Chapter 7—International Arbitrage and Interest Rate Parity 1. 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. a. forw forwar ard d reali realign gnme ment nt arbit arbitra rage ge b. triangular arbitrage c. cove covere red d inte intere rest st arb arbit itra rage ge d. loca locati tion onal al arbi arbitr trag agee A!" #
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&. Due to ____, ____, market forces forces should should realig realign n the spot spot rate of a currenc' currenc' among among banks. banks. a. forw forwar ard d reali realign gnme ment nt arbit arbitra rage ge b. triangular arbitrage c. cove covere red d inte intere rest st arb arbit itra rage ge d. loca locati tion onal al arbi arbitr trag agee A!" D
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. Due to ____, market market forces should realign the the cross exchange rate rate between two foreign currencies based on the spot exchange exchange rates of the two currencies currencies against the .!. dollar. dollar. a. forw forwar ard d reali realign gnme ment nt arbit arbitra rage ge b. triangular arbitrage c. cove covere red d inte intere rest st arb arbit itra rage ge d. loca locati tion onal al arbi arbitr trag agee A!" *
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+. f interest interest rate rate parit' parit' exists exists,, then ____ is not not feasible feasible.. a. forw forwar ard d reali realign gnme ment nt arbit arbitra rage ge b. triangular arbitrage c. cove covere red d inte intere rest st arb arbit itra rage ge d. loca locati tion onal al arbi arbitr trag agee A!" #
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-. n which which case will will locatio locational nal arbitrag arbitragee most likel' likel' be be feasible feasible a. /ne bank0s bank0s ask ask price for for a currenc' currenc' is greater greater than anoth another er bank0s bank0s bid price price for for the currenc'. b. /ne bank0s bid price price for a currenc' is greater than another another bank0s ask price for for the currenc'. c. /ne bank0s bank0s ask price price for a currenc' currenc' is less less than than another another bank0s bank0s ask price price for the currenc' currenc'.. d. /ne bank0s bank0s bid price price for a currenc' currenc' is is less than than another another bank0s bank0s bid price price for the currenc' currenc'.. A!" *
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. 2hen using ____, ____, funds are not not tied up for for an' length length of time. time. a. cove covere red d inte intere rest st arb arbit itra rage ge b. locational arbitrage arbitrage c. tria triang ngul ular ar arbi arbitr trag agee d. * and # A!" D
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3. 2hen using using ____, ____, funds funds are t'picall' t'picall' tied tied up for a signif significant icant period period of of time. a. cove covere red d inte intere rest st arb arbit itra rage ge b. locational arbitrage arbitrage c. tria triang ngul ular ar arbi arbitr trag agee d. * and # A!" A
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4. Assume Assume that the interest interest rate in the the home countr' countr' of #urrenc' 5 is a much higher higher interest interest rate rate than the .!. interest rate. According to interest rate parit', parit', the forward rate of #urrenc' 5" a. shou should ld exh exhib ibit it a dis disco coun unt. t. b. should exhibit exhibit a premium. c. shou should ld be be 6ero 6ero (i.e., (i.e., it it should should e7ual e7ual its spot rate). rate). d. * or # A!" A
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8. f the interest interest rate is higher in the .!. .!. than in the nited nited 9ingdom, and if the forward rate of the the *ritish pound (in .!. dollars) is the same as the pound0s spot rate, then" a. .!. invest investors ors could could possibl' possibl' benefi benefitt from covered covered interes interestt arbitrage. arbitrage. b. *ritish investors investors could possibl' benefit benefit from covered interest arbitrage. c. neither neither .!. nor nor *ritish *ritish investors investors could could benefit benefit from from covered covered interest interest arbitrag arbitrage. e. d. A and * A!" *
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1:. f the interest interest rate is lower in the .!. .!. than in the nited 9ingdom, and and if the forward rate of the *ritish pound is the same as its spot rate" a. .!. invest investors ors could could possibl' possibl' benefi benefitt from covered covered interes interestt arbitrage. arbitrage. b. *ritish investors investors could possibl' benefit benefit from covered interest arbitrage. c. neither neither .!. nor nor *ritish *ritish investors investors could could benefit benefit from from covered covered interest interest arbitrag arbitrage. e. d. A and * A!" A
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11. Assume that the .!. investors investors are benefiting from covered interest arbitrage arbitrage due to to high interest interest rates on euros. 2hich of the following forces should result from the act of this covered interest arbitrage a. downwa downward rd press pressure ure on on the euro euro0s 0s spot spot rate. rate. b. downward pressure on on the euro0s forward rate. c. downwa downward rd press pressure ure on on the .!. .!. inte interes restt rate. rate. d. upward upward pres pressur suree on the euro euro0s 0s inter interest est rate. rate. A!" *
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1&. Assume that !wiss investors investors are benefiting benefiting from covered interest interest arbitrage due to a high .!. interest interest rate. 2hich of the following forces results from the act of this covered interest arbitrage a. upward upward pres pressur suree on the !wis !wisss franc0 franc0ss spot spot rate. rate. b. upward pressure on the the .!. interest rate. c. downwa downward rd press pressure ure on on the !wiss !wiss inte interes restt rate. rate. d. upward upward pressu pressure re on on the the !wiss !wiss franc0 franc0ss forward forward rate. rate. A!" D
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1. Assume Assume that a .!. firm can can invest invest funds for for one 'ear in the the .!. at 1&; or invest invest funds funds in
'ear forward rate of the peso is =.1:. f .!. firms attempt to use covered interest arbitrage, what forces should occur
a. b. c. d.
