Chapter 5—Currency Derivatives 1. Kalons, Inc. is a U.S.-based MNC that frequently imports raw materials from Canada. Kalons is typically invoiced for
... [Show More] these goods in Canadian dollars and is concerned that the Canadian dollar will appreciate in the near future. Which of the following is not an appropriate hedging technique under these circumstances? c. purchase Canadian dollar put options. 2. Graylon, Inc., based in Washington, exports products to a German firm and will receive payment of €200,000 in three months. On June 1, the spot rate of the euro was $1.12, and the 3-month forward rate was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell €200,000 forward in three months. The spot rate of the euro on September 1 is $1.15. Graylon will receive $____ for the euros. b. 220,000 3. The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is quoted at $1.63. The forward ____ is ____ percent. b. discount; 1.8 4. The 90-day forward rate for the euro is $1.07, while the current spot rate of the euro is $1.05. What is the annualized forward premium or discount of the euro? c. 7.6 percent premium. 5. Thornton, Inc. needs to invest five million Nepalese rupees in its Nepalese subsidiary to support local operations. Thornton would like its subsidiary to repay the rupees in one year. Thornton would like to engage in a swap transaction. Thus, Thornton would: c. convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at today's forward rate. 6. In the U.S., the typical currency futures contract is based on a currency value in terms of: b. U.S. dollars. 7. Currency futures contracts sold on an exchange: a. contain a commitment to the owner, and are standardized. 8. Currency options sold through an options exchange: d. contain a right but not a commitment to the owner, and are standardized. 9. Currency options are commonly traded through the ____ system. contact: royfields212@gmail.com c. GLOBEX 10. Forward contracts: b. contain a commitment to the owner, and can be tailored to the desire of the owner. 11. Which of the following is the most likely strategy for a U.S. firm that will be receiving Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)? b. sell a futures contract on francs. 12. Which of the following is the most unlikely strategy for a U.S. firm that will be purchasing Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)? c. sell a futures contract on francs. 13. If your firm expects the euro to substantially depreciate, it could speculate by ____ euro call options or ____ euros forward in the forward exchange market. a. selling; selling 14. When you own ____, there is no obligation on your part; however, when you own ____, there is an obligation on your part. d. put options; forward contracts 15. The greater the variability of a currency, the ____ will be the premium of a call option on this currency, and the ____ will be the premium of a put option on this currency, other things equal. b. greater; greater 16. When currency options are not standardized and traded over-the-counter, there is ____ liquidity and a ____ bid/ask spread. d. less; wider 17. The shorter the time to the expiration date for a currency, the ____ will be the premium of a call option, and the ____ will be the premium of a put option, other things equal. c. lower; lower 18. Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is: b. $1,562.50. 19. Which of the following is true? a. The futures market is primarily used by speculators while the forward market is primarily used for hedging. 20. Which of the following is true? d. none of the above 21. If you expect the euro to depreciate, it would be appropriate to ____ for speculative purposes. d. sell a euro call and buy a euro put 22. If you expect the British pound to appreciate, you could speculate by ____ pound call options or ____ pound put options. a. purchasing; selling 23. Which of the following is correct? d. The lower the exercise price relative to the spot rate, the greater the value of a currency call option, other things equal. 24. Research has found that the options market is: b. efficient after controlling for transaction costs. 25. Assume no transactions costs exist for any futures or forward contracts. The price of British pound futures with a settlement date 180 days from now will: c. be about the same as the 180-day forward rate. 26. Assume that a currency's spot and future prices are the same, and the currency's interest rate is higher than the U.S. rate. The actions of U.S. investors to lock in this higher foreign return would ____ the currency's spot rate and ____ the currency's futures price. c. put upward pressure on; put downward pressure on 27. A firm sells a currency futures contract, and then decides before the settlement date that it no longer wants to maintain such a position. It can close out its position by: a. buying an identical futures contract. 