Question 1

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

Accepted Answer

A)  transaction costs 
B)  political risk 
C)  differential tax laws 
D)  All of these are correct. 
A)  transaction costs 
B)  political risk 
C)  differential tax laws 
D)  All of these are correct.

Question 2

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

Accepted Answer

A)  One bank's ask price will rise, and the other bank's bid price will fall. 
B)  One bank's ask price will fall, and the other bank's bid price will rise. 
C)  One bank's bid/ask spread will widen, and the other bank's bid/ask spread will fall. 
D)  One bank's ask price will rise, and the other bank's bid price will fall AND one bank's bid/ask spread will widen, and the other bank's bid/ask spread will fall. 
A)  One bank's ask price will rise, and the other bank's bid price will fall. 
B)  One bank's ask price will fall, and the other bank's bid price will rise. 
C)  One bank's bid/ask spread will widen, and the other bank's bid/ask spread will fall. 
D)  One bank's ask price will rise, and the other bank's bid price will fall AND one bank's bid/ask spread will widen, and the other bank's bid/ask spread will fall.

Question 3

​Assume the following information: You have $900,000 to invest:
Current spot rate of Australian dollar (A$)
=
$)62
180-day forward rate of the Australian dollar
=
$)64
180-day interest rate in the United States
=
3)5%
180-day interest rate in Australia
=
3)0%
​
If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days?

Accepted Answer

A)  ​$56,903 
B)  ​$61,548 
C)  ​$27,000 
D)  ​$31,500 
A)  ​$56,903 
B)  ​$61,548 
C)  ​$27,000 
D)  ​$31,500

Question 4

Locational arbitrage explains why spot exchange rates among banks at different locations normally will not differ by a significant amount.

Accepted Answer

A) True 
 B)False

Question 5

Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage.

Accepted Answer

A) True 
 B)False

Question 6

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

Accepted Answer

A) True 
 B)False

Question 7

The interest rate in South Africa is 8 percent. The interest rate in the United States is 5 percent. The South African forward rate should exhibit a premium of about 3 percent.

Accepted Answer

A) True 
 B)False

Question 8

The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

Accepted Answer

A) True 
 B)False

Question 9

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

Accepted Answer

A) True 
 B)False

Question 10

Assume the following information: Current spot rate of Australian dollar
=
$)64
Forecasted spot rate of Australian dollar 1 year from now
=
$)59
1-year forward rate of Australian dollar
=
$)62
Annual interest rate for Australian dollar deposit
=
9%
Annual interest rate in the United States
=
6%
​
Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____percent.

Accepted Answer

A)  about 6.60 
B)  about 9.00 
C)  about 7.33 
D)  about 8.14 
E)  about 5.59 
A)  about 6.60 
B)  about 9.00 
C)  about 7.33 
D)  about 8.14 
E)  about 5.59

Question 11

​Assume that interest rate parity holds, and the euro's interest rate is 9 percent while the U.S. interest rate is 12 percent. Then the euro's interest rate increases to 11 percent while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity.

Accepted Answer

A)  ​discount; increase 
B)  ​discount; decrease 
C)  ​premium; increase 
D)  ​premium; decrease 
A)  ​discount; increase 
B)  ​discount; decrease 
C)  ​premium; increase 
D)  ​premium; decrease

Question 12

The yield curve for the United States normally has an upward slope, meaning that the annualized interest rate is higher for longer terms to maturity.

Accepted Answer

A) True 
 B)False

Question 13

The word "covered" in "covered interest arbitrage" refers to the investors hedging their position to protect against the possibility of default risk.

Accepted Answer

A) True 
 B)False

Question 14

Assume that a U.S. firm can invest funds for one year in the United States at 12 percent or invest funds in Mexico at 14 percent. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur?

Accepted Answer

A)  Spot rate of peso increases; forward rate of peso decreases. 
B)  Spot rate of peso decreases; forward rate of peso increases. 
C)  Spot rate of peso decreases; forward rate of peso decreases. 
D)  Spot rate of peso increases; forward rate of peso increases. 
A)  Spot rate of peso increases; forward rate of peso decreases. 
B)  Spot rate of peso decreases; forward rate of peso increases. 
C)  Spot rate of peso decreases; forward rate of peso decreases. 
D)  Spot rate of peso increases; forward rate of peso increases.

Question 15

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

Accepted Answer

A) True 
 B)False

Question 16

Points below the IRP line represent situations where:​

Accepted Answer

A)  ​covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically. 
B)  ​covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically. 
C)  ​covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets. 
D)  ​covered interest arbitrage is feasible for neither domestic nor foreign investors. 
A)  ​covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically. 
B)  ​covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically. 
C)  ​covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets. 
D)  ​covered interest arbitrage is feasible for neither domestic nor foreign investors.

