CHAPTER 7 The bid-ask quotes for the Pound spot rate is $1.60-$1.

62 and for the Canadian dollar spot rate is $0.65-$0.69. What is the Pound/C$ crossrate?

a. $1.04-$1.12 b. $0.40-$0.43 c. $0.28-$0.32 d. None of the answers are correct.

Correct.

2. Interest rate parity theorem implies that a particular investor, faced with the decision to invest at home in local currency or abroad in foreign currency with the revenues sold forward, will be indifferent between the two investments.

True False

Correct.

3. Triangular arbitrage refers to the process of making a profit by exploiting the mispricing of crossrates.

True False

Correct.

4. You observe the following bid-ask quotes from Dragon Bank and Skytel Bank for the Euro: $1.25-$1.28 and $1.27-$1.29. Is there a profit from locational arbitrage?

a. yes, the profit is $0.02/Euro b. yes, the profit is $0.04/Euro c. no, there will be a loss of $0.01/Euro d. no, there will be a loss of $0.04/Euro

Incorrect.

5. The Pound spot rate is $1.56. The one-year forward rate is $1.60. The one-year nominal U.S. interest rate is 3%. The one-year nominal UK interest rate is 5%. What is the profit per

dollar from covered interest arbitrage?

a. $0.047 b. $0.085 c. $0.11 d. -$0.052

Correct.

6. If the annual U.S. interest rate is 5%, and the annual Euro interest rate is 3%, the ________ rate of the Euro should have a ________.

a. spot; discount of about 2% b. spot; premium of about 2% c. forward; premium of about 2% d. forward; discount of about 2%

Incorrect.

7. Because of triangular arbitrage, the crossrates will always be consistent with prevailing market spot rates through the dollar.

True False 8. If interest rate parity exists, then ________ is not feasible.

Correct.

a. triangular arbitrage b. covered interest arbitrage c. locational arbitrage d. None of the answers are correct. 9. Locational arbitrage is not possible if interest rate parity exists.

Incorrect.

True False

Incorrect.

10. Interest rate parity theorem implies that the approximate forward discount or premium of one currency as compared to another is reflected in the nominal interest rate differential between the two countries.

True False 11. Locational arbitrage refers to:

making a riskless profit off of mispricing in spot exchange rates between two making a riskless profit off of exploiting mispricing between the forward and

Correct.

a. banks.

Correct.

b. spot markets.

c. making a riskless profit off of mispricing of crossrates. d. None of the answers are correct. 12. Covered interest arbitrage refers to:

a. making a riskless profit off of exploiting a mispriced forward rate. b. making a riskless profit off of mispricing in crossrates. c. making a riskless profit off of different spot rates from two different banks. d. None of the answers are correct.

Correct.

13. Interest rate parity theorem implies that investors from different countries should all earn the same investment returns.

True False

Incorrect.

14. The $/Pound spot rate is $1.56. The one-year nominal U.S. interest rate is 3%. The one-

year nominal UK interest rate is 5%. What is the equilibrium one-year forward rate if interest rate parity theorem holds?

a. $1.56 b. $1.62 c. $1.53 d. $1.59

Incorrect. The forward rate = 1.56 x 1.03/1.05

15. If the Pound spot rate today is $1.56, and the one-year forward rate is $1.60:
the dollar is selling at a forward premium to the Pound of approximately the dollar is selling at a forward premium to the Pound of approximately

a. 1.39%.

Incorrect.

b. 4.20%. c. 2.56%.

the Pound is selling at a forward premium to the dollar of approximately

d. None of the answers are correct. 16. Profit from locational and triangular arbitrage is instantaneous; profit from covered interest arbitrage is not.

True False

Correct.

17. Which of the following institutions makes sure that forward rates are priced according to IRP at a given point in time?

a. the world bank b. the fed and the central banks of other countries c. the bank for international settlements d. banks and individuals arbitraging in the foreign exchange markets

Incorrect.

18. If the nominal interest rate differential between countries A and B is 2%, the country with higher nominal interest rates should observe a forward premium of its currency of about

2% as compared to the currency of the country with lower nominal interest rates.

True False 19. What are some reasons that interest rate parity might not hold?

Correct.

a. transactions costs b. political risk c. differential tax laws d. More than one of these.

Incorrect.

20. Assuming that IRP exists, if the spot rate of the Singapore dollar is $55 and the threemonth forward rate is $.58, then:

a. the U.S. interest rate must be higher than Singapore's interest rate. b. the U.S. interest rate must be lower than Singapore's interest rate. c. the U.S. interest rate must equal Singapore's interest rate. d. covered interest arbitrage is feasible. 21. Arbitrage is:

Incorrect.

a. the process of taking risks and making profits off of trading. b. the process of trading to offset risks on a cash market position. c. the process of making a riskless profit. d. None of the answers are correct.

Incorrect.

22. Covered interest arbitrage is possible for U.S. investors if Mexico's interest rate is equal to the U.S. interest rate and the Mexican peso's forward rate exhibits a premium.

True False

Correct.

23. If one country has much higher political risk than another, interest rate parity may not hold.

True False

Correct.

24. If interest rate parity holds, interest rates in the U.S. and interest rates in the Eurocurrency market will be the same.

True False

Incorrect.

25. The spot Pound spot rate is $1.56. The $/Euro spot rate is $1.25. A bank quotes the Pound/Euro crossrate as Pound 0.94/Euro. What is the profit per dollar from triangular arbitrage?

a. $0.45 b. $0.17 c. $0.22 d. -0.17

Incorrect. ($1/1.25) x 0.94 x $1.56 = $.17

26. Locational arbitrage only yields a profit when the bid price of one bank is higher than the ask of the other bank.

True False

Correct.

27. The empirical evidence suggests that interest rate parity theorem holds.

True False

Incorrect.

28. Arbitrage refers to the process of making a riskless profit off of mispricing.

True False

Correct.

29. If the annual U.S. interest rate is 4%, and the annual Euro interest rate is 7%, the ________ rate of the Euro should have a ________.

a. spot; discount of about 2% b. spot; premium of about 2% c. forward; premium of about 2% d. forward; discount of about 2%

Incorrect.

30. Locational arbitrage forces banks around the world to constantly update their quotes to reflect new information.

True False

Incorrect.