Question 1

Covered interest arbitrage moves the market ________ equilibrium because ________.

Accepted Answer

A)  toward; purchasing a currency on the spot market and selling in the forward market narrows the differential between the two
B)  toward; investors are now more willing to invest in risky securities
C)  away from; purchasing a currency on the spot market and selling in the forward market increases the differential between the two
D)  away from; demand for the stronger currency forces up interest rates on the weaker security A

Question 2

Other things equal,and assuming efficient markets,if a Honda Accord costs $21,375 in the U.S.then at an exchange rate of $1.63/£,the Honda Accord should cost ________ in Great Britain.

Accepted Answer

A)  £21,375
B)  £18,365
C)  £13,113
D)  £42,322 C

Question 3

According to the theory of interest rate parity,the difference in national interest rates for securities of similar risk and maturity should be ________ and ________ sign to the forward rate discount or premium for the foreign currency,except for transaction costs.

Accepted Answer

A)  equal to; of the same
B)  less than; of the same
C)  greater than; opposite in
D)  equal to; opposite in D

Question 4

Exchange rate pass-through may be defined as

Accepted Answer

A)  the bid/ask spread on currency exchange rate transactions.
B)  the degree to which the prices of imported and exported goods change as a result of exchange rate changes.
C)  the PPP of lesser-developed countries.
D)  the practice by Great Britain of maintaining the relative strength of the currencies of the Commonwealth countries under the current floating exchange rate regime.

Question 5

The Fisher Effect is a familiar economic theory in the domestic market.In words,define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

Accepted Answer

The answer of The Fisher Effect is a familiar economic...

Question 6

Some forecasters believe that foreign exchange markets for the major floating currencies are "efficient" and forward exchange rates are unbiased predictors of future spot exchange rates.What are the three conditions of market efficiency as defined by the authors? What is implied by the term unbiased predictors? What does the empirical evidence have to say about the forward rate as an unbiased predictor of future spot rates?

Accepted Answer

The answer of Some forecasters believe that foreign exchange markets...

Question 7

________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.

Accepted Answer

A)  Absolute PPP
B)  Relative PPP
C)  The Law of One Price
D)  The Fisher Effect

Question 8

One-year interest rates are currently 2.50% in the United States and 3.70% in Great Britain.The current spot rate between the pound and dollar is $1.9000/£.What is the expected spot rate in one year if the international Fisher effect holds?

Accepted Answer

A)  $1.9000/£
B)  $1.9222/£
C)  $1.8780/£
D)  $1.8500/£

Question 9

Assume a nominal interest rate on one-year U.S.Treasury Bills of 3.80% and a real rate of interest of 2.00%.Using the Fisher Effect Equation,what is the exact expected rate of inflation in the U.S.over the next year?

Accepted Answer

A)  1.84%
B)  1.80%
C)  1.76%
D)  1.72%

Question 10

Phillips NV produces DVD players and exports them to the United States.Last year the exchange rate was $1.25/euro and Phillips charged 120 euro per player in Euroland and $150 per DVD player in the United States.Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player.What is the degree of pass through by Phillips NV on their DVD players?

Accepted Answer

A)  92%
B)  33.3%
C)  41.7%
D)  4.1%

Question 11

If exchange markets were not efficient,it would pay for a firm to spend resources on forecasting exchange rates.

Accepted Answer

A) True 
 B)False

Question 12

Assume a nominal interest rate on one-year U.S.Treasury Bills of 3.10% and a real rate of interest of 1.00%.Using the Fisher Effect Equation,what is the approximate expected rate of inflation in the U.S.over the next year?

Accepted Answer

A)  2.10%
B)  2.05%
C)  2.00%
D)  1.90%

Question 13

________ states that the spot exchange rate is determined by the relative prices of similar baskets of goods.

Accepted Answer

A)  Absolute purchasing power parity
B)  Relative purchasing power parity
C)  Interest rate parity
D)  The Fisher Effect

Question 14

Empirical tests fail to conclusively demonstrate that PPP is an accurate predictor of future exchange rates.

Accepted Answer

A) True 
 B)False

Question 15

Assume the current U.S.dollar-British spot rate is 0.6134£/$.If the current nominal one-year interest rate in the U.S.is 2.5% and the comparable rate in Britain is 3.5%,what is the approximate forward exchange rate for 360 days?

