978-0134083285 Chapter 16 Part 2

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46) Buying and selling in more than one market to make a riskless profit is called

A) profit-maximization.

B) arbitrage.

C) international trading.

D) cannot be determined from the above information

Keywords: Arbitrage

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

47) Which of the following is true?

A) The forward rate is the same as the spot rate that will prevail in the future.

B) The future spot rate is equal to the forward rate less the current spot rate.

C) The actual spot rate that will prevail in the future is not known today.

D) The future spot rate is the current spot rate increased by the inflation rate.

Keywords: Forward Rate, Spot Rate

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

48) Forward rates are all of the following EXCEPT

A) quoted in both direct and indirect form.

B) quoted at a premium or discount.

C) beneficial to risk-reduction.

D) equal to future spot rates.

Keywords: Forward Rates

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

49) Which of the following is true regarding the correct price of the forward contract?

A) If the quote is less than the computed price, the forward contract is undervalued.

B) If the quote is greater than the computed price, the forward contract is overvalued.

C) Both A and B

D) Neither A nor B

Keywords: Forward Contracts

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

50) If you are an importer of goods and you need to make payment for the purchase of inventory before

the close of business today, which of the below is the correct term for the exchange rate that you will use?

A) indirect rate

B) spot rate

C) direct rate

D) forward rate

Keywords: Spot Rate

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

51) If you are an importer of goods and you will make payment for the purchase of inventory on 90–day

terms, which of the below is the correct term for the exchange rate that you will use?

A) indirect rate

B) spot rate

C) direct rate

D) forward rate

Keywords: Forward Rates

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

52) WSM Wine Importers, Inc. purchased 75,000 cases of French wine at a cost of 6,000,000 euros. If the

current exchange rate is 0.7576 euros to the U.S. dollar, what is the purchase price of the wine in U.S.

dollars?

A) $9,684,148

B) $9,328,651

C) $8,350,012

D) $ 7,919,747

Keywords: Exchange Rates

Learning Obj.: L.O. 16.2

AACSB: Analytical Thinking

53) Assume that the British pound is worth 1.6242 U.S. dollars. If a new Jaguar costs $138,000, what is the

cost in British pounds?

A) 201,000

B) 84,965

C) 71,642

D) 119,998

Keywords: Exchange Rates

Learning Obj.: L.O. 16.2

AACSB: Analytical Thinking

54) If the exchange rate quotes in two different countries were out of line with each other, an enterprising

trader could make a profit by buying in the market where the currency was cheaper and simultaneously

selling it in the market where the currency was more expensive. Such a person would be known as a(n)

A) spot trader.

B) arbitrageur.

C) cross trader.

D) capitalist.

Keywords: Arbitrageur

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

55) Why do currency exchange rates throughout the world trade within a very narrow range on any

given day?

A) because of purchasing power parity

B) because of the international translation effect

C) because of arbitrage

D) because of the law of one price

Keywords: Arbitrage

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

56) You purchased 3,000,000 Indian rupees in London at an exchange rate of 54.86 to the dollar and

simultaneously sold the rupees in Bahrain at an exchange rate of 55.12 to the dollar. What is the name for

such a transaction?

A) trend trading

B) arbitrage

C) currency swapping

D) exchange rate hedging

Keywords: Arbitrage

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

57) A forward exchange contract

A) gives the owner the right, but not the obligation, to buy a foreign currency at a fixed exchange rate for

a fixed period of time.

B) gives the owner the right to purchase a foreign currency at some point in the future and any gains or

losses are credited/debited to the account at the close of business each day.

C) requires delivery, at a specified future date, of one currency for a specified amount of another

currency.

D) requires delivery, within two working days, of one currency for a specified amount of another

currency.

Keywords: Forward Exchange Contract

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

58) The current direct quote in New York is .01075 dollars per yen. Suppose the current direct quote in

Tokyo is 91 yen per dollar. What is the appropriate indirect quote in New York? What will arbitrageurs

do to eliminate the differential rates in these markets?

Keywords: Arbitrage, Direct Quote, Indirect Quote

Learning Obj.: L.O. 16.2

AACSB: Analytical Thinking

59) What is arbitrage? Assume that the dollar is quoted $1 = £0.625 in New York and the pound sterling is

quoted as £1 = $1.63 in London. Is there an arbitrage opportunity? If so, what would an astute trader do?

What will happen to the quotes as trades are made at current prices?

Keywords: Arbitrage

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

60) What is a spot transaction? What is a direct quote? An indirect quote?

Keywords: Spot Transaction

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

61) Who is an arbitrageur? How does an arbitrageur make money?

Keywords: Arbitrageur

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

62) What is a forward exchange rate?

Keywords: Forward Rate, Spot Rate

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

63) Describe exchange rate risk in direct foreign investment.

Keywords: Direct Foreign Investment, Political Risk Exchange Rate Risk

Learning Obj.: L.O. 16.2

AACSB: Reflective Thinking

Learning Objective 16.3

1) Interest rate parity theory states that the forward premium or discount should be equal and opposite in

sign to the difference in the national interest rates for securities of the same maturity.

