Question 1

If purchasing power parity holds,what is the expected German inflation rate,if the US expected inflation rate is 3%,the spot exchange rate is USD0.667= EUR1 and the expected spot rate is USD0.625 = EUR1?

Accepted Answer

1 + expected German inflation = 1.03 × 0.667 / 0.625 = 1.099

Question 2

Yesterday the spot exchange rate of yen-to-dollar was JPY105 = USD1.What is today's spot exchange rate if the yen has appreciated 10% against the dollar today?

Accepted Answer

Today's spot rate = 105 × .9 = JPY94.5 = USD1

Question 3

Which of the following is correct when contracting ahead in the forward exchange market?

Accepted Answer

When contracting ahead in the forward exchange market, your cost is locked in from the beginning of the contract, regardless of market changes. This means that even if the exchange rate changes in the future, you will still pay the rate that was contracted at the beginning of the agreement. Option A is incorrect because at contract close, you only pay the forward rate that was contracted, not the then-current rate. Option B is incorrect because the cost of contracting ahead may be more expensive than waiting to pay spot rates, depending on the market conditions. Option D is incorrect because contracting forward provides certainty and protection against fluctuating exchange rates, which may be riskier than paying spot rates.

Question 4

The international Fisher effect is valid in the long run because:

Accepted Answer

Investors will move their money into countries with high real interest rates because they want to earn a higher return on their investment. This will cause the demand for the currency of the country with the high real interest rate to increase, which will in turn cause the value of the currency to appreciate. This appreciation will offset the effects of inflation, so that the real interest rate will remain the same.

Question 5

Which one of these is an example of operational hedging?

Accepted Answer

Operational hedging refers to the management of production and supply chain activities to mitigate risks. Manufacturing goods in the country where they will be sold can reduce exposure to exchange rate fluctuations and risks associated with international trade. This is because production costs and revenues are denominated in the same currency, which can reduce cost volatility and improve pricing flexibility. The other options do not involve modifying production or supply chain activities to manage risks, and therefore do not represent operational hedging.

Question 6

What would you expect to be the relationship between real rates of interest in Japan and the United States if inflation is expected to be 3% in Japan and 6% in the United States?

Accepted Answer

Real interest rates tend to equalize across countries due to capital mobility and arbitrage opportunities, assuming no significant barriers to capital flows.

Question 7

Assume you can exchange $1 for either C$1.03 or €0.74.How many Canadian dollars can be acquired with one euro?

Accepted Answer

1.03 / 0.74 = C$1.3919

Question 8

Today,you purchased 125,000 yen 6-months forward at JPY130 = USD1 per dollar.The spot rate today is JPY128 =USD1.If the yen appreciates by 10% over the next six months,how many dollars must you pay to acquire the 125,000 yen?

Accepted Answer

Dollar cost = 125,000 / 130 = $961.54

Question 9

You have the opportunity to invest in the United States at 6% or invest in an equally risky Australian investment that offers 20%.This is too good to be true! The current exchange rate is AUD1.65 = USD1.Which one of the following do you suspect about this 1-year investment?

Accepted Answer

Forward rate = 1.65 × 1.20 / 1.06. AUD1.8679 = USD1

Question 10

If nominal interest rates are 5% in the United States and 8% in Mexico,you should convert the expected cash flows on your Mexican project into US dollars:

Accepted Answer

The best choice would be to assume that the Mexican peso will depreciate by about 3% a year. This is because the nominal interest rate in Mexico is higher than that in the United States, which can lead to a depreciation of the Mexican peso relative to the US dollar due to higher inflation expectations. By assuming that the Mexican peso will depreciate by about 3% a year, you can convert the expected cash flows on your Mexican project into US dollars taking into account the expected exchange rate movements.

Question 11

Buckingham plc,a British corporation,owes $1 million due in 2 months.How can Buckingham hedge the exchange risk?

Accepted Answer

Buckingham can hedge the exchange risk by buying dollars in the forward market to lock in the exchange rate for when the payment is due in 2 months.

Question 12

Consider the following spot exchange rates for the British pound,the Japanese yen,the euro and the Swedish krona: USD1.60 = GBP1,JPY105 = USD1,USD0.625 = EUR1,and SEK6.2 = USD1.If gold sells for $290 per ounce in the United States,which one of the following prices for 1 ounce of gold seems to violate the law of one price?

Accepted Answer

£181.25 × 1.60 = $290¥30,450 / 105 = $290€405 × 0.625 = $253.13 violates the law of one price.kr1,798 / 6.2 = $290

Question 13

Which one of the following appears to be a safe assumption when there is no difference between the forward and spot exchange rates between two currencies?

Accepted Answer

When there is no difference between the forward and spot exchange rates between two currencies, it is safe to assume that the countries have equal nominal interest rates. This is known as interest rate parity, where the difference in the interest rates between two countries is equal to the difference in the exchange rates between their currencies.

Question 14

According to the theory of purchasing power parity,exchange rates will adjust to offset differences in:

Accepted Answer

The theory of purchasing power parity suggests that exchange rates will adjust to offset differences in expected inflation rates across countries. This means that if a country is expected to have higher inflation in the future compared to another country, its currency will depreciate to offset the difference in purchasing power. In this way, goods and services should cost roughly the same in different countries after accounting for exchange rates. Differences in interest rates, forward rates, and international Fisher rates may also affect exchange rates, but PPP specifically focuses on inflation differentials.

Question 15

A firm must make a large future payment in a foreign currency and wants to hedge the associated exchange rate risk.Which one of the following identifies the cost of such a hedge?

Accepted Answer

The cost of hedging using a forward contract is the difference between the forward rate and the expected future spot rate. This reflects the potential gain or loss from locking in a rate that may differ from the future spot rate.

Question 16

What would you expect to occur if the expected rate of inflation in the United States is considerably lower than the expected inflation in Germany?

Accepted Answer

If the expected rate of inflation in the United States is lower than the expected inflation in Germany, the purchasing power of the dollar will be stronger than that of the euro. This would result in an increase in demand for the dollar and a decrease in demand for the euro, causing the dollar to appreciate against the euro. Therefore, choice C is the correct answer.

Question 17

An indirect exchange rate can be converted to a direct exchange rate by:

Accepted Answer

To convert an indirect exchange rate to a direct exchange rate, we need to take the inverse of the indirect rate. This can be done by dividing 1 by the indirect rate or by finding the reciprocal of the indirect rate. This will give us the direct exchange rate, which is the number of units of the other currency that can be purchased with one unit of the domestic currency.

Question 18

Which one of the following is correct when foreign currency is bought in the forward market?

Accepted Answer

The answer of Which one of the following is correct...

Question 19

Which one of these is probably the best means of reducing or offsetting political risk?

Accepted Answer

Borrowing money in the country where you have foreign operations will help to establish connections with local financial institutions and provide an incentive for them to support your business. In addition, having local debt will reduce the perception of political risk, as the company has a financial obligation to the local economy. This aligns the interests of the company and the local community, making conflict less likely.

Question 20

What is the expected spot rate for Japanese yen one year from now if the current spot rate is JPY106 = USD1 and the yen is selling 1-year forward at JPY114 = USD1?

Accepted Answer

The expected spot rate one year from now is the forward rate, which is JPY114 = USD1.

Quiz 22: International Financial Management