International Financial Management, 8e (Eun)
1) An arbitrage is best defined as
A) a legal condition imposed by the CFTC.
B) the act of simultaneously buying and selling the same or equivalent assets or commodities for
the purpose of making reasonable profits.
C) the act of simultaneously buying and selling the same or equivalent assets or commodities for
the purpose of making certain guaranteed profits.
D) none of the options
2) Interest Rate Parity (IRP) is best defined as
A) occurring when a government brings its domestic interest rate in line with other major financial
markets.
B) occurring when the central bank of a country brings its domestic interest rate in line with its
major trading partners.
C) an arbitrage condition that must hold when international financial markets are in equilibrium.
D) none of the options
3) When Interest Rate Parity (IRP) does not hold
A) there is usually a high degree of inflation in at least one country.
B) the financial markets are in equilibrium.
C) there are opportunities for covered interest arbitrage.
D) the financial markets are in equilibrium and there are opportunities for covered interest
arbitrage.
4) Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 5% APR in the U.S.
and 3% APR in the euro zone, what is the no-arbitrage 1-year forward rate?
A) €1.0704/$
B) $1.0704/€
C) €1.0300/$
D) $1.0300/€
5) Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 3 percent APR in
the U.S. and 5 percent APR in the euro zone, what is the no-arbitrage 1-year forward rate?
A) €1.0704/$
B) $1.0704/€
C) €1.0300/$
D) $1.0300/€
6) Suppose you observe a spot exchange rate of $2.00/£. If interest rates are 5 percent APR in the
U.S. and 2 percent APR in the U.K., what is the no-arbitrage 1-year forward rate?
A) £2.0588/$
B) $2.0588/£
C) £1.9429/$
D) $1.9429/£
7) A formal statement of IRP is
A) = .
B) = .
C) = .
D) F($ / €) – S($ / €) = – .
8) Suppose that the one-year interest rate is 5.0 percent in the United States; the spot exchange rate
is $1.20/€; and the one–year forward exchange rate is $1.16/€. What must the one-year interest rate
be in the euro zone to avoid arbitrage?
A) 5.0%
B) 6.09%
C) 8.62%
D) none of the options
9) Suppose that the one-year interest rate is 3.0 percent in Italy, the spot exchange rate is $1.20/€,
and the one-year forward exchange rate is $1.18/€. What must the one-year interest rate be in the
United States?
A) 1.2833%
B) 1.0128%
C) 4.75%
D) none of the options
10) Suppose that the one-year interest rate is 4.0 percent in Italy, the spot exchange rate is $1.60/€,
and the one-year forward exchange rate is $1.58/€. What must the one-year interest rate be in the
United States?
A) 2%
B) 2.7%
C) 5.32%
D) none of the options
11) Covered Interest Arbitrage (CIA) activities will result in
A) unstable international financial markets.
B) restoring equilibrium prices quickly.
C) a disintermediation.
D) no effect on the market.
12) Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in
Germany, and that the spot exchange rate is $1.12/€ and the one-year forward exchange rate, is
$1.16/€. Assume that an arbitrageur can borrow up to $1,000,000.
A) This is an example where interest rate parity holds.
B) This is an example of an arbitrage opportunity; interest rate parity does not hold.
C) This is an example of a Purchasing Power Parity violation and an arbitrage opportunity.
D) none of the options
13) Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six
months. You are considering the purchase of U.S. T-bills that yield 1.810 percent (that’s a six
month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate
is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. The interest rate in Japan (on an
investment of comparable risk) is 13 percent. What is your strategy?
A) Take $1m, invest in U.S. T-bills.
B) Take $1m, translate into yen at the spot, invest in Japan, and repatriate your yen earnings back
into dollars at the spot rate prevailing in six months.
C) Take $1m, translate into yen at the spot, invest in Japan, hedge with a short position in the
forward contract.
D) Take $1m, translate into yen at the forward rate, invest in Japan, hedge with a short position in
the spot contract.
14) Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in
Germany, and that the spot exchange rate is $1.60/€ and the forward exchange rate, with one-year
maturity, is $1.58/€. Assume that an arbitrager can borrow up to $1,000,000 or €625,000. If an
astute trader finds an arbitrage, what is the net cash flow in one year?
A) $238.65
B) $14,000
C) $46,207
D) $7,000
15) A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year.
The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€
= 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 =
€1.00. Show how to realize a certain profit via covered interest arbitrage.
A) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at i€ = 6%; translate proceeds
back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600.
B) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit $2,400.
C) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit €2,000.
D) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400.
Additionally, one may borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the
U.S. at i$ = 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00.