28. If the spot rate of the euro increased substantially over a one-month period, the futures price on euros would likely ____ over that same period. c. increase substantially 29. A U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if the bid is accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against exchange rate exposure by: d. buying franc call options. 30. A firm wants to use an option to hedge 12.5 million in receivables from New Zealand firms. The premium is $.03. The exercise price is $.55. If the option is exercised, what is the total amount of dollars received (after accounting for the premium paid)? d. $6,500,000. 31. If you purchase a straddle on euros, this implies that you: e. none of the above 32. The premium on a pound put option is $.03 per unit. The exercise price is $1.60. The break-even point is ____ for the buyer of the put, and ____ for the seller of the put. (Assume zero transactions costs and that the buyer and seller of the put option are speculators.) e. none of the above 33. The existing spot rate of the Canadian dollar is $.82. The premium on a Canadian dollar call option is $.04. The exercise price is $.81. The option will be exercised on the expiration date if at all. If the spot rate on the expiration date is $.87, the profit as a percent of the initial investment (the premium paid) is: c. 50 percent. 34. You purchase a call option on pounds for a premium of $.03 per unit, with an exercise price of $1.64; the option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $1.65, your net profit per unit is: b. $.02. 35. You purchase a put option on Swiss francs for a premium of $.02, with an exercise price of $.61. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $.58, your net profit per unit is: e. none of the above 36. You are a speculator who sells a call option on Swiss francs for a premium of $.06, with an exercise price of $.64. The option will not be exercised until the expiration date, if at all. If the spot rate of the Swiss franc is $.69 on the expiration date, your net profit per unit, assuming that you have to buy Swiss francs in the market to fulfill your obligation, is: c. $.01. 37. You are a speculator who sells a put option on Canadian dollars for a premium of $.03 per unit, with an exercise price of $.86. The option will not be exercised until the expiration date, if at all. If the spot rate of the Canadian dollar is $.78 on the expiration date, your net profit per unit is: e. none of the above 38. European currency options can be exercised ____; American currency options can be exercised ____. d. only on the expiration date; any time up to the expiration date 39. Macomb Corporation is a U.S. firm that invoices some of its exports in Japanese yen. If it expects the yen to weaken, it could ____ to hedge the exchange rate risk on those exports. d. sell futures contracts on yen 40. A call option on Australian dollars has a strike (exercise) price of $.56. The present exchange rate is $.59. This call option can be referred to as: a. in the money. 41. A put option on British pounds has a strike (exercise) price of $1.48. The present exchange rate is $1.55. This put option can be referred to as: b. out of the money. 42. Which of the following is not an instrument used by U.S.-based MNCs to cover their foreign currency positions? e. all of the above are instruments used to cover foreign currency positions. 43. When the futures price on euros is below the forward rate on euros for the same settlement date, astute investors may attempt to simultaneously ____ euros forward and ____ euro futures. b. buy; sell 44. When the futures price is equal to the spot rate of a given currency, and the foreign country exhibits a higher interest rate than the U.S. interest rate, astute investors may attempt to simultaneously ____ the foreign currency, invest it in the foreign country, and ____ futures in the foreign currency. c. buy; sell 45. Which of the following would result in a profit of a euro futures contract when the euro depreciates? b. sell a euro futures contract; buy a futures contract after the euro has depreciated. 46. Which of the following is not true regarding options? a. Options are traded on exchanges, never over-the-counter. 47. A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$) receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally? b. $84,000. 48. A U.S. corporation has purchased currency call options to hedge a 70,000 pound payable. The premium is $.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the total amount paid by the corporation if it acts rationally? d. $36,400. 