securities.
buy; buy
Which of the following is an example of triangular arbitrage initiation?
buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand/Singapore dollar exchange rate at SAR3.00 when the spot rate for the rand is $.20.
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:
depreciation in the Australian dollar's value over the next year
If interest rate parity holds, then the one-year forward rate of a currency will be ____ the predicted spot rate of the currency in one year according to the international Fisher effect.
equal to
If the Fed desires to weaken the dollar without affecting the dollar money supply, it should:
exchange dollars for foreign currencies, and sell some of its existing Treasury security holdings for dollars.
Which of the following is not a limitation of fundamental forecasting? a. uncertain timing of impact. b. forecasts are needed for factors that have a lagged impact. c. omission of other relevant factors from the model. d. possible change in sensitivity of the forecasted variable to each factor over time. e. none of the above
forecasts are needed for factors that have a lagged impact.
If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation countries.
forward; high
Factors such as economic growth, inflation, and interest rates are an integral part of ____ forecasting.
fundamental
Which of the following forecasting techniques would best represent the use of relationships between economic factors and exchange rate movements to forecast the future exchange rate?
fundamental forecasting.
According to the international Fisher effect, if Venezuela has a much higher nominal rate than other countries, its inflation rate will likely be ____ than other countries, and its currency will ____.
higher; weaken
Which of the following theories suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries?
interest rate parity (IRP).
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?
international Fisher effect (IFE).
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.
Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:
larger will be the forward discount of the foreign currency.
Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:
larger will be the forward premium of the foreign currency.
Due to ____, market forces should realign the spot rate of a currency among banks.
locational arbitrage
A weak dollar is normally expected to cause:
low unemployment and high inflation in the U.S.
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.
lower U.S. inflation; depreciate
Which of the following forecasting techniques would best represent the use of today's forward exchange rate to forecast the future exchange rate?
market-based forecasting.
Assume that interest rate parity holds, and the euro's interest rate is 9% while the U.S. interest rate is 12%. Then the euro's interest rate increases to 11% while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity.
premium; decrease
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?
purchasing power parity (PPP).
The Fisher effect is used to determine the:
real interest rate.
Which of the following forecasting techniques would best represent the sole use of the pattern of historical currency values of the euro to predict the euro's future currency value?
technical forecasting.
Under purchasing power parity, the future spot exchange rate is a function of the initial spot rate in equilibrium and:
the inflation differential.
Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 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?
$15,385 ($1,000,000/$.325 = NZ$3,076,923 × $.33 = $1,015,385. Thus, the profit is $15,385)
Assume the British pound is worth $1.60, and the Canadian dollar is worth $.80. What is the value of the Canadian dollar in pounds?
.50. ($.80/$1.60 = 0.50)
You just received a gift from a friend consisting of 1,000 Thai baht, which you would like to exchange for Australian dollars (A$). You observe that exchange rate quotes for the baht are currently $.023, while quotes for the Australian dollar are $.576. How many Australian dollars should you expect to receive for your baht?
A$39.93. ($.023/$.576 × THB1,000 = A$39.93.)
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:
British investors could possibly benefit from covered interest arbitrage.
It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce inflation. Which of the following is an appropriate action given this scenario?
Buy dollars with foreign currency
T/F: A common way to reduce inflation is to weaken the value of the domestic currency.
False
T/F: A currency peg is insulated from economic or political conditions, such that the exchange rate in the market will only change if the country's government breaks the peg and sets a new exchange rate.
False
T/F: Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.
False
T/F: Direct intervention is usually more effective than indirect intervention.
False
T/F: For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.
False
T/F: Forward rates are driven by the government rather than market forces.
False
T/F: If a U.S. firm plans to frequently purchases goods from Hong Kong over the next several years, it does not have to worry about exchange rate risk.
False
T/F: If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage should be equal to the rate available in the foreign country.
False
T/F: The Fed's indirect method of intervention is to trade dollars for or against other currencies.
False
T/F: 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%.
False
T/F: Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.
False
T/F: If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.