Net profit is €2,000.
16) Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in
Germany, and that the spot exchange rate is $1.12/€ and the forward exchange rate, with one-year
maturity, is $1.16/€. Assume that an arbitrager can borrow up to $1,000,000. If an astute trader
finds an arbitrage, what is the net cash flow in one year?
A) $10,690
B) $15,000
C) $46,207
D) $21,964.29
17) A U.S.-based currency dealer has good credit and can borrow $1,000,000 for one year. The
one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ =
6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 =
€1.00. Show how to realize a certain dollar profit via covered interest arbitrage.
A) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at i€ = 6%; translate proceeds
back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600.
B) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400.
C) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000.
D) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000.
Alternatively, one could borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the
U.S. at i$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00.
Net profit is $2,400.
18) An Italian currency dealer has good credit and can borrow €800,000 for one year. The one-year
interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The
spot exchange rate is $1.25 = €1.00 and the one–year forward exchange rate is $1.20 = €1.00. Show
how to realize a certain euro-denominated profit via covered interest arbitrage.
A) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at i€ = 6%; translate proceeds
back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600.
B) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400.
C) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000.
D) Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one
year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000.
Alternatively, one could borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the
U.S. at i$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00.
Net profit is $2,400.
19) Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six
months. You are considering the purchase of U.S. T-bills that yield 1.810% (that’s a six month rate,
not an annual rate) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and
the six month forward rate is $1.00 = ¥110. What must the interest rate in Japan (on an investment
of comparable risk) be before you are willing to consider investing there for six months?
A) 1.991 percent
B) 1.12 percent
C) 7.45 percent
D) −7.45 percent
20) How high does the lending rate in the euro zone have to be before an arbitrageur would not
consider borrowing dollars, trading for euro at the spot, investing in the euro zone and hedging
with a short position in the forward contract?
Bid
Ask
Borrowing
Lending
S0($/€)
$1.40 – €1.00
$1.43 – €1.00
i$
4.20% APR
4.10% APR
F360($/€)
$1.44 – €1.00
$1.49 – €1.00
i€
A) The bid-ask spreads are too wide for any profitable arbitrage when i€ > 0
B) 3.48%
C) −2.09%
D) none of the options
21) Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in
Germany, and the one-year forward exchange rate is $1.16/€. What must the spot exchange rate
be?
A) $1.1768/€
B) $1.1434/€
C) $1.12/€
D) none of the options
22) A higher U.S. interest rate (i$ ↑) relative to interest rates abroad, ceteris paribus, will result in
A) a stronger dollar.
B) a lower spot exchange rate (expressed as foreign currency per U.S. dollar).
C) a stronger dollar and a lower spot exchange rate (expressed as foreign currency per U.S. dollar).
D) none of the options
23) If the interest rate in the U.S. is i$ = 5 percent for the next year and interest rate in the U.K. is i£
= 8 percent for the next year, uncovered IRP suggests that
A) the pound is expected to depreciate against the dollar by about 3 percent.
B) the pound is expected to appreciate against the dollar by about 3 percent.
C) the dollar is expected to appreciate against the pound by about 3 percent.
D) the pound is expected to depreciate against the dollar by about 3 percent and the dollar is
expected to appreciate against the pound by about 3 percent.
24) A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year.
The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€
= 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate
arbitrage opportunities?
A) $1.2471 = €1.00
B) $1.20 = €1.00
C) $1.1547 = €1.00
D) none of the options
25) Will an arbitrageur facing the following prices be able to make money?
Borrowing
Lending
Bid
Ask
$
5%
4.5%
Spot
$1.00 = €1.00
$1.01 = €1.00
€
6%
5.5%
Forward
$0.99 = €1.00
$1.00 = €1.00
A) Yes, borrow $1,000 at 5 percent; trade for € at the ask spot rate $1.01 = €1.00; Invest €990.10 at
5.5 percent; hedge this with a forward contract on €1,044.55 at $0.99 = €1.00; receive $1.034.11.
B) Yes, borrow €1,000 at 6 percent; trade for $ at the bid spot rate $1.00 = €1.00; invest $1,000 at
4.5 percent; hedge this with a forward contract on €1,045 at $1.00 = €1.00.
C) No; the transactions costs are too high.
D) none of the options
26) If IRP fails to hold,
A) pressure from arbitrageurs should bring exchange rates and interest rates back into line.
B) it may fail to hold due to transactions costs.
C) it may be due to government-imposed capital controls.
D) all of the options
27) Although IRP tends to hold, it may not hold precisely all the time
A) due to transactions costs, like the bid-ask spread.