spot rate of peso increases? forward rate of peso decreases. spot rate of peso decreases? forward rate of peso increases. spot rate of peso decreases? forward rate of peso decreases. spot rate of peso increases? forward rate of peso increases.
A!" A
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1+. Assume the bid rate of a ew @ealand dollar is =. while the ask rate is =.- at *ank 5. Assume the bid rate of the ew @ealand dollar is =.& while the ask rate is =.&- at *ank . Biven this information, what would be 'our gain if 'ou use =1,:::,::: and execute locational arbitrage %hat is, how much will 'ou end up with over and above the =1,:::,::: 'ou started with a. =1-,4-. b. =1-,&-. c. =&&,1. d. =1,&-:. A!" A SOLUTION:
=1,:::,:::C=.&- @=,:3,8& × =. =1,:1-,4-. %hus, the profit is =1-,4-.
$%!" 1 1-. *ased on interest rate parit', the larger the degree b' which the foreign interest rate exceeds the .!. interest rate, the" a. larger will be the forward discount of the foreign currenc'. b. larger will be the forward premium of the foreign currenc'. c. smaller will be the forward premium of the foreign currenc'. d. smaller will be the forward discount of the foreign currenc'. A!" A
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1. Assume the following information" ou have =1,:::,::: to invest" #urrent spot rate of pound 8:>da' forward rate of pound >month deposit rate in .!. >month deposit rate in Breat *ritain
=1.: =1.&4 ; +;
f 'ou use covered interest arbitrage for a 8:>da' investment, what will be the amount of .!. dollars 'ou will have after 8: da's a. =1,:&+,:::. b. =1,::,:::. c. =1,:+:,:::. d. =1,:+,:::. e. none of the above A!" A SOLUTION:
=1,:::,:::C=1.: 38,&1 pounds × (1.:+) 4::,::: pounds × 1.&4 =1,:&+,:::
$%!" 1 13. Assume that the .!. interest rate is 1:;, while the *ritish interest rate is 1-;. f interest rate parit' exists, then"
a. *ritish investors who invest in the nited 9ingdom will achieve the same return as .!. investors who invest in the .!. b. .!. investors will earn a higher rate of return when using covered interest arbitrage than what the' would earn in the .!. c. .!. investors will earn 1-; whether the' use covered interest arbitrage or invest in the .!. d. .!. investors will earn 1:; whether the' use covered interest arbitrage or invest in the .!. A!" D
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14. Assume the following information" .!. investors have =1,:::,::: to invest" 1>'ear deposit rate offered on .!. dollars 1>'ear deposit rate offered on !ingapore dollars 1>'ear forward rate of !ingapore dollars !pot rate of !ingapore dollar
1&; 1:; =.+1& =.+::
Biven this information" a. interest rate parit' exists and covered interest arbitrage b' .!. investors results in the same 'ield as investing domesticall'. b. interest rate parit' doesn0t exist and covered interest arbitrage b' .!. investors results in a 'ield above what is possible domesticall'. c. interest rate parit' exists and covered interest arbitrage b' .!. investors results in a 'ield above what is possible domesticall'. d. interest rate parit' doesn0t exist and covered interest arbitrage b' .!. investors results in a 'ield below what is possible domesticall'. A!" * SOLUTION:
=1,:::,:::C=.+::
!=&,-::,::: × (1.1) !=&,3-:,::: × =.+1& =1,1,::: ield (=1,1,::: − =1,:::,:::)C=1,:::,::: 1.; %his 'ield exceeds what is possible domesticall'.