Question 17

If interest rate parity exists, then ____ is not feasible.​

Accepted Answer

A)  ​forward realignment arbitrage 
B)  ​triangular arbitrage 
C)  ​covered interest arbitrage 
D)  ​locational arbitrage 
A)  ​forward realignment arbitrage 
B)  ​triangular arbitrage 
C)  ​covered interest arbitrage 
D)  ​locational arbitrage

Question 18

Exhibit 7-1
Assume the following information:
You have $300,000 to invest:
The spot bid quote for the euro (€) is $1.08
The spot ask quote for the euro is $1.10
The 180-day forward rate (bid) of the euro is $1.08
The 180-day forward rate (ask) of the euro is $1.10
The 180-day interest rate in the United States is 6%
The 180-day interest rate in Europe is 8%
-Refer to Exhibit 7-1 above. If you conduct covered interest arbitrage, what amount will you have after 180 days?

Accepted Answer

A)  $318,109.10 
B)  $330,000.00 
C)  $312,218.20 
D)  $323,888.90 
E)  None of these are correct. 
A)  $318,109.10 
B)  $330,000.00 
C)  $312,218.20 
D)  $323,888.90 
E)  None of these are correct.

Question 19

Assume the following information for a bank quoting on spot exchange rates: ​
Exchange rate of Singapore dollar in U.S.$
=
$)32
Exchange rate of pound in U.S.$
=
$1)50
Exchange rate of pound in Singapore dollars
=
S$4)50
​
Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot exchange rates?

Accepted Answer

A)  The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. 
B)  The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. 
C)  The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should appreciate. 
D)  The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should depreciate, and the pound value in Singapore dollars should appreciate. 
A)  The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. 
B)  The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. 
C)  The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should appreciate. 
D)  The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should depreciate, and the pound value in Singapore dollars should appreciate.

Question 20

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Accepted Answer

A) True 
 B)False

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

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

Locational arbitrage explains why spot exchange rates among banks at different locations normally will not differ by a significant amount.

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

The interest rate in South Africa is 8 percent. The interest rate in the United States is 5 percent. The South African forward rate should exhibit a premium of about 3 percent.

The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

The yield curve for the United States normally has an upward slope, meaning that the annualized interest rate is higher for longer terms to maturity.

The word "covered" in "covered interest arbitrage" refers to the investors hedging their position to protect against the possibility of default risk.

Assume that a U.S. firm can invest funds for one year in the United States at 12 percent or invest funds in Mexico at 14 percent. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur?

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

Points below the IRP line represent situations where:

If interest rate parity exists, then ____ is not feasible.

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Multinational Financial Management: an Overview

International Flow of Funds

International Financial Markets

Exchange Rate Determination

Currency Derivatives

Government Influence on Exchange Rates

Relationships Among Inflation, Interest Rates, and Exchange Rates

Forecasting Exchange Rates

Measuring Exposure to Exchange Rate Fluctuations

Managing Transaction Exposure

Managing Economic Exposure and Translation Exposure

Direct Foreign Investment

Multinational Capital Budgeting

International Corporate Governance and Control

Country Risk Analysis

Multinational Capital Structure and Cost of Capital

Long-Term Debt Financing

Financing International Trade

Short-Term Financing

International Cash Management

Filters

Exam 7: International Arbitrage and Interest Rate Parity

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

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

Locational arbitrage explains why spot exchange rates among banks at different locations normally will not differ by a significant amount.

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

The interest rate in South Africa is 8 percent. The interest rate in the United States is 5 percent. The South African forward rate should exhibit a premium of about 3 percent.

The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

The yield curve for the United States normally has an upward slope, meaning that the annualized interest rate is higher for longer terms to maturity.

The word "covered" in "covered interest arbitrage" refers to the investors hedging their position to protect against the possibility of default risk.

Assume that a U.S. firm can invest funds for one year in the United States at 12 percent or invest funds in Mexico at 14 percent. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur?

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

Points below the IRP line represent situations where:​

If interest rate parity exists, then ____ is not feasible.​

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Multinational Financial Management: an Overview

International Flow of Funds

International Financial Markets

Exchange Rate Determination

Currency Derivatives

Government Influence on Exchange Rates

Relationships Among Inflation, Interest Rates, and Exchange Rates

Forecasting Exchange Rates

Measuring Exposure to Exchange Rate Fluctuations

Managing Transaction Exposure

Managing Economic Exposure and Translation Exposure

Direct Foreign Investment

Multinational Capital Budgeting

International Corporate Governance and Control

Country Risk Analysis

Multinational Capital Structure and Cost of Capital

Long-Term Debt Financing

Financing International Trade

Short-Term Financing

International Cash Management

Filters

Points below the IRP line represent situations where:

If interest rate parity exists, then ____ is not feasible.