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6) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond
that has an annual interest rate of 5% rather than a comparable British bond that has an annual
interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at
least 1% per year over the next 5 years.
A) British pound; appreciate
B) British pound; revalue
C) U.S. dollar; appreciate
D) U.S. dollar; depreciate
7) ________ states that the spot exchange rate should change in an equal amount but in the
opposite direction to the difference in interest rates between two countries.
A) Fisher-open
B) Fisher-closed
C) The Fisher Effect
D) none of the above
8) A ________ is an exchange rate quoted today for settlement at some time in the future.
A) spot rate
B) forward rate
C) currency rate
D) yield curve
9) Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current nominal one-year
interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate
forward exchange rate for 360 days?
A) £1.42/$
B) £1.43/$
C) £0.6993/$
D) £0.7060/$
10) Assume the current U.S. dollar-yen spot rate is 90 ¥/$. Further, the current nominal 180-day
rate of return in Japan is 1% and 2% in the United States. What is the approximate forward
exchange rate for 180 days?
A) ¥89.12/$
B) ¥89.55/$
C) ¥90.89/$
D) ¥90.45/$
11) The current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange rate is 127
¥/$ then the yen is selling at a per annum ________ of ________.
A) premium; 1.57%
B) premium; 6.30%
C) discount; 1.57%
D) discount; 6.30%
12) The forward rate is calculated from all the following observable data items EXCEPT:
A) the forecast of the future spot exchange rate
B) the home currency deposit rate
C) the foreign currency deposit rate
D) the spot exchange rate
13) The theory of ________ states that the difference in the national interest rates for securities
of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or
premium for the foreign currency, except for transaction costs.
A) international Fisher Effect
B) absolute PPP
C) interest rate parity
D) the law of one price
14) With covered interest arbitrage:
A) the market must be out of equilibrium.
B) a "riskless" arbitrage opportunity exists.
C) the arbitrageur trades in both the spot and future currency exchange markets.
D) all of the above
15) Arbitragers applying Covered Interest Arbitrage drive the international currency and money
markets toward the equilibrium described by:
A) the effective exchange rate index.
B) the purchasing power parity.
C) the nominal effective exchange rate index.
D) the interest rate parity.
16) Covered interest arbitrage moves the market ________ equilibrium because ________.
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
17) The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of
return and π = the expected rate of inflation, is often dropped from the equation because the
number is simply too large for most Western economies.
18) Empirical studies show that the Fisher Effect works best for short-term securities.
19) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is
¥127/$ then the yen is at a forward premium.
20) The premium or discount on forward currency exchange rates between any two countries is
visually obvious when you plot the interest rates of each country on the same yield curve. The
currency of the country with the higher yield curve should be selling at a forward discount.
21) Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-
free one-year U.S. security with an annual return of 4%, and a comparable British security with a
return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction
costs, the investor should invest in the U.S. security.
22) Both covered and uncovered interest arbitrage are risky operations in the sense that even
without default in the securities, the returns are unknown until all transactions are complete.
23) All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.
24) COVERED interest arbitrage (CIA), is where investors borrow in countries and currencies
exhibiting relatively low interest rates and convert the proceeds into currencies that offer much
higher interest rates. The transaction is "covered," because the investor does not sell the higher
yielding currency proceeds forward.
25) The authors describe an application of uncovered interest arbitrage (UIA) known as "yen
carry trade." Define UIA and describe the example of yen carry trade. Why would an investor
engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this
investment strategy?
26) 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.
6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
1) If the forward rate is an unbiased predictor of the expected spot rate, which of the following is
NOT true?
A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2
delivery, available now.
B) The distribution of possible actual spot rates in the future is centered on the forward rate.
C) The future spot rate will actually be equal to what the forward rate predicts.
D) All of the above are true.
2) Which of the following is NOT an assumption of market efficiency?
A) Instruments denominated in other currencies are perfect substitutes for one another.
B) Transaction costs are low or nonexistent.
C) All relevant information is quickly reflected in both spot and forward exchange markets.
D) All of the above are true.
3) Empirical tests have yielded ________ evidence about market efficiency with a general
consensus that developing foreign markets are ________.
A) conflicting; not efficient
B) conflicting; efficient
C) consistent; inefficient
D) none of the above
4) If exchange markets were not efficient, it would pay for a firm to spend resources on
forecasting exchange rates.
5) If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates
will always be equal to current forward rates.
6) If exchange markets were efficient, the deviation of the actual future quote and today's
forward rate will be zero.
7) 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.
Explain the rationale of this statement including the assumptions made, the meaning of
"efficient" and "unbiased", and the empirical evidence.
6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium
1) According to the International Fisher Effect, the forecast change in the spot rate between two
countries is equal to:
A) the current spot rate multiplied by the ratio of the inflation rates in the respective countries.
B) but the opposite sign to the difference between nominal interest rates.
C) but the opposite sign to the difference between inflation rates.
D) but the opposite sign to the difference between real interest rates.
2) In their approximate form, PPP, IRP, and forward rates as an unbiased predictor of the future
spot rate lead to similar forecasts of the future spot rate.