$%!" 1 18. Assume the following information" #urrent spot rate of ew @ealand dollar Eorecasted spot rate of ew @ealand dollar 1 'ear from now /ne>'ear forward rate of the ew @ealand dollar Annual interest rate on ew @ealand dollars Annual interest rate on .!. dollars
=.+1 =.+ =.+& 4; 8;
Biven the information in this 7uestion, the return from covered interest arbitrage b' .!. investors with =-::,::: to invest is ____;. a. about 11.83 b. about 8. c. about 11.1& d. about 11.+ e. about 1:. A!" F
SOLUTION:
=-::,:::C=.+1
@=1,&18,-1& × (1.:4) @=1,13,:3 × .+& =--,131 ield (=--,131 − =-::,:::)C=-::,::: 1:.;
$%!" 1 &:. Assume the following bid and ask rates of the pound for two banks as shown below"
*ank A *ank *
Bid =1.+1 =1.8
As =1.+& =1.+:
As locational arbitrage occurs" a. the bid rate for pounds at *ank A will increase? the ask rate for pounds at *ank * will increase. b. the bid rate for pounds at *ank A will increase? the ask rate for pounds at *ank * will decrease. c. the bid rate for pounds at *ank A will decrease? the ask rate for pounds at *ank * will decrease. d. the bid rate for pounds at *ank A will decrease? the ask rate for pounds at *ank * will increase. A!" D
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&1. Assume the bid rate of a !ingapore dollar is =.+: while the ask rate is =.+1 at *ank 5. Assume the bid rate of a !ingapore dollar is =.+& while the ask rate is =.+&- at *ank @. Biven this information, what would be 'our gain if 'ou use =1,:::,::: and execute locational arbitrage %hat is, how much will 'ou end up with over and above the =1,:::,::: 'ou started with a. =11,3+. b. −=11,8+. c. =,-4-. d. =&+,8:. e. =14,&18. A!" D SOLUTION:
=1,:::,:::C=.+1 !&,+8,:&+ × =.+& =1,:&+,8:
$%!" 1 &&. *ased on interest rate parit', the larger the degree b' which the .!. interest rate exceeds the foreign interest rate, the" a. larger will be the forward discount of the foreign currenc'. b. larger will be the forward premium of the foreign currenc'. c. smaller will be the forward premium of the foreign currenc'. d. smaller will be the forward discount of the foreign currenc'. A!" *
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&. Assume the following exchange rates" =1 @=, @=1 <5$&, and =1 <5$-. Biven this information, as 'ou and others perform triangular arbitrage, the exchange rate of the ew @ealand dollar (@) with respect to the .!. dollar should ____, and the exchange rate of the
c. depreciate? depreciate d. appreciate? appreciate e. remain stable? appreciate A!" A
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&+. Assume the following information" !pot rate toda' of !wiss franc 1>'ear forward rate as of toda' for !wiss franc Fxpected spot rate 1 'ear from now Gate on 1>'ear deposits denominated in !wiss francs Gate on 1>'ear deposits denominated in .!. dollars
=.: =. =.+ 3; 8;
Erom the perspective of .!. investors with =1,:::,:::, covered interest arbitrage would 'ield a rate of return of ____;. a. -.:: b. 1&.c. 1-.-: d. 1+.1 e. 11.&& A!" * SOLUTION:
=1,:::,:::C=.:
!E1,,3 × (1.:3) !E1,34, × =. =1,1&,-:: ield (=1,1&,-:: − =1,:::,:::)C=1,:::,::: 1&.-;
$%!" 1 &-. Assume the following information for a bank 7uoting on spot exchange rates" Fxchange rate of !ingapore dollar in .!. = Fxchange rate of pound in .!. = Fxchange rate of pound in !ingapore dollars
=.& =1.-: !=+.-:
*ased on the information given, as 'ou and others perform triangular arbitrage, what should logicall' happen to the spot exchange rates a. %he !ingapore dollar value in .!. dollars should appreciate, the pound value in .!. dollars should appreciate, and the pound value in !ingapore dollars should depreciate. b. %he !ingapore dollar value in .!. dollars should depreciate, the pound value in .!. dollars should appreciate, and the pound value in !ingapore dollars should depreciate. c. %he !ingapore dollar value in .!. dollars should depreciate, the pound value in .!. dollars should appreciate, and the pound value in !ingapore dollars should appreciate. d. %he !ingapore dollar value in .!. dollars should appreciate, the pound value in .!. dollars should depreciate, and the pound value in !ingapore dollars should appreciate. A!" D
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&. Assume the *ritish pound is worth =1.:, and the #anadian dollar is worth =.4:. 2hat is the value of the #anadian dollar in pounds a. &.:. b. &.+:. c. .4:. d. .-:.
e. none of the above A!" D SOLUTION:
=.4:C=1.: :.-:
$%!" 1 &3. Assume that the euro0s interest rates are higher than .!. interest rates, and that interest rate parit' exists. 2hich of the following is true a. Americans using covered interest arbitrage earn the same rate of return as Bermans who attempt covered interest arbitrage. b. Americans who invest in the .!. earn the same rate of return as Bermans who attempt covered interest arbitrage. c. Americans who invest in the .!. earn the same rate of return as Bermans who invest in Berman' d. A and * e. one of the above A!" F
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&4. Assume the .!. interest rate is &; higher than the !wiss rate, and the forward rate of the !wiss franc has a +; premium. Biven this information" a. !wiss investors who attempt covered interest arbitrage earn the same rate of return as if the' invested in !wit6erland. b. .!. investors who attempt covered interest arbitrage earn a higher rate of return than if the' invested in the .!. c. A and * d. none of the above A!" *
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&8. Assume that *ritish interest rates are higher than .!. rates, and that the spot rate e7uals the forward rate. #overed interest arbitrage puts ____ pressure on the pound0s spot rate, and ____ pressure on the pound0s forward rate. a. downward? downward b. downward? upward c. upward? downward d. upward? upward A!" #
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:. Assume that interest rate parit' holds, and the euro0s interest rate is 8; while the .!. interest rate is 1&;. %hen the euro0s interest rate increases to 11; while the .!. interest rate r emains the same. As a result of the increase in the interest rate on euros, the euro0s forward ____ will ____ in order to maintain interest rate parit'. a. discount? increase b. discount? decrease c. premium? increase d. premium? decrease A!" D
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1. Assume the bid rate of a !wiss franc is =.-3 while the ask rate is =.-38 at *ank 5. Assume the bid rate of the !wiss franc is =.-: while the ask rate is =.- at *ank . Biven this information, what would be 'our gain if 'ou use =1,:::,::: and execute locational arbitrage %hat is, how much will 'ou end up with over and above the =1,:::,::: 'ou started with a. =3,:3. b. =4,--. c. =1:,11+. d. =1&,&4. A!" A SOLUTION:
=1,:::,:::C=.- !E1,3,34+ × =.-3 =1,::3,:3. %hus, the profit is =3,:3.