49. Frank is an option speculator. He anticipates the Danish kroner to appreciate from its current level of $.19 to $.21. Currently, kroner call options are available with an exercise price of $.18 and a premium of $.02. Should Frank attempt to buy this option? If the future spot rate of the Danish kroner is indeed $.21, what is his profit or loss per unit? b. yes; $0.01. 50. Carl is an option writer. In anticipation of a depreciation of the British pound from its current level of $1.50 to $1.45, he has written a call option with an exercise price of $1.51 and a premium of $.02. If the spot rate at the option's maturity turns out to be $1.54, what is Carl's profit or loss per unit (assuming the buyer of the option acts rationally)? a. $0.01. 51. Johnson, Inc., a U.S.-based MNC, will need 10 million Thai baht on August 1. It is now May 1. Johnson has negotiated a non-deliverable forward contract with its bank. The reference rate is the baht's closing exchange rate (in $) quoted by Thailand's central bank in 90 days. The baht's spot rate today is $.02. If the rate quoted by Thailand's central bank on August 1 is $.022, Johnson will ____ $____. b. be paid; 20,000 52. If the observed put option premium is less than what is suggested by the put-call parity equation, astute arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying currency. b. buying; selling; buying 53. A put option premium has a lower bound that is equal to the greater of zero and the difference between the underlying ____ prices. The upper bound of a call option premium is the ____ price. c. exercise and spot; exercise 54. A call option premium has a lower bound that is equal to the greater of zero and the difference between the underlying ____ prices. The upper bound of a call option premium is the ____ price. b. spot and exercise; spot 55. Assume the spot rate of the Swiss franc is $.62 and the one-year forward rate is $.66. The forward rate exhibits a ____ of ____. d. premium; about 6.45% 56. Assume the spot rate of a currency is $.37 and the 90-day forward rate is $.36. The forward rate of this currency exhibits a ____ of ____ on an annualized basis. d. discount; 10.81% 57. Which of the following are most commonly traded on an exchange? b. futures contracts. 58. Conditional currency options are: b. options where the premiums are canceled if a trigger level is reached. 59. Which of the following is true regarding the options markets? c. Hedgers and speculators are both necessary in order for the market to be liquid. 60. The premium of a currency put option will increase if: d. none of the above 61. Which of the following is true of options? c. The buyer decides if the option will be exercised. 62. The purchase of a currency put option would be appropriate for which of the following? b. Corporations who expect to buy foreign currency to finance foreign subsidiaries. 63. If you have bought the right to sell, you are a: b. put buyer. 64. If you have a position where you might be obligated to buy Euros, you are: c. a put buyer. 65. Which of the following is true for futures, but not for forwards? d. none of the above 66. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now? d. $47,500. 67. The spot rate for the Singapore dollar is $.588. The 30-day forward rate is $.590. The forward rate contains an annualized ____ of ____%. d. premium; 4.08 103. As mentioned in the text, the most common maturities for forward rates are: a. one, three, six, and twelve months. 105. The 180-day forward rate for the euro is $1.34, while the current spot rate of the euro is $1.29. What is the annualized forward premium or discount of the euro? c. 7.75% premium 106. The annualized forward premium on the euro is 7%. What is the 90-day forward rate on the euro if the spot rate today is $1.25? a. $1.27 107. The one-year forward rate of the Japanese yen is quoted at $.013, and the spot rate of Japanese yen is quoted at $.011. The forward ____ is ____ percent. b. premium; 18.18 108. The spot rate of British pound is quoted at $1.49. The 90-day forward rate exhibits a 2% discount. What is the 90-day forward rate of the pound? d. $1.46 109. The spot rate of euro is quoted at $1.29. The annualized forward premium on the euro is 10%. What is the 30-day forward rate of the euro? b. $1.30 110. The premium on a euro call option is $.02. The exercise price is $1.32. The break-even point is ____ for the buyer of the call, and ____ for the seller of the call. (Assume zero transactions costs and that the buyer and seller of the put option are speculators.) d. $1.34; $1.34 111. If you have a position where you might be obligated to sell pounds, you are: a. a call writer. 112. If you have bought a right to buy foreign currency, you are: b. a call buyer. 113. The premium on a pound put option is $.04. The spot rate and the exercise price is $1.52. The spot rate at the time of this option expiration is expected to be $1.51. The speculators could profit by: d. writing a call option and buying a call option simultaneously. 