International Finance Chapter 5

1 An arbitrage is best defined asa) A legal condition imposed by the CFTC.b) The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making reasonable profits.c) The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making guaranteed profits.d) None of the above C
2 Interest Rate Parity (IRP) is best defined asa) When a government brings its domestic interest rate in line with other major financial markets.b) When the central bank of a country brings its domestic interest rate in line with its major trading partners.c) An arbitrage condition that must hold when international financial markets are in equilibrium.d) None of the above C
3 When Interest Rate Parity (IRP) does not holda) there is usually a high degree of inflation in at least one country.b) the financial markets are in equilibrium.c) there are opportunities for covered interest arbitrage.d) both b) and c) C
4 Suppose you observe a spot exchange rate of $1.50/€. If interest rates are 5% APR in the U.S. and 3% APR in the euro zone, what is the no-arbitrage 1-year forward rate?a) €1.5291/$b) $1.5291/€c) €1.4714/$d) $1.4714/€ B
5 Suppose you observe a spot exchange rate of $1.50/€. If interest rates are 3% APR in the U.S. and 5% APR in the euro zone, what is the no-arbitrage 1-year forward rate?a) €1.5291/$b) $1.5291/€c) €1.4714/$d) $1.4714/€ D
6 Suppose you observe a spot exchange rate of $2.00/£. If interest rates are 5% APR in the U.S. and 2% APR in the U.K., what is the no-arbitrage 1-year forward rate?a) £2.0588/$b) $2.0588/£c) £1.9429 /$d) $1.9429/£ B
7 Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/€. What must the spot exchange rate be? a) $1.1768/€ b) $1.1434/€c) $1.12/€ d) None of the above B
8 A higher U.S. interest rate (i$ ↑) will result in a) a stronger dollar.b) a lower spot exchange rate (expressed as foreign currency per U.S. dollar).c) both a) and b)d) none of the above A
9 If the interest rate in the U.S. is i$ = 5 percent for the next year and interest rate in the U.K. is i£ = 8 percent for the next year, uncovered IRP suggests that a) the pound is expected to depreciate against the dollar by about 3 percent.b) the pound is expected to appreciate against the dollar by about 3 percent.c) the dollar is expected to appreciate against the pound by about 3 percent.d) both a) and c) D
10 If IRP fails to holda) pressure from arbitrageurs should bring exchange rates and interest rates back into line.b) it may fail to hold due to transactions costs.c) it may be due to government-imposed capital controls.d) all of the above D
11 Although IRP tends to hold, it may not hold precisely all the timea) due to transactions costs, like the bid ask spread.b) due to asymmetric information.c) due to capital controls imposed by governments.d) both a) and c) D
12 If a foreign county experiences a hyperinflation,a) its currency will depreciate against stable currencies.b) its currency may appreciate against stable currencies.c) its currency may be unaffected—it’s difficult to say.d) none of the above A
13 As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?a) €1.00 = $1.2379b) €1.00 = $1.2623c) €1.00 = $0.9903d) $1.00 = €1.2623 A
14 Purchasing Power Parity (PPP) theory states thata) the exchange rate between currencies of two countries should be equal to the ratio of the countries’ price levels.b) as the purchasing power of a currency sharply declines (due to hyperinflation) that currency will depreciate against stable currencies.c) the prices of standard commodity baskets in two countries are not related.d) both a) and b) D
15 As of today, the spot exchange rate is €1.00 = $1.60 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?a) €1.00 = $1.6157b) €1.6157= $1.00c) €1.00 = $1.5845d) $1.00 × 1.03 = €1.60 × 1.02 C
16 In view of the fact that PPP is the manifestation of the law of one price applied to a standard commodity basket, a) it will hold only if the prices of the constituent commodities are equalized across countries in a given currency.b) it will hold only if the composition of the consumption basket is the same across countries.c) both a) and b)d) none of the above C
17 Some commodities never enter into international trade. Examples includea) nontradables.b) haircuts.c) housing.d) all of the above D
18 Generally unfavorable evidence on PPP suggests thata) substantial barriers to international commodity arbitrage exist.b) tariffs and quotas imposed on international trade can explain at least some of the evidence.c) shipping costs can make it difficult to directly compare commodity prices.d) all of the above D
19 The price of a McDonald’s Big Mac sandwicha) is about the same in the 120 countries that McDonalds does business in.b) varies considerably across the world in dollar terms.c) supports PPP.d) none of the above. B
20 The International Fisher Effect suggests thata) any forward premium or discount is equal to the expected change in the exchange rate. b) any forward premium or discount is equal to the actual change in the exchange ratec) the nominal interest rate differential reflects the expected change in the exchange rate. d) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country. C
21 The Fisher effect states thata) any forward premium or discount is equal to the expected change in the exchange rate. b) any forward premium or discount is equal to the actual change in the exchange rate.c) the nominal interest rate differential reflects the expected change in the exchange rate. d) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country. D
22 The main approaches to forecasting exchange rates area) Efficient market, Fundamental, and Technical approaches.b) Efficient market and Technical approaches.c) Efficient market and Fundamental approaches.d) Fundamental and Technical approaches. A
23 The benefit to forecasting exchange ratesa) are greatest during periods of fixed exchange rates.b) are nonexistent now that the euro and dollar are the biggest game in town.c) accrue to, and are a vital concern for, MNCs formulating international sourcing, production, financing and marketing strategies.d) all of the above C

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