$%!" 1 &. Assume the following information" ou have =1,:::,::: to invest" #urrent spot rate of pound 8:>da' forward rate of pound >month deposit rate in .!. >month deposit rate in .9.
=1.: =1.-3 ; +;
f 'ou use covered interest arbitrage for a 8:>da' investment, what will be the amount of .!. dollars 'ou will have after 8: da's a. =1,:&:,-::. b. =1,:+-,::. c. =1,:3,:. d. =1,:8+,&:. e. =1,11,&-:. A!" A SOLUTION:
=1,:::,:::C=1.: &-,::: pounds × (1.:+) -:,::: pounds × 1.-3 =1,:&:,-::
$%!" 1 . Assume the following information" .!. investors have =1,:::,::: to invest" 1>'ear deposit rate offered b' .!. banks 1>'ear deposit rate offered on !wiss francs 1>'ear forward rate of !wiss francs !pot rate of !wiss franc
1&; 1:; =.& =.:
Biven this information" a. interest rate parit' exists and covered interest arbitrage b' .!. investors results in the same 'ield as investing domesticall'. b. interest rate parit' doesn0t exist and covered interest arbitrage b' .!. investors results in a 'ield above what is possible domesticall'. c. interest rate parit' exists and covered interest arbitrage b' .!. investors results in a 'ield above what is possible domesticall'. d. interest rate parit' doesn0t exist and covered interest arbitrage b' .!. investors results in a 'ield below what is possible domesticall'.
A!" * SOLUTION:
=1,:::,:::C=.: !E1,,3 × (1.1) !E1,4, × =.& =1,1,3 ield (=1,1,3 − =1,:::,:::)C=1,:::,::: 1.3; %his 'ield exceeds what is possible domesticall'.
$%!" 1 +. Assume the following information" #urrent spot rate of Australian dollar Eorecasted spot rate of Australian dollar 1 'ear from now 1>'ear forward rate of Australian dollar Annual interest rate for Australian dollar deposit Annual interest rate in the .!.
=.+ =.-8 =.& 8; ;
Biven the information in this 7uestion, the return from covered interest arbitrage b' .!. investors with =-::,::: to invest is ____;. a. about .:: b. about 8.:: c. about 3. d. about 4.1+ e. about -.-8 A!" F SOLUTION:
=-::,:::C=.+
A=341,&-: × (1.:8) A=4-1,- × =.& =-&3,88 ield (=-&3,88 − =-::,:::)C=-::,::: -.-8;
$%!" 1 -. Assume the following bid and ask rates of the pound for two banks as shown below"
*ank # *ank D
Bid =1.1 =1.-4
As =1. =1.:
As locational arbitrage occurs" a. the bid rate for pounds at *ank # will increase? the ask rate for pounds at *ank D will increase. b. the bid rate for pounds at *ank # will increase? the ask rate for pounds at *ank D will decrease. c. the bid rate for pounds at *ank # will decrease? the ask rate for pounds at *ank D will decrease. d. the bid rate for pounds at *ank # will decrease? the ask rate for pounds at *ank D will increase. A!" D
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. Assume the bid rate of an Australian dollar is =.: while the ask rate is =.1 at *ank H. Assume the bid rate of an Australian dollar is =.& while the ask rate is =.&- at *ank I. Biven this information, what would be 'our gain if 'ou use =1,:::,::: and execute locational arbitrage %hat is, how much will 'ou end up with over and above the =1,:::,::: 'ou started with a. =1:,::.
b. c. d. e.
=1&,:. =1+,++1. =1,8. =14,&18.
A!" D SOLUTION:
=1,:::,:::C=.1 A=1,8,++ × =.& =1,:1,8. %hus, the profit is =1,8.
$%!" 1 3. Assume the following information for a bank 7uoting on spot exchange rates" Fxchange rate of !ingapore dollar in .!. = Fxchange rate of pound in .!. = Fxchange rate of pound in !ingapore dollars
=.: =1.-: !=&.
