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Exam 7: International Arbitrage and Interest Rate Parity

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Question 1

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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.

E) A) and D)
F) C) and D)

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Question 2

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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 these are true.

F) C) and D)
G) A) and B)

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Question 3

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Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.

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.

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?​

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?

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.

Which of the following is not mentioned in the text as a form of international arbitrage?

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.

​Assume that the U.S. interest rate is 10 percent, while the British interest rate is 15 percent. If interest rate parity exists, then:

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 ____.​

If quoted exchange rates are the same across different locations, then ____ is not feasible.

Which of the following is not true regarding covered interest arbitrage?

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?​

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.

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.

If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.

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.

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.​

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?​