Chapter 07: International Arbitrage and Interest Rate Parity
1. Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and
the forward premium (or discount) on the forward exchange rate between the two currencies
a.
forward realignment arbitrage
b.
triangular arbitrage
c.
covered interest arbitrage
d.
locational arbitrage
2. Due to ____, market forces should realign the spot rate of a currency among banks.
a.
forward realignment arbitrage
b.
triangular arbitrage
c.
covered interest arbitrage
d.
locational arbitrage
3. Due to ____, market forces should realign the cross exchange rate between two foreign currencies based on the spot
exchange rates of the two currencies against the U.S. dollar.
a.
forward realignment arbitrage
b.
triangular arbitrage
c.
covered interest arbitrage
d.
locational arbitrage
4. If interest rate parity exists, then ____ is not feasible.
a.
forward realignment arbitrage
b.
triangular arbitrage
c.
covered interest arbitrage
d.
locational arbitrage
5. In which case will locational arbitrage most likely be feasible?
a.
One bank’s ask price for a currency is greater than another bank’s bid price for the currency.
b.
One bank’s bid price for a currency is greater than another bank’s ask price for the currency.
c.
One bank’s ask price for a currency is less than another bank’s ask price for the currency.
d.
One bank’s bid price for a currency is less than another bank’s bid price for the currency.
6. When using ____, funds are not tied up for any length of time
a.
b.
c.
d.
7. When using ____, funds are typically tied up for a significant period of time
a.
b.
c.
d.
8. Assume that the interest rate in the home country of Currency X is much higher than the U.S. interest rate. According to
interest rate parity, the forward rate of Currency X:
a.
should exhibit a discount.
b.
should exhibit a premium.
Chapter 07: International Arbitrage and Interest Rate Parity
c.
should be zero (i.e., it should equal its spot rate).
d.
B or C
9. If the interest rate is higher in the United States than in the United Kingdom, and if the forward rate of the British
pound (in U.S. dollars) is the same as the pound’s spot rate, then:
a.
U.S. investors could possibly benefit from covered interest arbitrage.
b.
British investors could possibly benefit from covered interest arbitrage.
c.
neither U.S. nor British investors could benefit from covered interest arbitrage.
d.
A and B
10. If the interest rate is lower in the United States than in the United Kingdom, and if the forward rate of the British
pound is the same as its spot rate:
a.
U.S. investors could possibly benefit from covered interest arbitrage
b.
British investors could possibly benefit from covered interest arbitrage.
c.
neither U.S. nor British investors could benefit from covered interest arbitrage.
d.
A and B
11. Assume that U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of
the following forces should result from this covered interest arbitrage activity?
a.
downward pressure on the euro’s spot rate
b.
downward pressure on the euro’s forward rate
c.
downward pressure on the U.S. interest rate
d.
upward pressure on the euro’s interest rate
12. Assume that Swiss investors are benefiting from covered interest arbitrage due to a high U.S. interest rate. Which of
the following forces results from this covered interest arbitrage activity?
a.
upward pressure on the Swiss franc’s spot rate
b.
upward pressure on the U.S. interest rate
c.
downward pressure on the Swiss interest rate
d.
upward pressure on the Swiss franc’s forward rate
13. Assume that a U.S. firm can invest funds for one year in the United States at 12 percent or invest funds in Mexico at
14 percent. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to
use covered interest arbitrage, what forces should occur?
a.
Spot rate of peso increases; forward rate of peso decreases.
b.
Spot rate of peso decreases; forward rate of peso increases.
c.
Spot rate of peso decreases; forward rate of peso decreases.
d.
Spot rate of peso increases; forward rate of peso increases.
14. Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the bid rate of the
New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. Given this information, what would be your gain if you
use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000
you started with?
a.
$15,385
b.
$15,625
c.
$22,136
d.
$31,250
15. Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:
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.
16. Assume the following information:
You have $1,000,000 to invest:
Current spot rate of pound
=
$1.30
90-day forward rate of pound
=
$1.28
3-month deposit rate in United States
=
3%
3-month deposit rate in Great Britain
=
4%
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?
a.
$1,024,000.
b.
$1,030,000.
c.
$1,040,000.
d.
$1,034,000.
e.
none of the above
17. Assume that the U.S. interest rate is 10 percent, while the British interest rate is 15 percent. If interest rate parity
exists, then:
a.
British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest
in the United States.
b.
U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would
earn in the United States.
c.