*ased on the information given, as 'ou and others perform triangular arbitrage, what should logicall' happen to the spot exchange rates a. %he !ingapore dollar value in .!. dollars should appreciate, the pound value in .!. dollars should appreciate, and the pound value in !ingapore dollars should depreciate. b. %he !ingapore dollar value in .!. dollars should depreciate, the pound value in .!. dollars should appreciate, and the pound value in !ingapore dollars should depreciate. c. %he !ingapore dollar value in .!. dollars should depreciate, the pound value in .!. dollars should appreciate, and the pound value in !ingapore dollars should appreciate. d. %he !ingapore dollar value in .!. dollars should appreciate, the pound value in .!. dollars should depreciate, and the pound value in !ingapore dollars should appreciate. A!" *
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4. *ank A 7uotes a bid rate of =.:: and an ask rate of =.:- for the
=-::,:::C=.:- <G1,8,++ × =.: =-:1,8. %hus, the profit is =1,8.
$%!" 1 8. 2hich of the following is an example of triangular arbitrage initiation a. bu'ing a currenc' at one bank0s ask and selling at another bank0s bid, which is higher than the former bank0s ask. b. bu'ing !ingapore dollars from a bank (7uoted at =.--) that has 7uoted the !outh African rand (!AG)C!ingapore dollar (!=) exchange rate at !AG&.-: when the spot rate for the rand is =.&:. c. bu'ing !ingapore dollars from a bank (7uoted at =.--) that has 7uoted the !outh African randC!ingapore dollar exchange rate at !AG.:: when the spot rate for the rand is =.&:. d. converting funds to a foreign currenc' and investing the funds overseas. A!" #
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+:. ou Just received a gift from a friend consisting of 1,::: %hai baht, which 'ou would like to exchange for Australian dollars (A=). ou observe that exchange rate 7uotes for the baht are currentl' =.:&, while 7uotes for the Australian dollar are =.-3. Kow man' Australian dollars should 'ou expect to receive for 'our baht a. A=8.8. b. A=&-,:+.+4. c. A=--.::. d. none of the above A!" A SOLUTION:
=.:&C=.-3 × %K*1,::: A=8.8.
$%!" 1 +1. ational *ank 7uotes the following for the *ritish pound and the ew @ealand dollar"
Ialue of a *ritish pound (L) in = Ialue of a ew @ealand dollar (@=) in = Ialue of a *ritish pound in ew @ealand dollars
!"oted Bid Pri#e =1.1 =.--
!"oted As Pri#e =1.& =.-
@=&.8-
@=&.8
Assume 'ou have =1:,::: to conduct triangular arbitrage. 2hat is 'our profit from implementing this strateg' a. =33.+. b. =183.-. c. =1-.+. d. =111.4:. A!" # SOLUTION:
=1:,:::C=1.&
L,13&.4+ × &.8 @=14,&:8.44 × =.- =1:,:1-.+. %hus, the profit is =1-.+.
$%!" 1 +&. Assume the following information" ou have =8::,::: to invest" #urrent spot rate of Australian dollar (A=) 14:>da' forward rate of the Australian dollar 14:>da' interest rate in the .!. 14:>da' interest rate in Australia
=.& =.+ .-; .:;
f 'ou conduct covered interest arbitrage, what is the dollar profit 'ou will have reali6ed after 14: da's a. =-,8:. b. =1,-+4. c. =&3,:::. d. =1,-::. A!" A
SOLUTION:
=8::,:::C=.& A=1,+-1,1& × (1.:) A=1,+8-,11 × =.+ =8-,8:. %hus, the profit is =-,8:.
$%!" 1 +. Assume the following information" ou have =+::,::: to invest" #urrent spot rate of !udanese dinar (!DD) 8:>da' forward rate of the dinar 8:>da' interest rate in the .!. 8:>da' interest rate in !udan
=.::-3: =.::-8 +.:; +.&;
f 'ou conduct covered interest arbitrage, what amount will 'ou have after 8: da's a. =+1,:::.::. b. =+1,4::.::. c. =+&+,&+&.4. d. =+1,:4.33. e. none of the above A!" D SOLUTION:
=+::,:::C=.::-3
!DD3:,13-,+4.: × (1.:+&) !DD3,1&&,4:3.:& × =.::-8 =+1,:4.33
$%!" 1 $%hibit 7&' Assume the following information"
ou have =::,::: to invest" %he spot bid rate for the euro (M) is =1.:4 %he spot ask 7uote for the euro is =1.1: %he 14:>da' forward rate (bid) of the euro is =1.:4 %he 14:>da' forward rate (ask) of the euro is =1.1: %he 14:>da' interest rate in the .!. is ; %he 14:>da' interest rate in Furope is 4; ++. Gefer to Fxhibit 3>1. f 'ou conduct covered interest arbitrage, what amount will 'ou have after 14: da's a. =14,1:8.1:. b. =:,:::.::. c. =1&,&14.&:. d. =&,444.8:. e. none of the above A!" A SOLUTION:
$%!" 1
=::,:::C=1.1:
M&33,333.4: × (1.:4) M&8+,+++.+: × =1.:4 =14,1:8.1:
+-. Gefer to Fxhibit 3>1. f 'ou conduct covered interest arbitrage, what is 'our percentage return after 14: da's s covered interest arbitrage feasible in this situation a. 3.8;? feasible b. .:+;? feasible c. .:+;? not feasible d. +.:3;? not feasible e. 1:.::;? feasible A!" * SOLUTION:
=14,1:8.1:C=::,::: − 1 .:+;. !ince this rate is slightl' higher than the .!. interest rate of ;, covered interest arbitrage is feasible.