114. A call option on Japanese yen has a strike (exercise) price of $.012. The present exchange rate is $.011. This call option can be referred to as: b. out of the money. 115. A put option on Swiss franc has a strike (exercise) price of $.92. The present exchange rate is $.89. This put option can be referred to as: a. in the money. 116. Crown Co. is expecting to receive 100,000 British pounds in one year. Crown expects the spot rate of British pound to be $1.49 in a year, so it decides to avoid exchange rate risk by hedging its receivables. The spot rate of the pound is quoted at $1.51. The strike price of put and call options are $1.54 and $1.53 respectively. The premium on both options is $.03. The one-year forward rate exhibits a 2.65% premium. Assume there are no transaction costs. What is the best possible hedging strategy and how many U.S. dollars Crown Co. will receive under this strategy? b. sell pounds forward and receive $155,000. 117. J&L Co. is a U.S.-based MNC that frequently exports computers to Italy. J&L typically invoices these goods in euros and is concerned that the euro will depreciate in the near future. Which of the following is not an appropriate technique under these circumstances? d. sell euro put options. 118. The ____ the existing spot price relative to the strike price, the ____ valuable the call options will be. a. higher; less 119. The ____ the existing spot price relative to the strike price, the ____ valuable the put options will be. d. lower; more 120. On January 1st, Madison Co. ordered raw material from Japan and agreed to pay 100 million yen for this order on April 1st. It negotiated a 3-month forward contract to obtain 100 million Japanese yen on that date at $.009. On February 1st, the Japanese firm informed Madison Co. that it won't be able to fulfill that order. The Japanese yen spot rate on February 1st is $.0087 and 2-month forward rate exhibits 3% discount. To offset its existing contract Madison Co. will negotiate a forward contract to ____ for the date of April 1st and the profit/loss generated from this transaction is a ____ U.S. dollars. b. sell yen; loss of $60,000 121. Assume that a speculator received news that makes her believe that the yen will appreciate or depreciate substantially in the near future, but she is not certain of the direction. Also assume that exercise price of call and put options are the same. The most appropriate method for speculation is ____and it may be achieved by ____. a. straddle; purchase put option and purchase call option. 122. Which of the following does not represent the risk from using forward contracts? b. if a forward contract is used to hedge receivables, and the spot exchange rate at the time of expiration of contract is lower than the contract price. 150. A forward rate for a currency is said to exhibit a discount if b. the forward rate is less than the existing spot rate. 151. If the spot rate of the British pound is $1.50, and the one-year forward rate has a discount of 3 percent, the one-year forward rate is $____. d. 1.46 152. Which of the following is not true regarding futures contracts? c. There is an active over-the-counter market for currency futures contracts. 153. When the futures price is above the forward rate, astute investors may attempt to simultaneously buy a currency forward and sell futures in that currency. These actions would place ____ pressure on the forward rate and ____ pressure on the futures rate. a. upward; downward 154. Assume that the British pound (£) futures price for September is $1.60. Given that 62,500 units are in a British pound futures contract, the seller of British pound futures will receive $____ on the delivery date. b. 100,000 155. Which of the following would result in a profit of a futures contract when the underlying currency depreciates? b. Sell a futures contract; buy a futures contract after the currency has depreciated 156. Currency futures can be used by MNCs to hedge payables. That is, an MNC would ____ futures to hedge a foreign payable position. Also, currency futures can be used for speculation. For example, a speculator expecting a currency to appreciate would ____ futures. a. buy; buy 157. Which of the following is not true regarding options? a. Options are traded on exchanges, never over-the-counter. 158. When the existing spot rate exceeds the exercise price, a call option is ____, and a put option is ____. d. in the money; out of the money 159. When a currency call option is classified as "in the money," this indicates that b. the spot rate of the currency is greater than the exercise price of the option. 