Exam 5: The Market for Foreign Exchange

Assume the current $/£ exchange rate is 1.7 $/£ and 1-year forward exchange rate is 1.68$/£.The risk-free interest rates in US and UK are 4% and 6% respectively.Is there an arbitrage opportunity?

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Question 1

Correct Answer:

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Direct investment of $s gives you 4%
Indirect investment gives (1/1.7)*1.06*1.68 1 = 0.0475 or 4.75%
Thus,arbitrage is possible.Strategy:
Today: Borrow $1,buy 1/1.7 = £0.5882,invest it at 6% (so that you expect to receive 1.06*(1/1.7)= £0.6235 one year from now)and sell forward contract for £0.6235
1-year from now: Collect £0.6235 from your investment,sell £0.6235 trough previously sold forward contract,receive 0.6235*1.68 = $1.0475,repay your debt of 1*1.04 = $1.04.Profit = 1.0475 1.04 = $0.0075

The forward expectations parity states that

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Question 2

Correct Answer:

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The 9-months inflation rate in Great Britain is expected to be 4% p.a.,and the 9-months inflation rate in Switzerland is predicted to be 6% p.a.The real interest rate is 3% in Great Britain.Assume that the parity conditions hold. a)What is the nominal interest rate in Switzerland? b)What is the nine-month forward rate of the Swiss franc with respect to the British pound? c)If the inflation rates are expected to stay unchanged over the next two years,what is the expected spot exchange rate between the British pound and the Swiss franc in two years?

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Question 3

Correct Answer:

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a)(1.03)(1.06) 1 = 0.0918 or 9.18% p.a.
b)1/0.4928 = SF 2.0292/pound
c)0.5(1.04/1.06)2 = pound 0.4813/ SF

Uncovered interest rate parity

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Question 4

Deviations from interest rate parity exist for all of the following reasons except:

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Question 5

Purchasing Power Parity (PPP)theory states that:

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Question 6

The net cash flow in one year is

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Question 7

Covered Interest Arbitrage (CIA)activities will result in

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Question 8

Covered interest rate arbitrage would not be possible if the forward rate would be:

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Question 9

According to the fundamental approach,if all of the regression coefficients are already estimated,all of the following matters in the exchange rate determination EXCEPT

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Question 10

The above mentioned scenario

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Question 11

PPP does not hold well because of the following except

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Question 12

The international Fisher effect is the same as the

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Question 13

Germany has a higher rate of inflation than Japan.The nominal exchange rate is constant.

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Question 14

The 9-months inflation rate in Great Britain is expected to be 4% p.a.,and the 9-months inflation rate in Switzerland is predicted to be 6% p.a.Assume that the parity conditions hold. a)By what percentage rate do you expect the Swiss franc to appreciate (depreciate)with respect to the British pound over the next nine months,based on purchasing power parity? b)If the spot rate is pound 0.5/SF,what is the expected spot exchange rate between the Swiss franc and the British pound in nine months?

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Question 15

When Interest Rate Parity (IRP)holds between two different countries X and Y,your decision to invest your money will:

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Question 16

Interest Rate Parity (IRP)is best defined as:

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Question 17

Assume the current $/£ exchange rate is 1.7 $/£ and 1-year forward exchange rate is 1.68$/£.The risk-free interest rates at which you can invest in US and UK are 4% and 6% respectively.However,since you do not have a very good credit rating,you can borrow funds only at higher rates.Namely,you can borrow $s at 5% and you can borrow £s at 7%.Is there an arbitrage opportunity?

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Question 18

Suppose that the two-months interest rate is 8.0 percent per annum in the Canada and 7.0 percent per annum in France,and that the spot exchange rate is $1.50/€ and the forward exchange rate,with one-year maturity,is $1.50/€.Assume that an arbitrager can borrow up to $1,000,000 or €666,666. a)What kind of arbitrage is possible? b)Determine the arbitrage profit that can be made. c)What would the French interest rate have to be so that there would be no arbitrage opportunity?

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Question 19

Canada's competitive position will

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Question 20

Showing 1 - 20 of 27

Assume the current $/£ exchange rate is 1.7 $/£ and 1-year forward exchange rate is 1.68$/£.The risk-free interest rates in US and UK are 4% and 6% respectively.Is there an arbitrage opportunity?

The forward expectations parity states that

Uncovered interest rate parity

Deviations from interest rate parity exist for all of the following reasons except:

Purchasing Power Parity (PPP)theory states that:

The net cash flow in one year is

Covered Interest Arbitrage (CIA)activities will result in

Covered interest rate arbitrage would not be possible if the forward rate would be:

According to the fundamental approach,if all of the regression coefficients are already estimated,all of the following matters in the exchange rate determination EXCEPT

The above mentioned scenario

PPP does not hold well because of the following except

The international Fisher effect is the same as the

Germany has a higher rate of inflation than Japan.The nominal exchange rate is constant.

When Interest Rate Parity (IRP)holds between two different countries X and Y,your decision to invest your money will:

Interest Rate Parity (IRP)is best defined as:

Canada's competitive position will

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