$%!" 1 +. According to interest rate parit' (G$)" a. the forward rate differs from the spot rate b' a sufficient amount to offset the inflation differential between two currencies. b. the future spot rate differs from the current spot rate b' a sufficient amount to offset the interest rate differential between two currencies. c. the future spot rate differs from the current spot rate b' a sufficient amount to offset the inflation differential between two currencies. d. the forward rate differs from the spot rate b' a sufficient amount to offset the interest rate differential between two currencies. A!" D
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+3. Assume that interest rate parit' holds. %he
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+4. f the cross exchange rate of two nondollar currencies implied b' their individual spot rates with respect to the dollar is less than the cross exchange rate 7uoted b' a bank, locational arbitrage is possible. a. %rue b. Ealse A!" E
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+8. Eor locational arbitrage to be possible, one bank0s ask rate must be higher than another bank0s bid rate for a currenc'. a. %rue b. Ealse A!" E
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-:. Assume locational arbitrage is possible and involves two different banks. %he realignment that would occur due to market forces would increase one bank0s ask rate and would decrease the other bank0s bid rate.
a. %rue b. Ealse A!" %
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-1. %riangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. a. %rue b. Ealse A!" E
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-&. %he interest rate on euros is 4;. %he interest rate in the .!. is -;. %he euro0s forward rate should exhibit a premium of about ;. a. %rue b. Ealse A!" E
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-. #apitali6ing on discrepancies in 7uoted prices involving no risk and no investment of funds is referred to as interest rate parit'. a. %rue b. Ealse A!" E
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-+. Gealignment in the exchange rates of banks will eliminate locational arbitrage.
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--. Nocational arbitrage involves investing in a foreign countr' and covering against exchange rate risk b' engaging in forward contracts. a. %rue b. Ealse A!" E
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-. %o capitali6e on high foreign interest rates using covered interest arbitrage, a .!. investor would convert dollars to the foreign currenc', invest in the foreign countr', and simultaneousl' sell the foreign currenc' forward. a. %rue b. Ealse A!" %
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-3. f interest rate parit' (G$) exists, then the rate of return achieved from covered interest arbitrage should be e7ual to the rate available in the foreign countr'. a. %rue b. Ealse
A!" E
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-4. f interest rate parit' (G$) exists, then triangular arbitrage will not be possible. a. %rue b. Ealse A!" E
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-8. Eorward rates are driven b' the government rather than market forces. a. %rue b. Ealse A!" E
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:. %he foreign exchange market is an over>the>counter market. a. %rue b. Ealse A!" E
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1. %he 'ield curve of ever' countr' has its own uni7ue shape. a. %rue b. Ealse A!" %
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&. Assume the following information" .!. investors have =1,:::,::: to invest" 1>'ear deposit rate offered b' .!. banks 1>'ear deposit rate offered on *ritish pounds 1>'ear forward rate of !wiss francs !pot rate of !wiss franc
1:; 1.-; =1.& =1.:
Biven this information" a. interest rate parit' exists and covered interest arbitrage b' .!. investors results in the same 'ield as investing domesticall'. b. interest rate parit' doesn0t exist and covered interest arbitrage b' .!. investors results in a 'ield above what is possible domesticall'. c. interest rate parit' exists and covered interest arbitrage b' .!. investors results in a 'ield above what is possible domesticall'. d. interest rate parit' doesn0t exist and covered interest arbitrage b' .!. investors results in a 'ield below what is possible domesticall'. A!" A SOLUTION:
=1,:::,:::C=1.: 38,-1 pounds × (1.1-) 8::,38+ × =1.& =1,1::,:3. ield" (=1,1::,:3 − =1,:::,:::)C(=1,:::,:::) 1:;.
