PARITY THEORY QUESTIONS

1. If the $/ spot rate is 1$=110 and the interest rate in Tokyo and New York are
3% and 4% respectively. What is the expected $/ exchange rate 1 year
hence?
2. The USD/DM exchange rate is 1DM= $ 0.35 and DM/FF exchange rate is
1FF= DM 0.31. What is the FF/USD exchange rate?
3. What is the essence of Interest Rate Parity Theory? The interest rate in US is
10% and in Japan, the comparable rate is 7%. The spot rate for Yen is
$0.0038
If the interest rate parity holds, what is the 90 day forward rate?
4. If the inflation rate in the country is 6.5% and expected real interest rate is 5%,
then what is the Nominal interest rate, an investor should earn?
5. Consider the value of DM relative to USD. The spot rate is DM 1.82. The
interest rate in US and Germany are 5% and 3% respectively. Estimate the
price of 4 month forward contract.
6. Given the following data calculate arbitrage possibility
Spot rate 1$ = Rs 42.0010
6 months forward rate 1$ = Rs 42.8020
Annualised interest rate on 6 month Rupee 12%
Annualised interest rate on 6 month Dollar 8%
7. Given the following data work out arbitrage possibility
Spot rate Rs 35.0020= 1$
6 months forward rate Rs 35.9010 = 1$
Annualised interest rate on 6 month Rupee 12%
Annualised interest rate on 6 month USD 7%
Assume a borrowing of Rs 1000 at 12% p.a

8. What is covered interest arbitrage?

Spot rate 1 = 1.60$
180 day forward rate 1 = 1.56$
180 day interest rate in UK is 4%
180 day interest rate in US is 3%
Is covered interest arbitrage by US investor feasible?
9. From the following data, calculate the possibility of arbitrage
Spot rate FFR 6.00=1$
6 months forward rate 1$= FFR 6.0020
Annualised interest rate on 6 month FFR 8%
Annualised interest rate on 6 month USD 5%

10.Analyse arbitrage possibility

Spot rate 1 FFR = Rs 6.60
6 months forward rate 1FFR = Rs 6.85
Annualised interest rate on 6 month FFR 8.3%
Annualised interest rate on 6 month Rupee 10.5%
11. Determine whether arbitrage possibility exists in this situation
Spot rate 1DM = Rs. 22.50
1 year forward rate 1DM = Rs 23.25
Annualised interest rate for DM = 10.2%
Annualised interest rate for Rupee = 9.5%
12.Assume the following information
Particulars

Bid Quote

Ask Quote

spot

$ 1.12

$ 1.13

1 year forward

$ 1.11

$ 1.12

Particulars

Deposit Rate

Loan Rate

Interest rate on $

6%

9%

Interest rate on

6.50%

9.50%

Youve 1000 USD to invest for one year. Find out if there exists covered
interest arbitrage
13. Assume the following information
Spot rate 1 = $ 1.60 - $ 1.65
180 day forward rate 1 = $ 1.50 - $ 1.60
180 day British interest rate 4% - 6%
180 day US interest rate 3% - 5%
Find out, if there exists any covered interest arbitrage opportunity, If not,
explain the reason for the same
14. The 6 month interest rate for Canadian dollar is 9% p.a, while the 6 month
interest rate interest rate for USD is 6.75% p.a
The spot quotation for Canadian Dollar (CD) in NewYork is USD 0.9100 & six
month forward rate is 0.9025
a) Is interest rate parity holding?
b) If not how could advantage be taken of the above situation
c) If a large No. of operators decide to do arbitrage suggest under
situation B what will be the effect upon Spot and forward quotation and
upon the interest rate for the two currencies

15.Consider the following data

Particulars

Exchange Rate

$ Interest Rate

Interest Rate

Spot Rate

$ 1.5753/

Nil

Nil

1 month

$ 1.5623/

3.00% p.a

8.50% p.a

3 months

$ 1.5577/

3.50% p.a

7.50% p.a

6 months

$ 1.5536/

3.50% p.a

7.00% p.a

Forward Rates

Questions:
a) Find out the arbitrage possibility for various periods
b) Show how interest rate parity will be restored as a result of arbitrage
activity

16.An American firm purchases $ 4000 of perfumes (FFR 20000) from a French
firm. The American distributor must make the payment in 90 days in FFR
The following quotation and expectation exists for the FFR
Spot Rate $ 0.2000
90 day forward rates $ 0.2200
US interest rate is 15%
France interest rate 10%
Your expectation of the spot rate, 90 days hence is $ 0.2400
a) What is the premium or discount forward French Franc?
b) What is the interest differential between US and France?
c) Is there an incentive for covered interest arbitrage?
d) If there is incentive for covered interest arbitrage, how can an arbitrager
take advantage of the above situation assuming that he can borrow $
4000 or FFR 20000 and there is no transaction cost?
e) If transaction cost of $ 50 exists, would an opportunity for covered
interest arbitrage still exists
f) If the expected spot is certain to occur in Future, is it advisable to take
up naked interest arbitrage?
17.In April 2009, Quotes
SF/$ = 1.4854 1.4900 (spot rate)
SF/$ = 1.4825 1.4915 (3 month forward)
3 month interest rate were $ = 5.80/5.90
3 month interest rate for SF = 1.90/2
Explain how a trader could take advantage in any of the situation

18.An importer has purchased from France goods worth 50000 FFR, there is no
quote available for Rs Vs FFR
The quotes available are:
USD = Rs 35.0000 35.0080
USD = FFR 5.1025 5.1050
What is the value of this transaction in Rs terms?
19.DM spot was quoted at $ 0.4/DM in NY.
The price of was quoted as $1.8/
a) What would you expect the price of to be in Germany (DM/)
b) IF the be quoted in Frankfort at DM 4.4/, what would you do to profit
from the above situation?
20.Spot rate 1FFR = Rs. 6.60
Forward rates:
1USD = Rs. 42.0283
1 FFR = Rs. 6.50
Exposure: 90 day Transaction, 40, 00,000 FFR
Type of Exposure: Receivable
Interest in India 9% pa
Interest in France 12 % pa
21.A trader works for Newyork bank, the spot exchange rate against Canadian $
is USD 0.9968 and 1 month year forward rates are: USD 0.9985 and USD
1.0166 respectively.
12 month interest rate in US and Canada are 6.45% and 4.46% respectively
a) What is forward premium in annualised percentage?
b) Which currency is at premium and why?
The trader becomes party to some inside information which suggests that US
interest rate will rise by 1% pa during the next month.
The bank has a rule of buy equals sell in foreign exchange market. Indicate the
mechanism of two operations by which you may trade in expectation of profit for
the bank.
Should the insider information turn out to be well founded, indicate the cost of
hedging or not