Question 1

If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax laws.

Accepted Answer

A) True 
 B)False

Question 2

Assume the U.S. interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss franc has a 4% premium. Given this information:

Accepted Answer

A)  Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland. 
B)  U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the U.S. 
C)  A and B 
D)  none of the above

Question 3

The foreign exchange market is an over-the-counter market.

Accepted Answer

A) True 
 B)False

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

Cross exchange rates are used to determine the relationship between the dollar and two nondollar currencies.

Accepted Answer

A) True 
 B)False

Question 6

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

Accepted Answer

A) True 
 B)False

Question 7

Assume that the euro's interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the following is true?

Accepted Answer

A)  Americans using covered interest arbitrage earn the same rate of return as Germans who attempt covered interest arbitrage. 
B)  Americans who invest in the U.S. earn the same rate of return as Germans who attempt covered interest arbitrage. 
C)  Americans who invest in the U.S. earn the same rate of return as Germans who invest in Germany 
D)  A and B 
E)  None of the above

Question 8

According to interest rate parity (IRP):

Accepted Answer

A)  the forward rate differs from the spot rate by a sufficient amount to offset the inflation differential between two currencies. 
B)  the future spot rate differs from the current spot rate by a sufficient amount to offset the interest rate differential between two currencies. 
C)  the future spot rate differs from the current spot rate by a sufficient amount to offset the inflation differential between two currencies. 
D)  the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.

Question 9

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

Accepted Answer

A)  upward pressure on the Swiss franc's spot rate. 
B)  upward pressure on the U.S. interest rate. 
C)  downward pressure on the Swiss interest rate. 
D)  upward pressure on the Swiss franc's forward rate.

Question 10

Assume you 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.

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)  A and C

Question 11

If interest rate parity exists, then the rate of return achieved from covered interest arbitrage should be equal to the interest rate available in the foreign country.

Accepted Answer

A) True 
 B)False

Question 12

Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country.

Accepted Answer

A) True 
 B)False

Question 13

Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate of the Swiss franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?

Accepted Answer

A)  $7,067. 
B)  $8,556. 
C)  $10,114. 
D)  $12,238.

Question 14

Assume the following bid and ask rates of the pound for two banks as shown below:
$\begin{array}{lll} 
& \underline{\text { Bid }} & \underline{\text { Ask }} \
\text { Bank A } & \$ 1.41 & \$ 1.42 \
\text { Bank B } & \$ 1.39 & \$ 1.40
\end{array}$

As locational arbitrage occurs:

Accepted Answer

A)  the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will increase. 
B)  the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will decrease. 
C)  the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will decrease. 
D)  the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will increase.

Question 15

To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward.

Accepted Answer

A) True 
 B)False

Question 16

Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.

Accepted Answer

A) True 
 B)False

Question 17

When using ____, funds are not tied up for any length of time.

Accepted Answer

A)  covered interest arbitrage 
B)  locational arbitrage 
C)  triangular arbitrage 
D)  B and C

Question 18

When using ____, funds are typically tied up for a significant period of time.

Accepted Answer

A)  covered interest arbitrage 
B)  locational arbitrage 
C)  triangular arbitrage 
D)  B and C

Question 19

Assume the following information:
$$\begin{array} { l l r } 
\text { Exchange rate of Japanese yen in U.S. \$ } & = & \$ .011 \
\text { Exchange rate of euro in U.S. \$ } & = & \$ 1.40 \
\text { Exchange rate of euro in Japanese yen } & = & 140 \text { yen }
\end{array}$$
What will be the yield for an investor who has $1,000,000 available to conduct triangular arbitrage?

Accepted Answer

A)  $100,000 
B)  -$90,909 
C)  10% 
D)  -9.09%

Question 20

Assume the following information:
U.S. investors have $1,000,000 to invest:
$\begin{array}{lll}
1 \text {-year deposit rate oftered by U.S. banks } & = & 12 \% \
1 \text {-year deposit rate offered on Swiss francs } & = & 10 \% \
1 \text {-year forward rate of Swiss francs } & = & \$ .62 \% \
\text { Spot rate of Swiss franc } & =&\$.60%
\end{array}$

Given this information:

Accepted Answer

A)  interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically. 
B)  interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. 
C)  interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. 
D)  interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically.

Exam 7: International Arbitrage and Interest Rate Parity

If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax laws.

Assume the U.S. interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss franc has a 4% premium. Given this information:

The foreign exchange market is an over-the-counter market.

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.

Cross exchange rates are used to determine the relationship between the dollar and two nondollar currencies.

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

Assume that the euro's interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the following is true?

According to interest rate parity (IRP) :

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

Assume you 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.

If interest rate parity exists, then the rate of return achieved from covered interest arbitrage should be equal to the interest rate available in the foreign country.

Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country.

Assume the following bid and ask rates of the pound for two banks as shown below: $\begin{array}{lll} & \underline{\text { Bid }} & \underline{\text { Ask }} \\\text { Bank A } & \$ 1.41 & \$ 1.42 \\\text { Bank B } & \$ 1.39 & \$ 1.40\end{array}$ As locational arbitrage occurs:

To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward.

Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.

When using ____, funds are not tied up for any length of time.

When using ____, funds are typically tied up for a significant period of time.