$%!" 1 . f 7uoted 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 # A!" D
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+. $oints above the G$ line represent situations where" a. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same 'ield as investing domesticall'. b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a 'ield above what is possible domesticall'. c. covered interest arbitrage is feasible from the perspective of foreign investors and results in a 'ield above what is possible in their local markets. d. covered interest arbitrage is not feasible for neither domestic nor foreign investors. A!" #
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-. $oints below the G$ line represent situations where" a. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same 'ield as investing domesticall'. b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a 'ield above what is possible domesticall'. c. covered interest arbitrage is feasible from the perspective of foreign investors and results in a 'ield above what is possible in their local markets. d. covered interest arbitrage is not feasible for neither domestic nor foreign investors. A!" *
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. 2hich of the following might discourage covered interest arbitrage even if interest rate parit' does not exist a. transaction costs. b. political risk. c. differential tax laws. d. all of the above. A!" D
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3. Assume that interest rate parit' holds. .!. interest rate is 1; and *ritish interest rate is 1:;. %he forward rate on *ritish pounds exhibits a ____ of ____ percent. a. discount? &.3 b. premium? &.3 c. discount? .d. premium? .A!" *
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4. Assume the following information" Fxchange rate of Oapanese 'en in .!. = Fxchange rate of euro in .!. = Fxchange rate of euro in Oapanese 'en
=.:11 =1.+: 1+: 'en
2hat will be the 'ield for an investor who has =1,:::,::: available to conduct triangular arbitrage a. =1::,::: b. −=8:,8:8
c. 1:; d. −8.:8; A!" # SOLUTION:
Fxchange dollars for pounds =1,:::,:::C=1.+ 31+.&4? exchange pounds for 'en 31+,&4 × 1+: 1::,:::,::: 'en. Fxchange 'en for dollars 1::,:::,::: 'en × =.:11 =1,1::,:::. ield (=1,1::,::: − =1,:::,:::)C =1,:::,::: 1:;
$%!" 1 8. Assume the following information"
Ialue of an Australian dollar (A=) in = Ialue of
!"oted Bid Pri#e =:.3 =.:3+
4.&
!"oted As Pri#e =:.8 =.:33
4.-
Assume 'ou have =1::,::: to conduct triangular arbitrage. 2hat will be 'our profit from implementing this strateg' a. =,1 b. =&,4 c. =,-14 d. =1,311 A!" * SOLUTION:
=1::,:::C=.:33 1,&84,3:1 pesosC4.- A=1-&,344 × =:.3 =1:&,4 $rofit =1:&,4 − =1::,:::
$%!" 1 3:. %he interest rate on 'en is 3;. %he interest rate in the .!. is 8;. %he 'en0s forward rate should exhibit a premium of about &;. a. %rue b. Ealse A!" %
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31. %he interest rate on pounds in the .9. is 4;. %he interest rate in the .!. is -;. nterest rate parit' exists. .!. investors will earn a lower return domesticall' than *ritish investors earn domesticall'. a. %rue b. Ealse A!" %
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3&. Assume that the real interest rate in the .!. and in the .9. is ;. %he expected annual inflation in the .!. is ;, while in the .9. it is +;. %he forward rate on the pound should exhibit a premium of about 1;. a. %rue b. Ealse A!" E
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3. f the cross exchange rate of two nondollar currencies implied b' their individual spot rates with respect to the dollar is less than the cross exchange rate 7uoted b' a bank, locational arbitrage is possible. a. %rue b. Ealse A!" E
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3+. Eor locational arbitrage to be possible, one bank0s ask rate must be higher than another bank0s bid rate for a currenc'. a. %rue b. Ealse A!" E
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3-. %echnolog' enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange 7uotations among locations. a. %rue b. Ealse A!" %
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3. Assume locational arbitrage is possible and involves two different banks. %he realignment that would occur due to market forces would increase one bank0s ask rate and would decrease the other bank0s bid rate. a. %rue b. Ealse A!" %
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33. Nocational arbitrage explains wh' prices among banks at different locations will not normall' differ b' a significant amount. a. %rue b. Ealse A!" %
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34. #ross exchange rates are used to determine the relationship between the dollar and two nondollar currencies. a. %rue b. Ealse A!" E
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38. %riangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. a. %rue b. Ealse A!" E
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4:. %he e7uilibrium state in which covered interest arbitrage is no longer possible is called interest rate parit' (G$).
