Question 1

Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.

Accepted Answer

With the use of technology, banks can have access to real-time exchange rates and market information, which allows for more consistent pricing across locations and reduces the risk of errors or discrepancies in foreign exchange quotations.

Question 2

Assume that the real interest rate in the U.S. and in the U.K. is 3%. The expected annual inflation in the U.S. is 3%, while in the U.K. it is 4%. The forward rate on the pound should exhibit a premium of about 1%.

Accepted Answer

The answer of Assume that the real interest rate in...

Question 3

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.

Accepted Answer

According to interest rate parity, the forward rate on a currency should equal the currency's spot rate times the ratio of the two countries' interest rates. Using this formula, the forward rate on pounds would be:

Forward rate = Spot rate x (1 + British interest rate) / (1 + U.S. interest rate)
Forward rate = Spot rate x (1 + 0.10) / (1 + 0.13)
Forward rate = Spot rate x 0.9709

Since the U.S. interest rate is higher than the British interest rate, the forward rate is at a premium. Therefore, the answer is B.

To calculate the percentage of the premium, we can take the difference between the forward rate and the spot rate, divide it by the spot rate, and then multiply by 100.

Premium = (Forward rate - Spot rate) / Spot rate x 100%
Premium = (Spot rate x 0.9709 - Spot rate) / Spot rate x 100%
Premium = 0.9709 - 1 x 100%
Premium = -2.91%

Note that the premium is negative, indicating that the dollar is expected to appreciate against the pound. However, the question only asks for the absolute value of the premium, which is 2.91%, or approximately 2.73% when rounded to two decimal places.

Question 4

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Accepted Answer

The answer of For locational arbitrage to be possible, one...

Question 5

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.

Accepted Answer

Interest rate parity implies that the expected return on an investment in one currency should be equal to the expected return on an investment in another currency, taking into account the exchange rate and interest rates. In this case, the interest rate in the U.K. is higher than the interest rate in the U.S., so U.S. investors will earn a lower return domestically than British investors earn domestically.

Question 6

Points below the IRP line represent situations where:

Accepted Answer

Points below the IRP (Interest Rate Parity) line indicate that domestic investors can engage in covered interest arbitrage to earn a yield higher than what is available domestically.

Question 7

If quoted exchange rates are the same across different locations, then ____ is not feasible.

Accepted Answer

Locational arbitrage relies on differences in exchange rates across locations, and triangular arbitrage depends on discrepancies in cross-exchange rates. If rates are the same everywhere, neither can be profitably pursued.

Question 8

Assume the following information:  Assume you have $100,000 to conduct triangular arbitrage. What will be your profit from implementing this strategy?

Accepted Answer

The answer of Assume the following information:  Assume you...

Question 9

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%.

Accepted Answer

The interest rate differential between the two countries is 2% (9% - 7%), which means that the yen should trade at a premium in the forward market to compensate for the higher interest rate in the U.S.

Question 10

The yield curve of every country has its own unique shape.

Accepted Answer

Every country's yield curve is affected by its own economic factors, such as inflation rate, political stability, and monetary policies, which can result in a unique shape.

Question 11

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

Accepted Answer

Triangular arbitrage involves taking advantage of discrepancies between three currencies in the foreign exchange market, not directly influencing the relationship between interest rates of two countries and their forward exchange rate premium or discount.

Question 12

Points above the IRP line represent situations where:

Accepted Answer

The answer of Points above the IRP line represent situations...

Question 13

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.

Accepted Answer

Locational arbitrage involves buying and selling the same currency in two different locations to take advantage of price differences. As a result of this activity, market forces would realign the exchange rates between the two locations, leading to an increase in the bank's ask rate and a decrease in the other bank's bid rate. Therefore, the statement is true.

Question 14

The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).

Accepted Answer

This statement is true. Interest rate parity (IRP) is the equilibrium state in which covered interest arbitrage is no longer possible, and refers to the theoretical relationship between the spot exchange rate, forward exchange rate, and the interest rates of the two currencies involved. IRP suggests that the return on domestic investment should equal the return on foreign investment after taking into account exchange rate changes, and is a key concept in international finance.

Question 15

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.

Accepted Answer

The answer of If the cross exchange rate of two...

Question 16

Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount.

Accepted Answer

Locational arbitrage involves taking advantage of price differences in different locations, which leads to market forces that quickly eliminate these discrepancies, ensuring prices remain similar across locations.

Question 17

Assume the following information:  What will be the yield for an investor who has $1,000,000 available to conduct triangular arbitrage?

Accepted Answer

The answer of Assume the following information:  What will...

Question 18

Cross exchange rates are used to determine the relationship between the dollar and two nondollar currencies.

Accepted Answer

Cross exchange rates are used to determine the exchange rate between two nondollar currencies using a common third currency, often the dollar, as a reference.

Question 19

Assume the following information: U.S. investors have $1,000,000 to invest:
 Given this information:

Accepted Answer

The answer of Assume the following information: U.S. investors have...

Question 20

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

Accepted Answer

Even if interest rate parity does not exist, covered interest arbitrage may still not be profitable due to transaction costs, political risk, and differential tax laws. These factors can increase the cost of executing the arbitrage trade and reduce the potential profits. Therefore, all of the above options might discourage covered interest arbitrage.

Quiz 7: International Arbitrage and Interest Rate Parity