# MCQ due in 1 hour

QUESTION 1

1. A currency dealer has good credit and can borrow either \$1,000,000 or €800,000 for one year. The one-year inflation rate in the U.S. is π\$ = 2.5% and in the euro zone the one-year inflation rate is π€ = 5.5%. The one-year forward exchange rate is \$1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities?

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\$1.2471 = €1.00

\$1.1547 = €1.00

\$1.0200 = €1.00

\$1.2351 = €1.00

5 points

QUESTION 2

1. Suppose that the annual interest rate is1.5 percent in the United States and 3 percent in Germany, and that the spot exchange rate is \$1.57/€ and the forward exchange rate, with one-year maturity, is \$1.58/€. Assume that an arbitrager can borrow up to \$1,000,000 or €625,000. If an astute trader finds an arbitrage, what is the arbitrage profit in one year?

€10,262

€13,390

\$46,207

\$21,561

5 points

QUESTION 3

1. The Mexican peso/US\$ spot exchange rates in December 1997 and December 1998 were 6.3 and 7.0, respectively. During 1998 inflation rates in Mexico and US were at 23% and 5%, respectively, and the one-year interest rates in December 1998 in pesos and dollars were 15% and 8%, respectively. What happened to the real value of the peso during 1998?

Mexican peso appreciated by 5.43% against US dollar

Mexican peso depreciated by 7.00% against US dollar

Mexican peso appreciated by 7.00% against US dollar

Mexican peso depreciated by 5.43% against US dollar

5 points

QUESTION 4

1. You are a U.S.-based treasurer with \$1,000,000 to invest. The dollar-euro exchange rate is quoted as \$1.53 = €1.00 and the dollar-pound exchange rate is quoted at \$1.83= £1.00. If a bank quotes you a cross rate of £1.00 = €1.12 how much money can an astute trader make?

\$41,667

\$67,927

\$160,000

No arbitrage is possible

5 points

QUESTION 5

1. On November 1, 1999, the exchange rate between the Brazilian real and U.S. dollar is R\$1.95/\$. The consensus forecast for the U.S. and Brazil inflation rates for the next 3-year period is 2.6% and 20.0% per year, respectively. What would you forecast the exchange rate to be at around November 1, 2002?

R\$2.2807/\$

R\$3.6673/\$

R\$3.1199/\$

R\$2.6675/\$

5 points

QUESTION 6

1.  Using the table below,

American Terms

European Terms

Bank Quotations

Bid

Bid

British pounds

\$1.9700

\$1.9715

£ 0.5072

£ 0.5076

Euros

\$1.474

\$1.485

€ 0.6734

€ 0.6784

What are the bid and ask prices of euros in terms of pounds, respectively?

€/£: 1.3266 – 1.3375

£/€: 0.7476 – 0.7479

€/£: 1.3276 – 1.3364

£/€: 0.7476 – 0.7538

5 points

QUESTION 7

1. Using the table below,

American Terms

European Terms

Bank Quotations

Bid

Bid

British pounds

\$1.9700

\$1.9715

£ 0.5072

£ 0.5076

Euros

\$1.474

\$1.485

€ 0.6734

€ 0.6784

What are the bid and ask prices of pounds in terms of euros, respectively?

£/€: 0.7476 – 0.7479

€/£: 1.3266 – 1.3375

£/€: 0.7476 – 0.7538

€/£: 1.3276 – 1.3364

5 points

QUESTION 8

1. A German businessman has just completed transactions in America and England. He is now holding \$100,000 and £500,000, and wants to convert both amounts to the euro. His bank quotes him the following exchange rates: GBP/USD £0.5031–£0.5057, and USD/EUR \$1.4740–\$1.4744. What are his proceeds from conversion?

€738,421.39

€735,911.27

€742,691.86

€738,621.77

5 points

QUESTION 9

1. The current spot exchange rate is \$1.95/£ and the three-month forward rate is \$1.90/£. Based on your analysis of the exchange rate, you are pretty confident that the spot exchange rate will be \$1.88/£ in three months. Assume that you would like to buy or sell £1,000,000. What actions do you need to take to speculate in the forward market and what is the expected dollar payoff from speculation?

sell £1,000,000 forward; expected profit is \$30,000

buy £1,000,000 forward; expected profit is \$20,000

sell £1,000,000 forward; expected profit is \$20,000

buy £1,000,000 forward; expected profit is \$30,000

5 points

QUESTION 10

1. Suppose that the current spot exchange rate is €0.80/\$ and the three-month forward exchange rate is €0.7813/\$. The three-month interest rate is 5.60 percent per annum in the United States and 5.40 percent per annum in France. Which of the following is going to happen as a result of covered arbitrage activities toward restoring the interest parity condition?

The euro interest rate will fall

The dollar interest rate will fall

The €/\$ spot exchange rate will rise

The €/\$ forward exchange rate will fall

5 points

QUESTION 11

1. Suppose that the one-year interest rate is 6.0 percent in the United States; the spot exchange rate is \$1.21/€; and the one-year forward exchange rate is \$1.24/€. What must one-year interest rate be in the euro zone to avoid arbitrage?

