Quiz 4

Question 1

For points lying to the left of the IRP line, covered interest arbitrage is not possible from a US investor’s perspective, but it is possible from a foreign investor’s perspective.

Answer 1

True

Question 2

Which of the following is an example of triangular arbitrage intitiation?

Answer 2

Buying Singapore dollars from the bank (quoted at .55) that has quoted the South African rand/Singapore dollar exchange rate at SAR3.00 when the spot rate is .20

Question 3

Assume you have discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs’ actions, the following adjustments must take place.

Answer 3

One bank’s ask price will rise and the other bank’s bid price will fall.

Question 4

If nominal British interest rates are 3% and nominal US interest rates are 6%, then the British pound is expected to __ by about __ %, according to the IFE (international fisher effect)

Answer 4

appreciate; 2.9

Question 5

Assume that Swiss investors are benefiting from covered interest arbitrage due to a high U.S. interest rate. Which of the following forces result from this covered interest arbitrage activity?

Answer 5

upward pressure on the Swiss franc’s forward rate

Question 6

According to the IFE, the exchange rate percentage change should be approximately equal to the differential in income levels between two countries.

Answer 6

False

Question 7

Assume the British interest rates are higher than US rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts __ pressure on the pound’s spot rate and __ pressure on the pound’s forward rate.

Answer 7

upward; downward

Question 8

Assume that the interest rate in the home country of Currency X is much higher than the U.S. interest rate. According to the interest rate parity, the forward rate of currency X:

Answer 8

should exhibit a discount

Question 9

Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.

Answer 9

True

Question 10

Due to __, market forces should realign the cross exchange rate between two foreign currencies based on the spot exchange rates of the two currencies against the dollar.

Answer 10

Triangular arbitrage

Question 11

Local arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in forward contracts.

Answer 11

False

Question 12

Points above the IRP line represent situations in which:

Answer 12

covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets.

Question 13

Assume that the New Zealand inflation rate is higher than the US inflation rate. This will cause US consumers to __ their imports from NZ and NZ to __ their imports from US. According to the PPP, this will result in a __ of the NZ dollar.

Answer 13

reduce; increase; depreciate

Question 14

The nominal interest rate can be measured as the real interest rate minus the expected inflation rate.

Answer 14

False

Question 15

Purchasing Power Parity (PPP) focusses on the relationship between nominal interest rates and exchange rates between two countries.

Answer 15

False

Question 16

Which of the following is true regarding covered interest arbitrage?

Answer 16

Covered interest arbitrage opportunities only exist when the foreign interest rate is higher than the interest rate in the home country.

Question 17

According to PPP, if a foreign country’s inflation rate is below the inflation rate at home, home country consumers will increase their imports from the foreign country, and foreign consumers will lower their demand for home country products. These market forces cause the foreign currency to appreciate.

Answer 17

True

Question 18

Assume the real interest rate in the US and in the UK is 3%. The expected annual inflation in the US is 3%, while in the UK it is 4%. The forward rate of the pound should exhibit a premium of about 1%.

Answer 18

False

Question 19

If purchasing power parity holds, then the Fisher effect must also hold.

Answer 19

False

Question 20

Location arbitrage involves investing in a foreign country and covering against an exchange rate by engaging in forward contracts.

Answer 20

False

Question 21

Which of the following is not true regarding covered interest arbitrage?

Answer 21

Covered interest arbitrage is a reason for observing interest rate parity (IRP).

Question 22

According to the international Fisher effect, if investors in all countries require the same real rate of return, the differential in nominal interest rates between two countries:

Answer 22

is due to their inflation differentials

Question 23

There is much evidence to suggest that Japanese investors invest in US treasury securities when US interest rates are higher than Japanese interest rates. These investors most likely believe in the international Fisher effect

Answer 23

False

Question 24

According to the IFE, when the nominal interest rate at home exceeds the nominal interest rate in the foreign country, the home currency should depreciate.

Answer 24

True

Question 25

Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.

Answer 25

True

Question 26

According to IFE, if British interest rates exceed US interest rates:

Answer 26

the British pound will depreciate against the dollar

Question 27

Assume that interest rate parity holds. The US interest rate is 13% and the British interest rate is 10%. the forward rate on British pounds exhibits a __ of __ percent.

Answer 27

premium; 2.73

Question 28

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Answer 28

False

Question 29

Assume the British pound is worth $1.60 and the Canadian dollar is worth $.80. What is the value of the Canadian dollar in pounds?

Answer 29

.50

Question 30

Assume that the international fisher effect holds between the US and the UK. The US inflation is expected to be 5%, while British inflation is expected to be 3%. The interest rate offered on pounds is 7%, and the US interest rate is 7%. What does this say about real interest rates expected by British investors?

Answer 30

Real interest rates expected by British investors are 2% points above the real interest rates expected by US investors.

Question 31

Assume US and Swiss investors require a real rate of return of 3%. Assume the nominal US interest rate is 6% and the nominal swiss rates is 4%. According to the international Fisher effect, the franc will __ by about __.

Answer 31

appreciate; 2%

Question 32

Due to __, market forces should realign the spot rate of a currency among banks.

Answer 32

locational arbitrage

Question 33

Which of the following theories suggest that the percentage change in the spot exchange rate of a currency should be equal to the inflation differential between two countries?

Answer 33

purchasing power parity (PPP)

Question 34

Sometimes the overall performance of an MNC may already be insulated by offsetting effects between subsidiaries, and it may not be necessary to hedge the position of each individual subsidiary.​

Answer 34

True

Question 35

The exact cost of hedging with call options (as measured in the text) is not known with certainty at the time that the options are purchased.​

Answer 35

True

Question 36

To hedge a contingent exposure, in which an MNC's exposure is contingent on a specific event occurring, the appropriate hedge would be a(n) ____ hedge.​

Answer 36

Options

Question 37

Overhedging refers to the hedging of a larger amount in a currency than the actual transaction amount.​

Answer 37

True

Question 38

A money market hedge involves taking a money market position to cover a future payables or receivables position.​

Answer 38

True

Question 39

​The real cost of hedging payables with a forward contract equals:

Answer 39

c. ​the dollar cost of hedging minus the dollar cost of not hedging.

Question 40

When comparing the forward hedge to the money market hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.​

Answer 40

True

Question 41

A money market hedge on payables would involve, among others, borrowing ____ and investing in the ____.​

Answer 41

c. ​dollars; foreign country

Question 42

​Under FASB 52:

Answer 42

b. ​translation gains and losses are included in stockholder's equity.

Question 43

​Generally, MNCs with less foreign revenues than foreign costs will be ____ affected by a ____ foreign currency.

Answer 43

b. ​favorably; weaker

Question 44

If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis indicates that remaining unhedged will probably be less costly than hedging.​

Answer 44

True

Question 45

When a perfect hedge is not available to eliminate transaction exposure, the firm may consider methods to at least reduce exposure, such as ____.​

Answer 45

All of the above . ​leading b. ​lagging c. ​cross-hedging d. ​currency diversification e. ​all of the above

Question 46

Lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate.​

Answer 46

True

Question 47

A futures hedge involves taking a money market position to cover a future payables or receivables position.​

Answer 47

False

Question 48

​Translation exposure reflects:

Answer 48

a. ​the exposure of a firm's financial statements to exchange rate fluctuations.

Question 49

​Purely domestic firms are never affected by economic exposure.

Answer 49

False

Question 50

​The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high.

Answer 50

False

Question 51

Many MNCs use selective hedging, in which they consider each type of transaction separately.​

Answer 51

True