U.S. investors will earn 15 percent whether they use covered interest arbitrage or invest in the United States.
d.
U.S. investors will earn 10 percent whether they use covered interest arbitrage or invest in the United States.
18. Assume the following information:
Current spot rate of New Zealand dollar
=
$.41
Forecasted spot rate of New Zealand dollar 1 year from now
=
$.43
One-year forward rate of the New Zealand dollar
=
$.42
Annual interest rate on New Zealand dollars
=
8%
Annual interest rate on U.S. dollars
=
9%
Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest
is ____ percent.
a.
about 11.97
b.
about 9.63
c.
about 11.12
d.
about 11.64
e.
about 10.63
19. Assume the following bid and ask rates of the pound for two banks as shown below:
Bid
Ask
Bank A
$1.41
$1.42
Bank B
$1.39
$1.40
As locational arbitrage occurs:
a.
the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will increase.
b.
the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will decrease.
c.
the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will decrease.
d.
the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will increase.
20. Assume the bid rate of a Singapore dollar is $.40 while the ask rate is $.41 at Bank X. Assume the bid rate of a
Singapore dollar is $.42 while the ask rate is $.425 at Bank Z. Given this information, what would be your gain if you use
$1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you
Chapter 07: International Arbitrage and Interest Rate Parity
started with?
a.
$11,764.
b.
−$11,964.
c.
$36,585.
d.
$24,390.
e.
$18,219.
21. Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:
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.
22. Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this information, as you
and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar
should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____.
a.
appreciate; depreciate
b.
depreciate; appreciate
c.
depreciate; depreciate
d.
appreciate; appreciate
e.
remain stable; appreciate
23. Assume the following information:
Spot rate today of Swiss franc
=
$.60
1-year forward rate as of today for Swiss franc
=
$.63
Expected spot rate 1 year from now
=
$.64
Chapter 07: International Arbitrage and Interest Rate Parity
Rate on 1-year deposits denominated in Swiss francs
=
7%
Rate on 1-year deposits denominated in U.S. dollars
=
9%
From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of ____
percent.
a.
5.00
b.
12.35
c.
15.50
d.
14.13
e.
11.22
24. Assume the following information for a bank quoting on spot exchange rates:
Exchange rate of Singapore dollar in U.S $
=
$.32
Exchange rate of pound in U.S.$
=
$1.50
Exchange rate of pound in Singapore dollars
=
S$4.50
Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot
exchange rates?
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
25. Assume the British pound is worth $1.60, and the Canadian dollar is worth $.80. What is the value of the Canadian
dollar in pounds?
a.
2.0.
b.
2.40.
Chapter 07: International Arbitrage and Interest Rate Parity
c.
.80.
d.
.50.
e.
none of the above
$.80/$1.60 = 0.50
26. Assume that the euro’s interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the
following is true?
a.
Americans using covered interest arbitrage earn the same rate of return as Germans who attempt covered
interest arbitrage.
b.
Americans who invest in the United States earn the same rate of return as Germans who attempt covered
interest arbitrage.
c.
Americans who invest in the United States earn the same rate of return as Germans who invest in Germany
d.
A and B
e.
None of the above
27. Assume the U.S. interest rate is 2 percentage points higher than the Swiss rate, and the forward rate of the Swiss franc
has a 4 percent premium. Given this information:
a.
Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in
Switzerland.
b.
U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the
United States.
c.
A and B
d.
none of the above
28. Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered
interest arbitrage puts ____ pressure on the pound’s spot rate and ____ pressure on the pound’s forward rate.
a.
downward; downward
Chapter 07: International Arbitrage and Interest Rate Parity
b.
downward; upward
c.
upward; downward
d.
upward; upward
29. Assume that interest rate parity holds, and the euro’s interest rate is 9 percent while the U.S. interest rate is 12 percent.
Then the euro’s interest rate increases to 11 percent while the U.S. interest rate remains the same. As a result of the
increase in the interest rate on euros, the euro‘s forward ____ will ____ in order to maintain interest rate parity.
a.
discount; increase
b.
discount; decrease
c.
premium; increase
d.
premium; decrease
30. Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate of the Swiss
franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would be your gain if you use
$1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you
started with?
a.
$7,067
b.
$8,556
c.
$10,114
d.
$12,238
31. Assume the following information:
You have $1,000,000 to invest:
Current spot rate of pound
=
$1.60
90-day forward rate of pound
=
$1.57
3-month deposit rate in U.S.