Keywords: Interest Rate Parity Theory

Learning Obj.: L.O. 16.3

AACSB: Reflective Thinking

2) Interest Rate Parity theory states that interest rates must be the same in all countries using floating

exchange rates or else international markets will not be in equilibrium.

Keywords: Interest Rate Parity

Learning Obj.: L.O. 16.3

AACSB: Reflective Thinking

3) Suppose the 360-day forward exchange rate is 1.657 dollars per British pound, and the current spot rate

is 1.625 dollars per British pound. If the 360-day interest rate in the United States is 5% and the 360-day

interest rate in Great Britain is 3%, is the market in equilibrium according to the interest rate parity

theory?

A) Yes, because the forward premium on the pound (2%) is exactly offset by the lower interest rate in

Great Britain.

B) No, because the higher interest rate in the United States (2%) implies that the forward exchange rate

should be 2% lower than the current spot rate.

C) No, because the forward premium on the pound is 2% while the interest rate in the United States is

67% higher than the interest rate in Great Britain.

D) Cannot be determined without knowing the amount of money being exchanged.

Keywords: Interest Rate Parity Theory

Learning Obj.: L.O. 16.3

AACSB: Analytical Thinking

4) Money-market hedges and forward-market hedges rely on the

A) interest rate parity theory.

B) purchasing power parity theory.

C) law of large numbers.

D) capital asset pricing model.

Keywords: Interest Rate Parity Theory, Money-market Hedge, Forward Market Hedge

Learning Obj.: L.O. 16.3

AACSB: Reflective Thinking

5) One theory that is useful states that the forward premium or discount should be equal and opposite in

sign to the difference in the national interest rates for securities of the same maturity. This theory is

known as

A) the forward rate theory.

B) the interest rate parity theory.

C) the exchange rate theory.

D) the covered interest arbitrage theory.

Keywords: Interest Rate Parity

Learning Obj.: L.O. 16.3

AACSB: Reflective Thinking

6) Except for the effects of small transaction costs, the forward premium or discount should be equal and

opposite in size to the difference in the national interest rates for securities of the same maturity. What is

the name of this theory?

A) the purchasing power parity theory

B) the Bobby Fisher effect

C) interest rate parity theory

D) the law of one price

Keywords: Interest Rate Parity

Learning Obj.: L.O. 16.3

AACSB: Reflective Thinking

7) The spot exchange rate in New York is 1.600 dollars per British pound. The 360-day forward exchange

rate is 1.680 dollars per pound. The one-year interest rate in Great Britain is 2% while the one-year

interest rate in the United States is 4%.

a. If the interest rate in Great Britain remains at 2%, what should the interest rate be in the United States

according to the interest rate parity theory?

b. An American investor with $40,000 decides to take advantage of the differences in rates. Ignoring

transaction costs, how can the American investor exploit the disequilibrium? Compare the amount of

money the investor will have at the end of the year if he or she invests in one-year U.S. securities versus

one-year British securities.

Keywords: Interest Rate Parity Theory

Learning Obj.: L.O. 16.3

AACSB: Analytical Thinking

8) What does the law of one price say?

Keywords: Law of One Price, Purchasing Power Parity Theory

Learning Obj.: L.O. 16.3

AACSB: Reflective Thinking

Learning Objective 16.4

1) Purchasing power parity suggests that interest rates in different countries will adjust so that each

currency will have the same purchasing power.

Keywords: Purchasing Power Parity

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

2) Argentina experienced a period of extremely high inflation relative to its trading partners and

Argentina’s currency decreased in value. This is an example of purchasing power parity theory.

Keywords: Purchasing Power Parity Theory

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

3) Exceptions to purchase power parity exist if arbitrage opportunities are limited by characteristics such

as perishability or high transportation costs.

Keywords: Purchasing Power Parity, Arbitrage

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

4) Suppose the current spot rate in New York is .0119 dollars per yen. Inflation for the coming year in the

United States is expected to be 3%, while inflation for the coming year is Japan is expected to be only 1%.

Using the purchasing power parity theory, what is the expected spot rate at the end of the year should be

A) .0110147 dollars per yen.

B) .0108159 dollars per yen.

C) .0138373 dollars per yen.

D) .0121356 dollars per yen.

Keywords: Purchasing Power Parity Theory

Learning Obj.: L.O. 16.4

AACSB: Analytical Thinking

5) A bottle of German wine costs €21 (euros) in Berlin. According to the purchasing power parity theory,

what would the bottle sell for in New York if it costs the New York company $1.25 per bottle to transport

the wine to the United States? Assume the exchange rate is $1.32 per euro.

A) $40.54

B) $28.97

C) $27.22

D) $39.50

Keywords: Purchasing Power Parity Theory, Law of One Price

Learning Obj.: L.O. 16.4

AACSB: Analytical Thinking