B) due to asymmetric information.
C) due to capital controls imposed by governments.
D) due to transactions costs, like the bid-ask spread, as well as capital controls imposed by
governments.
28) The interest rate at which the arbitrager borrows tends to be higher than the rate at which he
lends, reflecting the
A) transaction cost paradigm.
B) midpoint.
C) bid-ask spread.
D) none of the options
29) Governments sometimes restrict capital flows, inbound and/or outbound. They achieve this
objective by means of
A) jawboning.
B) imposing taxes.
C) bans on cross-border capital movements.
D) all of the options
30) Will an arbitrageur facing the following prices be able to make money?
Bid
Ask
Borrowing
Lending
S0($/€)
$1.40 – €1.00
$1.43 – €1.00
i$
4.20%APR
4.10%APR
F360($/€)
$1.44 – €1.00
$1.49 – €1.00
i€
3.65%APR
3.50%APR
A) Yes, borrow €1,000,000 at 3.65 percent; trade for $ at the bid spot rate $1.40 = €1.00; invest at
4.1 percent; hedge this with a long position in a forward contract.
B) Yes, borrow $1,000,000 at 4.2 percent; trade for € at the spot ask exchange rate $1.43 = €1.00;
invest €699,300.70 at 3.5 percent; hedge this by going SHORT in forward (agree to sell € @ BID
price of $1.44/€ in one year). Cash flow in 1 year $237.76.
C) No; the transactions costs are too high.
D) none of the options
31) If a foreign county experiences a hyperinflation,
A) its currency will depreciate against stable currencies.
B) its currency may appreciate against stable currencies.
C) its currency may be unaffected-it’s difficult to say.
D) none of the options
32) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to
prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the
one-year forward rate that should prevail?
A) €1.00 = $1.2379
B) €1.00 = $1.2623
C) €1.00 = $0.9903
D) $1.00 = €1.2623
33) Purchasing Power Parity (PPP) theory states that
A) the exchange rate between currencies of two countries should be equal to the ratio of the
countries’ price levels.
B) as the purchasing power of a currency sharply declines (due to hyperinflation) that currency
will depreciate against stable currencies.
C) the prices of standard commodity baskets in two countries are not related.
D) the exchange rate between currencies of two countries should be equal to the ratio of the
countries’ price levels, and as the purchasing power of a currency sharply declines (due to
hyperinflation) that currency will depreciate against stable currencies.
34) As of today, the spot exchange rate is €1.00 = $1.60 and the rates of inflation expected to
prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the
one-year forward rate that should prevail?
A) €1.00 = $1.6157
B) €1.6157 = $1.00
C) €1.00 = $1.5845
D) $1.00 × 1.03 = €1.60 × 1.02
35) If the annual inflation rate is 5.5 percent in the United States and 4 percent in the U.K., and the
dollar depreciated against the pound by 3 percent, then the real exchange rate, assuming that PPP
initially held, is
A) 0.07.
B) 0.9849.
C) −0.0198.
D) 4.5.
36) If the annual inflation rate is 2.5 percent in the United States and 4 percent in the U.K., and the
dollar appreciated against the pound by 1.5 percent, then the real exchange rate, assuming that PPP
initially held, is ________.
A) parity
B) 0.9710
C) −0.0198
D) 4.5
37) In view of the fact that PPP is the manifestation of the law of one price applied to a standard
commodity basket,
A) it will hold only if the prices of the constituent commodities are equalized across countries in a
given currency.
B) it will hold only if the composition of the consumption basket is the same across countries.
C) it will hold only if the prices of the constituent commodities are equalized across countries in a
given currency or if the composition of the consumption basket is the same across countries.
D) none of the options
38) Some commodities never enter into international trade. Examples include
A) nontradables.
B) haircuts.
C) housing.
D) all of the options
39) Generally unfavorable evidence on PPP suggests that
A) substantial barriers to international commodity arbitrage exist.
B) tariffs and quotas imposed on international trade can explain at least some of the evidence.
C) shipping costs can make it difficult to directly compare commodity prices.
D) all of the options
40) The price of a McDonald’s Big Mac sandwich
A) is about the same in the 120 countries that McDonalds does business in.
B) varies considerably across the world in dollar terms.
C) supports PPP.
D) none of the options.
41) The Fisher effect can be written for the United States as:
A. i$ = ρ$ + E(π$) + ρ$ × E(π$)
B. ρ$ = i$ + E(π$) + i$ × E(π$)
C. q =
D. =
A) Option A
B) Option B
C) Option C
D) Option D