Exam 8: Relationships Among Inflation, Interest Rates, and Exchange Rates

Assume that inflation in the U.S. is expected to be 9%, while inflation in Australia is expected to be 5% over the next year. Today you receive an offer to purchase a one-year put option for $.03 per unit on Australian dollars at a strike price of $0.72. Today the Australian dollar is quoted at $0.70. You believe that purchasing power parity holds. You should accept the offer.

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

Assume that the international Fisher effect (IFE) holds between the U.S. and the U.K. The U.S. inflation is expected to be 5%, while British inflation is expected to be 3%. The interest rates offered on pounds are 7% and U.S. interest rates are 7%. What does this say about real interest rates expected by British investors?

Which of the following theories can be assessed using data that exists at one specific point in time?

Assume that the U.S. one-year interest rate is 5% and the one-year interest rate on euros is 8%. You have $100,000 to invest and you believe that the international Fisher effect (IFE) holds. The euro's spot exchange rate is $1.40. What will be the yield on your investment if you invest in euros?

Interest rate parity can only hold if purchasing power parity holds.

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 any two countries:

Which of the following is indicated by research regarding purchasing power parity (PPP)?

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound: Regression results indicate that a₀ = 0 and a₁ = 0.4. Therefore:

If nominal British interest rates are 3% and nominal U.S. interest rates are 6%, then the British pound (£) is expected to ____ by about ____%, according to the international Fisher effect (IFE).

According to the international Fisher effect, if Venezuela has a much higher nominal rate than other countries, its inflation rate will likely be ____ than other countries, and its currency will ____.

According to purchasing power parity (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.

Which of the following is not true regarding IRP, PPP, and the IFE?

If interest rate parity holds, then the international Fisher effect must hold.

The following regression was conducted for the exchange rate of the Cyprus pound (CYP): Regression results indicate that a₀ = 0 and a₁ = 2. Therefore,

If the international Fisher effect (IFE) did not hold based on historical data, then this suggests that:

Which of the following is not true regarding IRP, PPP, and the IFE?

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

If interest rate parity holds, and the international Fisher effect (IFE) holds, foreign currencies with relatively high interest rates should have forward discounts and those currencies would be expected to depreciate.

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