False
Assume a two-country world: Country A and Country B. Which of the following is correct about purchasing power parity (PPP) as related to these two countries?
If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken.
In which case will locational arbitrage most likely be feasible?
One bank's bid price for a currency is greater than another bank's ask price for the currency.
Which one is not a disadvantage of a freely floating exchange rate system?
The government may intervene to change the value of a given currency.
Which one of the following is a disadvantage of a fixed exchange rate system:
The government might change the value of the currency.
Which of the following is the most likely reason for revaluation of a currency?
To reduce inflation.
Which of the following is not mentioned in the text as a form of international arbitrage?
Transactional arbitrage
If quoted exchange rates are the same across different locations, then ____ is not feasible. a. triangular arbitrage b. covered interest arbitrage c. locational arbitrage d. A and C
Triangular and locational arbitrage
T/F 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.
True
T/F: A central bank may attempt to stimulate a stagnant economy by weakening the value of the currency.
True
T/F: A strong home currency can harm exports; exporters typically benefit from a weaker home country currency.
True
T/F: An example of indirect intervention by the Bank of Japan would be for the Bank of Japan to use interest rates to increase the value of the yen vs. the dollar.
True
T/F: Assume the Fed desires to strengthen the dollar. If it buys dollars and simultaneously buys Treasury securities, this is an example of sterilized intervention.
True
T/F: Currency devaluation can boost a country's exports, but currency revaluation can increase foreign competition.
True
T/F: Currency devaluations have the potential to reduce unemployment, while currency revaluations have the potential to reduce inflation.
True
T/F: Dollarization refers to the replacement of local currency with U.S. dollars.
True
T/F: 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.
True
T/F: 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.
True
T/F: Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount.
True
T/F: Nonsterilized intervention is intervention by a central bank in the foreign exchange market without adjusting for the change in money supply.
True
T/F: The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).
True
T/F: The interest rate on pounds in the U.K. is 8%. The interest rate in the U.S. is 5%. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.
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
T/F: Under a fixed exchange rate system, U.S. inflation would have a greater impact on inflation in other countries than it would under a freely floating exchange rate system.
True
T/F: Under a pegged exchange rate system, the home currency's value is pegged to a foreign currency.
True
T/F: Using indirect intervention, the Fed attempts to affect the dollar's value indirectly by influencing the factors that determine it, such as interest rates.
True
T/F: Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.
True
T/F: The interest rate on yen is 7%. The interest rate in the U.S. is 9%. The yen's forward rate should exhibit a premium of about 2%.
True
If the interest rate is lower in the U.S. than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate:
U.S. investors could possibly benefit from covered interest arbitrage.
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.
It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce unemployment. Which of the following is an appropriate action given this scenario?
Weaken the dollar
Given a home country and a foreign country, purchasing power parity (PPP) suggests that:
a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.
The international Fisher effect (IFE) suggests that:
a home currency will depreciate if the current home interest rate exceeds the current foreign interest rate.
Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist? a. transaction costs. b. political risk. c. differential tax laws. d. all of the above.
all of the above
Due to ____, market forces should realign the relationship 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
Points below the IRP line represent situations where:
covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically.
Points above the IRP line represent situations where:
covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets.
Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, the following adjustments must take place: a. One bank's ask price will rise and the other bank's bid price will fall. b. One bank's ask price will fall and the other bank's bid price will rise. c. One bank's bid/ask spread will widen and the other bank's bid/ask spread will fall. d. A and C
d. A and C
Which of the following is not true regarding interest rate parity (IRP)? a. When interest rate parity holds, covered interest arbitrage is not possible. b. 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. c. 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. d. When covered interest arbitrage is not feasible, interest rate parity must hold. e. All of the above are true.
d. When covered interest arbitrage is not feasible, interest rate parity must hold.