a. %rue b. Ealse A!" %
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41. f interest rate parit' exists, then the rate of return achieved from covered interest arbitrage should be e7ual to the interest rate available in the foreign countr'. a. %rue b. Ealse A!" E
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4&. nterest rate parit' (G$) states that the foreign currenc'0s forward rate premium or discount is roughl' e7ual to the interest rate differential between the .!. and the foreign countr'. a. %rue b. Ealse A!" %
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4. %he interest rate in !outh Africa is 4;. %he interest rate in the .!. is -;. %he !outh African forward rate should exhibit a premium of about ;. a. %rue b. Ealse A!" E
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4+. %he larger the degree b' which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currenc' specified b' the interest rate parit' (G$) formula. a. %rue b. Ealse A!" %
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4-. Eor points l'ing to the left of the interest rate parit' (G$) line, covered interest arbitrage is not possible from a .!. investor0s perspective, but is possible from a foreign investor0s perspective. a. %rue b. Ealse A!" %
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4. f interest rate parit' (G$) exists, then foreign investors will earn the same returns as .!. investors. a. %rue b. Ealse A!" E
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43. f interest rate parit' (G$) does not hold, there is still the possibilit' that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currenc' restrictions, and differential tax laws. a. %rue b. Ealse A!" %
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44. 2hich of the following is not mentioned in the text as a form of international arbitrage a. Nocational arbitrage b. %riangular arbitrage c. %ransactional arbitrage d. #overed interest arbitrage e. All of the above are mentioned in the text as forms of international arbitrage. A!" #
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48. *ank A 7uotes a bid rate of =:.:: and an ask rate of =:.:- for the
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8:. American *ank 7uotes a bid rate of =:.:& and an ask rate of =:.:&4 for the ndian rupee (G)? ational *ank 7uotes a bid rate of =:.:&+ and an ask rate for =:.:&-. Nocational arbitrage would involve" a. bu'ing rupees from American *ank at the bid rate and selling them to ational *ank at the ask rate. b. bu'ing rupees from ational *ank at the ask rate and selling them to American *ank at the bid rate. c. bu'ing rupees from American *ank at the ask rate and selling to ational *ank at the bid rate. d. bu'ing rupees from ational *ank at the bid rate and selling them to American *ank at the ask rate. e. Nocational arbitrage is not possible in this case. A!" *
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81. Assume 'ou discovered an opportunit' for locational arbitrage involving two banks and have taken advantage of it. *ecause of 'our and other arbitrageurs0 actions, the following adJustments must take place. a. /ne bank0s ask price will rise and the other bank0s bid price will fall. b. /ne bank0s ask price will fall and the other bank0s bid price will rise. c. /ne bank0s bidCask spread will widen and the other bank0s bidCask spread will fall. d. A and # A!" D
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8&. 2hich of the following is an example of triangular arbitrage initiation a. *u'ing a currenc' at one bank0s ask and selling at another bank0s bid, which is higher than the former bank0s ask. b. *u'ing !ingapore dollars from a bank (7uoted at =:.--) that has 7uoted the !outh African rand (@AG)C!ingapore dollar (!=) exchange rate at @AG&.-: when the spot rate for the !outh African rand is =:.&:. c. *u'ing !ingapore dollars from a bank (7uoted at =:.--) that has 7uoted the !outh African randC!ingapore dollar exchange rate at @AG.:: when the spot rate for the !outh African rand is =:.&:. d. #onverting funds to a foreign currenc' and investing the funds overseas.
A!" #
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8. Kewitt *ank 7uotes a value for the Oapanese 'en (P) of =:.::3, and a value for the #anadian Dollar (#=) of =:.4&1. %he cross exchange rate 7uoted b' the bank for the #anadian dollar is P114.::. ou have =-,::: to conduct triangular arbitrage. Kow much will 'ou end up with if 'ou conduct triangular arbitrage a. =,:-.&3 b. =-,::.+c. =,:8:.1 d. %riangular arbitrage is not possible in this case. A!" *
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8+. ational *ank 7uotes the following for the *ritish pound and the ew @ealand dollar"
Ialue of a *ritish pound (L) in = Ialue of a ew @ealand dollar (@=) in = Ialue of a *ritish pound in ew @ealand dollars
!"oted Bid Pri#e =1.1 =:.--
!"oted As Pri#e =1.& =:.-
@=&.8-
@=&.8
Assume 'ou have =1:,::: to conduct triangular arbitrage. 2hat is 'our profit from implementing this strateg' a. =33.+ b. =183.- c. =1-.+ d. =111.4: A!" #
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8-. 2hich of the following is not true regarding covered interest arbitrage a. #overed interest arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. b. #overed interest arbitrage involves investing in a foreign countr' and covering against exchange rate risk. c. #overed interest arbitrage opportunities onl' exist when the foreign interest rate is higher than the interest rate in the home countr'. d. f covered interest arbitrage is possible, 'ou can guarantee a return on 'our funds that exceeds the returns 'ou could achieve domesticall'. e. All of the above are true regarding covered interest arbitrage. A!" #
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8. 2hich of the following is not true regarding covered interest arbitrage a. #overed interest arbitrage is a reason for observing interest rate parit' (G$). b. f the forward rate is e7ual to the spot rate, conducting covered interest arbitrage will 'ield a return that is exactl' e7ual to the interest rate in the foreign countr'. c. 2hen interest rate parit' holds, covered interest arbitrage is not possible. d. 2hen interest rate disparit' exists, covered interest arbitrage ma' not be profitable. e. All of the above are true. A!" F
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83. 2hich of the following is not true regarding interest rate parit' (G$) a. 2hen interest rate parit' holds, covered interest arbitrage is not possible.
b. 2hen the interest rate in the foreign countr' is higher than that in the home countr', the forward rate of that countr'0s currenc' should exhibit a discount. c. 2hen the interest rate in the foreign countr' is lower than that in the home countr', the forward rate of that countr'0s currenc' should exhibit a premium. d. 2hen covered interest arbitrage is not feasible, interest rate parit' must hold. e. All of the above are true. A!" D
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