Question 1

Assume the following information for a bank quoting on spot exchange rates:
$$\begin{array} { l l r } 
\text { Exchange rate of Singapore dollar in U.S. S } & = & \$ .60 \
\text { Exchange rate of pound in U.S. S } & = & \$ 1.50 \
\text { Exchange rate of pound in Singapore dollars } & = & \text { S } \$ 2.6
\end{array}$$
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.

Question 2

Which of the following is an example of triangular arbitrage initiation?

Accepted Answer

A)  Buying a currency at one bank's ask and selling at another bank's bid, which is higher than the former bank's ask. 
B)  Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African rand (ZAR)/Singapore dollar (S$) exchange rate at ZAR2.50 when the spot rate for the South African rand is $0.20. 
C)  Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African rand/Singapore dollar exchange rate at ZAR3.00 when the spot rate for the South African rand is $0.20. 
D)  Converting funds to a foreign currency and investing the funds overseas.

Question 3

The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).

Accepted Answer

A) True 
 B)False

Question 4

Assume the following information:
$$\begin{array}{l}
\text { You have } \$ 1,000,000 \text { to invest: }\
\begin{array} { l l r } 
\text { Current spot rate of pound } & = & \$ 1.60 \
\text { 90-day forward rate of pound } & = & \$ 1.57 \
\text { 3-month deposit rate in U.S. } & = & 3 \% \
\text { 3-month deposit rate in U.K. } & = & 4 \%
\end{array}
\end{array}$$
If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days?

Accepted Answer

A)  $1,020,500. 
B)  $1,045,600. 
C)  $1,073,330. 
D)  $1,094,230. 
E)  $1,116,250.

Question 5

Which of the following is not mentioned in the text as a form of international arbitrage?

Accepted Answer

A)  Locational arbitrage 
B)  Triangular arbitrage 
C)  Transactional arbitrage 
D)  Covered interest arbitrage 
E)  All of the above are mentioned in the text as forms of international arbitrage.

Question 6

Assume the following information:
U.S. investors have $1,000,000 to invest:
$\begin{array}{lll}
1 \text {-year deposit rate offered on U.S. dollars } & = & 12 \% \
1 \text {-year deposit rate offered on Singapore dollars } & = & 10 \% \
1 \text {-year forward rate of Singapore dollars } & = & \$ .412 \
\text { Spot rate of Singapore dollar } & = & \$ 400
\end{array}$
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.

Question 7

American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR); National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would involve:

Accepted Answer

A)  buying rupees from American Bank at the bid rate and selling them to National Bank at the ask rate. 
B)  buying rupees from National Bank at the ask rate and selling them to American Bank at the bid rate. 
C)  buying rupees from American Bank at the ask rate and selling to National Bank at the bid rate. 
D)  buying rupees from National Bank at the bid rate and selling them to American Bank at the ask rate. 
E)  Locational arbitrage is not possible in this case.

Question 8

Assume the following information:
U.S. investors have $1,000,000 to invest:
$\begin{array} { l l r } 
1 \text {-year deposit rate affered by U.S. Gariks } & = & 10 \% \
1 \text {-year deposit rate affered an British pounds } & = & 13.5 \% \
1 \text {-year forward rate of Suriss francs } & = & \$ 1.26 \
\text { Spot rate of Swriss franc } & = & \$ 1.30
\end{array}$
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.

Question 9

Points above 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 not feasible for neither domestic nor foreign investors.

Question 10

Assume the following information:
$\begin{array} { l l l } 
\text { Spot rate today of Swis franc } & = & \$ 60 \
1 \text {-year forward rate as of today far Swiss franc } & = & \$ .63 \
\text { Fognected spot rate l year from now } & = & \$ 64 \
\text { Rate an 1-year deposits denominated in Swiss francs } & = & 7 \% \
\text { Rate an } 1 \text {-year deposits denominated in U.S. dallars } & = & 9 \%
\end{array}$
From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of ____%.

Accepted Answer

A)  5.00 
B)  12.35 
C)  15.50 
D)  14.13 
E)  11.22

Question 11

The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula.

Accepted Answer

A) True 
 B)False

Question 12

Assume the following information:
$$\begin{array} { l l r } 
\text { Current spot rate of Australian dollar } & = & \$ .64 \
\text { Forecasted spot rate of Australian dollar 1 year from now } & = & \$ .59 \
\text { 1-year forward rate of Australian dollar } & = & \$ .62 \
\text { Annual interest rate for Australian dollar deposit } & = & 9 \% \
\text { Annual interest rate in the U.S. } & = & 6 \%
\end{array}$$
Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____%.

Accepted Answer

A)  about 6.00 
B)  about 9.00 
C)  about 7.33 
D)  about 8.14 
E)  about 5.59

Question 13

Due to ____, market forces should realign the spot rate of a currency among banks.

Accepted Answer

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

Question 14

The interest rate in South Africa is 8%. The interest rate in the U.S. is 5%. The South African forward rate should exhibit a premium of about 3%.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following is not true regarding covered interest arbitrage?

Accepted Answer

A)  Covered interest arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. 
B)  Covered interest arbitrage involves investing in a foreign country and covering against exchange rate risk. 
C)  Covered interest arbitrage opportunities only exist when the foreign interest rate is higher than the interest rate in the home country. 
D)  If covered interest arbitrage is possible, you can guarantee a return on your funds that exceeds the returns you could achieve domestically. 
E)  All of the above are true regarding covered interest arbitrage.

Question 16

Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.

Accepted Answer

A) True 
 B)False

Question 17

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

Accepted Answer

A) True 
 B)False

Question 18

Assume the following bid and ask rates of the pound for two banks as shown below:
$$\begin{array} { l l l } 
& \underline { \text { Bid } } & \underline { \text { Ask } } \
\text { Bank C } & \$ 1.61 & \$ 1.63 \
\text { Bank D } & \$ 1.58 & \$ 1.60
\end{array}$$
As locational arbitrage occurs:

Accepted Answer

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

Question 19

Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:

Accepted Answer

A)  larger will be the forward discount of the foreign currency. 
B)  larger will be the forward premium of the foreign currency. 
C)  smaller will be the forward premium of the foreign currency. 
D)  smaller will be the forward discount of the foreign currency.

Question 20

Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso's forward ____ will ____.

Accepted Answer

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

Exam 7: International Arbitrage and Interest Rate Parity

Which of the following is an example of triangular arbitrage initiation?

The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).

Which of the following is not mentioned in the text as a form of international arbitrage?

American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR) ; National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would involve:

Points above the IRP line represent situations where:

The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula.

Due to ____, market forces should realign the spot rate of a currency among banks.

The interest rate in South Africa is 8%. The interest rate in the U.S. is 5%. The South African forward rate should exhibit a premium of about 3%.

Which of the following is not true regarding covered interest arbitrage?

Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.

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

Assume the following bid and ask rates of the pound for two banks as shown below: $\begin{array} { l l l } & \underline { \text { Bid } } & \underline { \text { Ask } } \\\text { Bank C } & \$ 1.61 & \$ 1.63 \\\text { Bank D } & \$ 1.58 & \$ 1.60\end{array}$ As locational arbitrage occurs:

Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:

Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso's forward will .