160. A U.S. corporation has purchased currency call options to hedge a 70,000 pound (£) payable. The premium is $0.02 and the exercise price of the option is $0.50. If the spot rate at the time of maturity is $0.65, what is the total amount paid by the corporation if it acts rationally? d. $36,400 161. Andrea is an option speculator. She anticipates the Canadian dollar to depreciate from its current level of $0.90 to $0.85. Currently, Canadian dollar call options are available with an exercise price of $0.91 and a premium of $0.02. Also, Canadian dollar put options are available with an exercise price of $0.88 and a premium of $0.02. If the future spot rate of the Canadian dollar is $0.85, what is Andrea's profit or loss per unit? c. $0.01 162. Which of the following is not true regarding options? d. The writer of a put option has the obligation to sell the currency to the buyer if the option is exercised. 163. If the observed put option premium is less than what is suggested by the put-call parity equation, astute arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying currency. b. buying; selling; buying Chapter 6—Government Influence on Exchange Rates 1. To force the value of the pound to appreciate against the dollar, the Federal Reserve should: a. sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB) should sell dollars for pounds in the foreign exchange market. 2. A weak dollar is normally expected to cause: d. low unemployment and high inflation in the U.S. 3. A strong dollar is normally expected to cause: b. high unemployment and low inflation in the U.S. 4. To force the value of the British pound to depreciate against the dollar, the Federal Reserve should: c. sell pounds for dollars in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market. 5. Consider two countries that trade with each other, called X and Y. According to the text, inflation in Country X will have a greater impact on inflation in Country Y under the ____ system. Now, consider two other countries that trade with each other, called A and B. Unemployment in Country A will have a greater impact on unemployment in Country B under the ____ system. c. fixed rate; fixed rate 6. A primary result of the Bretton Woods Agreement was: c. establishing that exchange rates of most major currencies were to be allowed to fluctuate 1% above or below their initially set values. 7. A primary result of the Smithsonian Agreement was: b. establishing that exchange rates of most major countries were to be allowed to fluctuate 2.25% above or below their initially set values. 8. Under a fixed exchange rate system: c. central bank intervention in the foreign exchange market is often necessary. 9. Under a managed float exchange rate system, the Fed may attempt to stimulate the U.S. economy by ____ the dollar. Such an adjustment in the dollar's value should ____ the U.S. demand for products produced by major foreign countries. b. weakening; decrease 10. The value of the Canadian dollar, Japanese yen, and Australian dollar with respect to the U.S. dollar are part of a: c. managed float system. 11. The interest rate of a country with a currency board: c. will move in tandem with the interest rate of the currency to which it is tied. 12. The currency of Country X is pegged to the currency of Country Y. Assume that Country Y's currency depreciates against the currency of Country Z. It is likely that Country X will export ____ to Country Z and import ____ from Country Z. c. more; less 13. Assume Countries A, B, and C produce goods that are substitutes of each other and that these countries engage in trade with each other. Assume that Country A's currency floats against Country B's currency, and that Country C's currency is pegged to B's. If A's currency depreciates against B, then A's exports to C should ____, and A's imports from C should ____. c. increase; decrease 14. Assume a central bank exchanges its currency for other foreign currencies in the foreign exchange market, but does not adjust for the resulting change in the money supply. This is an example of: c. nonsterilized intervention. 15. If the Fed desires to weaken the dollar without affecting the dollar money supply, it should: a. exchange dollars for foreign currencies, and sell some of its existing Treasury security holdings for dollars. 16. Which of the following is an example of direct intervention in foreign exchange markets? c. exchanging dollars for foreign currency. 17. A strong dollar places ____ pressure on inflation, which in turn places ____ pressure on the dollar. b. downward; upward 18. The Fed may use a stimulative monetary policy with least concern about causing inflation if the dollar's value is expected to: b. strengthen. 