=
3%
3-month deposit rate in U.K.
=
4%
Chapter 07: International Arbitrage and Interest Rate Parity
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?
a.
$1,020,500
b.
$1,045,600
c.
$1,073,330
d.
$1,094,230
e.
$1,116,250
32. Assume the following information:
U.S. investors have $1,000,000 to invest:
1-year deposit rate offered by U.S. banks
=
12%
1-year deposit rate offered on Swiss francs
=
10%
1-year forward rate of Swiss francs
=
$.62
Spot rate of Swiss franc
=
$.60
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.
This yield exceeds what is possible domestically.
33. Assume the following information:
Current spot rate of Australian dollar
=
$.64
Forecasted spot rate of Australian dollar 1 year from now
=
$.59
1-year forward rate of Australian dollar
=
$.62
Annual interest rate for Australian dollar deposit
=
9%
Chapter 07: International Arbitrage and Interest Rate Parity
Annual interest rate in the United States
=
6%
Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest
is ____percent.
a.
about 6.00
b.
about 9.00
c.
about 7.33
d.
about 8.14
e.
about 5.59
34. Assume the following bid and ask rates of the pound for two banks as shown below:
Bid
Ask
Bank C
$1.61
$1.63
Bank D
$1.58
$1.60
As locational arbitrage occurs:
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.
35. Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume the bid rate of an
Australian dollar is $.62 while the ask rate is $.625 at Bank V. Given this information, what would be your gain if you use
$1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you
started with?
a.
$10,003
b.
$12,063
c.
$14,441
d.
$16,393
e.
$18,219
36. Assume the following information for a bank quoting on spot exchange rates:
Exchange rate of Singapore dollar in U.S $
=
$.60
Exchange rate of pound in U.S.$
=
$1.50
Exchange rate of pound in Singapore dollars
=
S$2.6
Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot
exchange rates?
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
37. Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian ringgit (MYR). Bank B quotes a bid rate
of $.306 and an ask rate of $.310 for the ringgit. What will be the profit for an investor who has $500,000 available to
conduct locational arbitrage?
a.
$2,041,667
b.
$9,804
c.
$500
d.
$1,639
38. Which of the following is an example of triangular arbitrage initiation?
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 $.55) that has quoted the South African rand
(SAR)/Singapore dollar (S$) exchange rate at SAR2.50 when the spot rate for the rand is $.20
c.
buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand/Singapore dollar
exchange rate at SAR3.00 when the spot rate for the rand is $.20
d.
converting funds to a foreign currency and investing the funds overseas
39. You just received a gift from a friend consisting of 1,000 Thai baht, which you would like to exchange for Australian
dollars (A$). You observe that exchange rate quotes for the baht are currently $.023, while quotes for the Australian dollar
are $.576. How many Australian dollars should you expect to receive for your baht?
a.
A$39.93
b.
A$25,043.48
c.
A$553.00
d.
none of the above
40. National Bank quotes the following for the British pound and the New Zealand dollar:
Quoted Bid Price
Quoted Ask Price
Value of a British pound (£) in $
$1.61
$1.62
Value of a New Zealand dollar (NZ$) in $
$.55
$.56
Value of a British pound in
New Zealand dollars
NZ$2.95
NZ$2.96
Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy?
a.
$77.64
b.
$197.53
c.
$15.43
d.
$111.80
41. Assume the following information:
You have $900,000 to invest:
Current spot rate of Australian dollar (A$)
=
$.62
180-day forward rate of the Australian dollar
=
$.64
180-day interest rate in the United States
=
3.5%
180-day interest rate in Australia
=
3.0%
If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days?
a.
$56,903
b.
$61,548
c.
$27,000
d.
$31,500
Assume the following information:
You have $300,000 to invest:
The spot bid quote for the euro (€) is $1.08
The spot ask quote for the euro is $1.10
The 180-day forward rate (bid) of the euro is $1.08
The 180-day forward rate (ask) of the euro is $1.10
The 180-day interest rate in the United States is 6%
The 180-day interest rate in Europe is 8%
42. Refer to Exhibit 7-1 above. If you conduct covered interest arbitrage, what amount will you have after 180 days?
a.
$318,109.10
b.
$330,000.00
c.
$312,218.20
d.
$323,888.90
e.
none of the above
= $10,015.43.
Thus, the profit is $15.43.