Accepted Answer

A)  1.42£/$
B)  0.6075£/$
C)  0.6134£/$
D)  0.6194£/$

Question 16

The implied PPP rate of exchange of Mexican pesos per U.S.dollar is 8.58 according to the Big Mac Index. The current exchange rate is Peso 10.8/$1. Thus,according to PPP and the Law of One Price,at the current exchange rate the peso is ________.

Accepted Answer

A)  overvalued
B)  undervalued
C)  correctly valued
D)  not enough information to answer this question

Question 17

In its approximate form the Fisher effect may be written as ________,where: i = the nominal rate of interest,r = the real rate of return,and π = the expected rate of inflation.

Accepted Answer

A)  i = (r) (π) 
B)  i = r + π + (r) (π) 
C)  i = r + π
D)  i = r + 2 π

Question 18

Two general conclusions can be made from the empirical tests of purchasing power parity (PPP):

Accepted Answer

A)  PPP holds up well over the short run but poorly for the long run and the theory holds better for countries with relatively low rates of inflation.
B)  PPP holds up well over the short run but poorly for the long run and the theory holds better for countries with relatively high rates of inflation.
C)  PPP holds up well over the long run but poorly for the short run and the theory holds better for countries with relatively low rates of inflation.
D)  PPP holds up well over the long run but poorly for the short run and the theory holds better for countries with relatively high rates of inflation.

Question 19

The assumptions for absolute PPP are more rigid than the assumptions for relative PPP.

Accepted Answer

A) True 
 B)False

Question 20

The price of a Big Mac in the U.S.is $3.73 and the price in Mexico is Peso 32.0. What is the implied PPP of the peso per dollar?

Accepted Answer

A)  Peso 8.58/$1
B)  Peso 10.8/$1
C)  Peso 11.76/$1
D)  None of the above

Exam 7: International Parity Conditions

Covered interest arbitrage moves the market equilibrium because .

Other things equal,and assuming efficient markets,if a Honda Accord costs $21,375 in the U.S.then at an exchange rate of $1.63/£,the Honda Accord should cost ________ in Great Britain.

According to the theory of interest rate parity,the difference in national interest rates for securities of similar risk and maturity should be and sign to the forward rate discount or premium for the foreign currency,except for transaction costs.

Exchange rate pass-through may be defined as

The Fisher Effect is a familiar economic theory in the domestic market.In words,define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.

One-year interest rates are currently 2.50% in the United States and 3.70% in Great Britain.The current spot rate between the pound and dollar is $1.9000/£.What is the expected spot rate in one year if the international Fisher effect holds?

Assume a nominal interest rate on one-year U.S.Treasury Bills of 3.80% and a real rate of interest of 2.00%.Using the Fisher Effect Equation,what is the exact expected rate of inflation in the U.S.over the next year?

If exchange markets were not efficient,it would pay for a firm to spend resources on forecasting exchange rates.

Assume a nominal interest rate on one-year U.S.Treasury Bills of 3.10% and a real rate of interest of 1.00%.Using the Fisher Effect Equation,what is the approximate expected rate of inflation in the U.S.over the next year?

________ states that the spot exchange rate is determined by the relative prices of similar baskets of goods.

Empirical tests fail to conclusively demonstrate that PPP is an accurate predictor of future exchange rates.

Assume the current U.S.dollar-British spot rate is 0.6134£/$.If the current nominal one-year interest rate in the U.S.is 2.5% and the comparable rate in Britain is 3.5%,what is the approximate forward exchange rate for 360 days?

The implied PPP rate of exchange of Mexican pesos per U.S.dollar is 8.58 according to the Big Mac Index. The current exchange rate is Peso 10.8/$1. Thus,according to PPP and the Law of One Price,at the current exchange rate the peso is ________.

In its approximate form the Fisher effect may be written as ________,where: i = the nominal rate of interest,r = the real rate of return,and π = the expected rate of inflation.

Two general conclusions can be made from the empirical tests of purchasing power parity (PPP) :

The assumptions for absolute PPP are more rigid than the assumptions for relative PPP.

The price of a Big Mac in the U.S.is $3.73 and the price in Mexico is Peso 32.0. What is the implied PPP of the peso per dollar?