Given a home country and a foreign country, purchasing power parity suggests that: a. the inflation rates of both countries will be the same. b. the nominal interest rates of both countries will be the same. c. A and B d. none of the above
d. none of the above
Given a home country and a foreign country, the international Fisher effect (IFE) suggests that: a. the nominal interest rates of both countries are the same. b. the inflation rates of both countries are the same. c. the exchange rates of both countries will move in a similar direction against other currencies. d. none of the above
d. none of the above
Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso's forward ____ will ____.
discount; increase
A strong dollar places ____ pressure on U.S. inflation, which in turn places ____ pressure on U.S. interest rates, which in turn place ____ pressure on U.S. bond prices.
downward; downward; upward
Assume that the euro's interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the following is true? a. Americans using covered interest arbitrage earn the same rate of return as Germans who attempt covered interest arbitrage. b. Americans who invest in the U.S. earn the same rate of return as Germans who attempt covered interest arbitrage. c. Americans who invest in the U.S. earn the same rate of return as Germans who invest in Germany d. A and B e. None of the above
e. None of the above
Assume that the dollar has been consistently appreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using nonsterilized intervention. The Fed would: a. buy dollars with foreign currency and simultaneously sell Treasury securities for dollars. b. buy dollars with foreign currency and simultaneously buy Treasury securities with dollars. c. sell dollars for foreign currency and simultaneously sell Treasury securities for dollars. d. sell dollars for foreign currency and simultaneously buy Treasury securities with dollars. e. none of the above
e.none of the above
A "dirty" float represents a system of:
floating exchange rates, but the central bank can manipulate the currency.
Which of the following is not a reason for devaluation of a currency?
high inflation.
A strong dollar is normally expected to cause:
high unemployment and low inflation in the U.S.
If the Fed ____ the interest rates when inflationary expectations remain unchanged, the most likely result is that the value of dollar will ____ and the economy may ____.
increases; appreciate; weaken
Countries that have adopted the euro tend to have very similar ____.
interest rates
Countries that have adopted the euro must agree on a single ____ policy.
monetary
Assume a central bank exchanges its currency for other foreign currencies in the foreign exchange market, but does not adjust for the resulting change in the money supply. This is an example of:
nonsterilized intervention
Assume that the Fed intervenes by exchanging dollars for euros in the foreign exchange market. This will cause an ____ U.S. dollars and an ____ euros.
outward shift in supply of; outward shift in demand for
Assume that interest rate parity holds. U.S. interest rate is 13% and British interest rate is 10%. The forward rate on British pounds exhibits a ____ of ____ percent.
premium; 2.73
Because there are a variety of factors in addition to inflation that affect exchange rates, this will:
reduce the probability that PPP shall hold.
To force the value of the pound to appreciate against the dollar, the Federal Reserve should:
sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB) should sell dollars for pounds in the foreign exchange market.
To force the value of the British pound to depreciate against the dollar, the Federal Reserve should:
sell pounds for dollars in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market.
To weaken the dollar using sterilized intervention, the Fed will ____ U.S. dollars and simultaneously ____ Treasury securities.
sell; sell
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:
should exhibit a discount.
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?
spot rate of peso increases; forward rate of peso decreases.
According to the IFE, if British interest rates exceed U.S. interest rates
the British pound will depreciate against the dollar.
As locational arbitrage occurs:
the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will increase
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.
If interest rates on the euro are consistently below U.S. interest rates, then for the international Fisher effect (IFE) to hold:
the value of the euro would often appreciate against the dollar.
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 that Swiss investors are benefiting from covered interest arbitrage due to a high U.S. interest rate. Which of the following forces results from the act of this covered interest arbitrage?
upward pressure on the Swiss franc's forward rate.
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 Japan and the United States frequently trade with each other. Under the freely floating exchange rate system, high inflation in the U.S. will place ____ pressure on Japanese yen, ____ the amount of Japanese yen available for sale, and result in ____ inflation in Japan.
upward; reduce; unchanged
A weaker dollar places ____ pressure on U.S. inflation, which in turn places ____ pressure on U.S. interest rates, which places ____ pressure on U.S. bond prices.
upward; upward; downward
Under a managed float exchange rate system, the Fed may attempt to stimulate the U.S. economy by ____ the dollar. Such an adjustment in the dollar's value should ____ the U.S. demand for products produced by major foreign countries.
weakening; decrease
