Chapter 07: International Arbitrage and Interest Rate Parity
43. Refer to Exhibit 7-1 above. If you conduct covered interest arbitrage, what is your percentage return after 180 days? Is
covered interest arbitrage feasible in this situation?
a.
b.
c.
d.
e.
rate of 6%, covered interest arbitrage is feasible.
44. According to interest rate parity (IRP):
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.
45. Assume that interest rate parity holds. The Mexican interest rate is 50 percent, and the U.S. interest rate is 8 percent.
Subsequently, the U.S. interest rate decreases to 7 percent. According to interest rate parity, the peso’s forward ____ will
____.
a.
premium; increase
b.
discount; decrease
c.
discount; increase
Chapter 07: International Arbitrage and Interest Rate Parity
d.
premium; decrease
46. 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.
a.
True
b.
False
47. For locational arbitrage to be possible, one bank’s ask rate must be higher than another bank’s bid rate for a currency
a.
True
b.
False
48. 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
a.
True
b.
False
49. Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward
exchange rate premium or discount.
a.
True
b.
False
50. The interest rate on euros is 8 percent. The interest rate in the United States is 5 percent. The euro’s forward rate
should exhibit a premium of about 3 percent
a.
True
b.
False
51. Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest
rate parity.
a.
True
b.
False
52. Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will
increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the
bid rate of the bank to which the currency was sold to conduct locational arbitrage
a.
True
b.
False
53. Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in
forward contracts
a.
True
b.
False
54. 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
a.
True
b.
False
55. 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
a.
True
b.
False
56. If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.
a.
True
b.
False
57. Forward rates are driven by the government rather than market forces
a.
True
b.
False
58. Arbitrage involves capitalizing on a discrepancy in quoted prices in an attempt to make a profit, but it entails
substantial risk.
a.
True
b.
False
59. The yield curve of every country has its own unique shape
a.
True
b.
False
60. Assume the following information:
U.S. investors have $1,000,000 to invest:
1-year deposit rate offered by U.S. banks
=
10%
1-year deposit rate offered on British pounds
=
13.5%
1-year forward rate of Swiss francs
=
$1.26
Spot rate of Swiss franc
=
$1.30
Given this information:
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.
61. If quoted exchange rates are the same across different locations, then ____ is not feasible.
a.
triangular arbitrage
b.
covered interest arbitrage
c.
locational arbitrage
d.
A and C
62. Points above the IRP line represent situations where:
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 feasible for neither domestic nor foreign investors.
63. Points below the IRP line represent situations where:
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 feasible for neither domestic nor foreign investors.
64. Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?
Chapter 07: International Arbitrage and Interest Rate Parity
a.
transaction costs
b.
political risk
c.
differential tax laws
d.
all of the above
65. Assume that interest rate parity holds. The U.S. interest rate is 13 percent and the British interest rate is 10 percent.
The forward rate on British pounds exhibits a ____ of ____ percent.
a.
discount; 2.73
b.
premium; 2.73
c.
discount; 3.65
d.
premium; 3.65
66. Assume the following information:
Exchange rate of Japanese yen in U.S.$
=
$.011
Exchange rate of euro in U.S.$
=
$1.40
Exchange rate of euro in Japanese yen
=
140 yen
What will be the yield for an investor who has $1,000,000 available to conduct triangular arbitrage?
a.
$100,000
b.
−$90,909
c.
10 percent
d.
−9.09 percent
$1,000,000)/$1,000,000 = 10%
67. Assume the following information:
Quoted Bid Price
Quoted Ask Price
Value of an Australian dollar (A$) in $
$0.67
$0.69
Value of Mexican peso in $
$.074
$.077
Value of an Australian dollar in
Mexican pesos
8.2
8.5
Assume you have $100,000 to conduct triangular arbitrage. What will be your profit from implementing this strategy?
a.
$6,133
b.
$2,368
c.
$6,518
d.
$13,711
68. The interest rate on yen is 7 percent. The interest rate in the United States is 9 percent. The yen’s forward rate should
exhibit a premium of about 2 percent.
a.
True
b.
False
69. The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent.
Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.
a.
True
b.
False
70. Assume that the real interest rate in the United States and in the United Kingdom is 3 percent. The expected annual
inflation in the United States is 3 percent, while in the United Kingdom it is 4 percent. The forward rate on the pound
should exhibit a premium of about 1 percent
Chapter 07: International Arbitrage and Interest Rate Parity
a.
True
b.
False
71. Triangular arbitrage involves 3 transactions that must be executed at a single bank.
a.
True
b.
False
72. Locational arbitrage is focused on capitalizing on the difference in nominal interest rates in two different locations
a.
True
b.
False
73. Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in
foreign exchange quotations among locations.
a.
True
b.
False
74. The yield curve for the United States normally has an upward slope, meaning that the annualized interest rate is higher
for longer terms to maturity
a.
True
b.
False
75. Locational arbitrage explains why spot exchange rates among banks at different locations normally will not differ by a
significant amount
a.
True
b.
False
76. From the U.S. perspective, an example of a cross exchange rate is the exchange rate between a non-U.S. country and
the U.S.
a.
True
b.
False
77. The word “covered” in “covered interest arbitrage” refers to the investors hedging their position to protect against the
possibility of default risk.
a.
True
b.
False
78. The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).
a.
True
b.
False
79. Interest rate parity suggests that an exchange rate should change over time based on the difference in interest rates
between foreign versus domestic risk-free interest-bearing securities as of today.
a.
True
b.
False
80. 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 United States and the foreign country.
a.
True
b.
False
81. The interest rate in South Africa is 8 percent. The interest rate in the United States is 5 percent. The South African
forward rate should exhibit a premium of about 3 percent
a.
True
b.
False
82. 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
a.
True
b.
False
83. For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S.
investor’s perspective, but is possible from a foreign investor’s perspective
a.
True
b.
False
84. If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.
a.
True
b.
False
85. 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.
a.
True
b.
False
86. Which of the following is not mentioned in the text as a form of international arbitrage?
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.
87. 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:
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.
88. 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.
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
89. Hewitt Bank quotes a value for the Japanese yen (¥) of $0.007, and a value for the Canadian dollar (C$) of $0.821.
The cross exchange rate quoted by the bank for the Canadian dollar is ¥118.00. You have $5,000 to conduct triangular
arbitrage. How much will you end up with if you conduct triangular arbitrage?
a.
$6,053.27
b.
$5,030.45
c.
$6,090.13
d.
Triangular arbitrage is not possible in this case.
90. Which of the following is not true regarding covered interest arbitrage?
Chapter 07: International Arbitrage and Interest Rate Parity
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.
91. Which of the following is not true regarding covered interest arbitrage?
a.
Covered interest arbitrage is a reason for observing interest rate parity (IRP).
b.
If the forward rate is equal to the spot rate, conducting covered interest arbitrage will yield a return that is
exactly equal to the interest rate in the foreign country.
c.
When interest rate parity holds, covered interest arbitrage is not possible.
d.
When interest rate disparity exists, covered interest arbitrage may not be profitable.
e.
All of the above are true.
92. Which of the following is not true regarding interest rate parity (IRP)?
a.
When interest rate parity holds, covered interest arbitrage is not possible.
b.
When the interest rate in the foreign country is higher than that in the home country, the forward rate of that
country’s currency should exhibit a discount.
c.
When the interest rate in the foreign country is lower than that in the home country, the forward rate of that
country’s currency should exhibit a premium.
d.
When covered interest arbitrage is not feasible, interest rate parity must hold.
e.
All of the above are true.