3.44%

8.62%

7.24%

5.0%

5 points

QUESTION 12

1. Investors in both the U.S. and U.K. require the same real interest rate, 3%, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 2% in the U.S. and 1.5% in the U.K. for the next three years. The spot exchange rate is currently \$1.50/£. Using parity conditions, what is the most likely forward dollar-pound exchange rate for one-year maturity?

\$1.5350/₤

\$1.5075/₤

\$1.4925/₤

\$1.50/₤

5 points

QUESTION 13

1. Suppose that the current spot exchange rate is €0.8210/\$ and the three-month forward exchange rate is €0.7895/\$. The three-month interest rate is 6 percent per annum in the United States and 8 percent per annum in France. Assume that you can borrow up to \$1,000,000 or €821,000.

There is no arbitrage opportunity.

Arbitrage can generate a net profit around \$45,697.

Arbitrage can generate a net profit around €36,077.

Both B) and C)

5 points

QUESTION 14

1. On July 2, 1997 the Thai Baht fell 17% against the US dollar. By how much did the dollar appreciate against the baht??

117%

20.5%

17%

120.5%

5 points

QUESTION 15

1. A currency dealer has good credit and can borrow either \$1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i\$ = 3.5% and in the euro zone the one-year interest rate is i€ = 6.5%. The spot exchange rate is \$1.25 = €1.00 and the one-year forward exchange rate is \$1.20 = €1.00. Show how to realize a certain profit via covered interest arbitrage.

Borrow \$1,000,000 at 3.5%. Trade \$1,000,000 for €800,000; invest at i€ = 6.5%; translate proceeds back at forward rate of \$1.20 = €1.00, gross proceeds = \$1,022,400.

Borrow €800,000 at i€ = 6.5%; translate to dollars at the spot, invest in the U.S. at i\$ = 3.5% for one year; translate €852,000 back into dollars at the forward rate of \$1.20 = €1.00. Net profit \$12,600.

Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i\$ = 3.5% for one year; translate \$1,035,000 back into euro at the forward rate of \$1.20 = €1.00. Net profit €10,500.

Both B) and C)

5 points

QUESTION 16

1. During 2002 the yen went from \$ 0.0074074/yen at the beginning of the year to \$0.0084746/yen at the end of the year. What are the amount of appreciation/depreciation for the yen and the dollar, respectively?

Appreciation by 14.41%, depreciation by 12.59%

Appreciation by 14.41%, depreciation by 14.41%

Appreciation by 12.59%, depreciation by 12.59%

Appreciation by 12.59%, depreciation by 14.41%

5 points

QUESTION 17

1. Purchasing Power Parity (PPP) theory states that

the exchange rate between currencies of two countries should be equal to the ratio of the countries’ price levels.

as the purchasing power of a currency sharply declines (due to hyperinflation) that currency will appreciate against stable currencies.

the prices of standard commodity baskets in two countries are not related.

both a) and b)

5 points

QUESTION 18

1. During the currency crisis of September 1992, the Bank of England borrowed DM 33 billion from the Bundesbank when a pound was worth DM 2.78 or \$1.912. It sold these DM in the foreign exchange market for pounds in a futile attempt to prevent a devaluation of the pound. It repaid these DM at the post-crisis rate of DM 2.50=£1. By then, the dollar/pound exchange rate was \$1.782=£1.  By what percentages had the pound sterling devalued in the interim against the Deutsche mark and against the dollar, respectively?

-11.20%, -7.30%

-10.07%, -6.80%

-11.20%, -6.80%

-10.07%, -7.30%

5 points

QUESTION 19

1. During the currency crisis of September 1992, the Bank of England borrowed DM 33 billion from the Bundesbank when a pound was worth DM 2.78 or \$1.912. It sold these DM in the foreign exchange market for pounds in a futile attempt to prevent a devaluation of the pound. It repaid these DM at the post-crisis rate of DM 2.50=£1. By then, the dollar/pound exchange rate was \$1.782=£1.  What were the cost of intervention to the Bank of England in pounds and in dollars, respectively?

9.2400 billion pounds, 1.2012 billion dollars

1.3295 billion pounds, 2.3692 billion dollars

1.3295 billion pounds, 2.5420 billion dollars

1.3295 billion pounds, 0.8260 billion dollars

5 points

QUESTION 20

1. (Challenging!!) Suppose that the following prices are quoted in the markets where forward rates and interest rates on Euro-\$ and on Euro-¥ are all for 1-year ahead.  [Hint: Refer to the relevant information on covered interest arbitrage with bid-ask spreads to solve the problem.]

Bid

Spot (¥/\$)

99.95

100.05

Forward(¥/\$)

97.00

98.00

Euro-\$ (%)

4.95

5.05

Euro-¥ (%)

1.95

2.05

Which of the following is true?

It is impossible to make an arbitrage profit.

The strategy that borrows ¥ in Euro-¥ market and invests equivalent in Euro-\$ market is profitable.

The strategy that borrows \$ in Euro-\$ market and invests equivalent in Euro-¥ market is profitable.

Both B) and C).

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