19. A weaker dollar places ____ pressure on U.S. inflation, which in turn places ____ pressure on U.S. interest rates, which places ____ pressure on U.S. bond prices. c. upward; upward; downward 20. The euro is the currency: d. none of the above 21. The euro has not been adopted by: b. the U.K. 22. The exchange rate mechanism (ERM) refers to the method of linking ____ currencies to each other within boundaries. b. European 23. Countries that have adopted the euro must agree on a single ____ policy. a. monetary 24. Countries that have adopted the euro tend to have very similar ____. a. interest rates 25. The risk-free interest rates among countries that have adopted the euro should: a. not necessarily be similar to risk-free rates in other countries. 26. Which of the following is true regarding the euro? d. All of the above are true. 27. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce unemployment. Which of the following is an appropriate action given this scenario? a. Weaken the dollar 28. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce inflation. Which of the following is an appropriate action given this scenario? b. Buy dollars with foreign currency 29. To strengthen the dollar using sterilized intervention, the Fed would ____ dollars and simultaneously ____ Treasury securities. c. buy; buy 30. As foreign exchange activity has grown, a given degree of central bank intervention has become: c. less effective. 31. When using indirect intervention, a central bank is likely to focus on: b. interest rates. 32. Which of the following countries was probably the least affected (directly or indirectly) by the Asian crisis? d. China. 33. Which of the following is not true regarding Thailand? a. Thailand was one of the slowest growing countries before the Asian crisis. 34. China's yuan is presently: b. allowed to fluctuate but with central bank intervention. 35. During the period 1944-1971, the U.S. used a ____ system. b. fixed 36. Which of the following are examples of currency controls? d. all of the above 37. From a financial management perspective, which of the following is true regarding the introduction of the Euro? c. Transactions costs decline for MNCs that conduct transactions within Europe. 38. Which of the following countries have not adopted the euro? c. Switzerland 39. Which of the following are true about the Southeast Asian currency crisis? a. It was preceded by several years of large capital inflows to Asia. 72. Which one of the following is a disadvantage of a fixed exchange rate system: c. The government might change the value of the currency. 73. The Smithsonian Agreement called for a devaluation of the U.S. dollar by about ____ percent. d. 8 74. Which of the following did not occur as a result of Bretton Woods Agreement? d. The United States experienced no balance-of-trade deficits. 75. Assume that Japan and the United States frequently trade with each other. Under the freely floating exchange rate system, high inflation in the U.S. will place ____ pressure on Japanese yen, ____ the amount of Japanese yen available for sale, and result in ____ inflation in Japan. a. upward; reduce; unchanged 76. Which one is not a disadvantage of a freely floating exchange rate system? c. The government may intervene to change the value of a given currency. 77. A "dirty" float represents a system of: c. floating exchange rates, but the central bank can manipulate the currency. 80. The European Central Bank is located in: d. Frankfurt. 81. Which of the following is not true regarding the eurozone? b. Members cannot apply their own fiscal policies. 83. Which of the following is not a reason for devaluation of a currency? a. high inflation. 84. Which of the following is the most likely reason for revaluation of a currency? a. To reduce inflation. 85. To weaken the dollar using sterilized intervention, the Fed will ____ U.S. dollars and simultaneously ____ Treasury securities. b. sell; sell 87. If the Fed desires to strengthen the dollar without affecting the dollar money supply, it should: d. exchange foreign currencies for dollars, and buy existing Treasury securities with dollars. 88. Assume that the Fed intervenes by exchanging dollars for euros in the foreign exchange market. This will cause an ____ U.S. dollars and an ____ euros. c. outward shift in supply of; outward shift in demand for 89. If the Fed ____ the interest rates when inflationary expectations remain unchanged, the most likely result is that the value of dollar will ____ and the economy may ____. a. increases; appreciate; weaken 92. If a speculator expects that the Fed will intervene by exchanging dollars for Japanese yen, she would most likely ____ to capitalize on this intervention. b. sell yen futures contracts 93. If a speculator expects that the Fed will intervene by exchanging euros for U.S. dollars, she would most likely ____ to capitalize on this intervention. a. purchase euro put options 95. A strong dollar places ____ pressure on U.S. inflation, which in turn places ____ pressure on U.S. interest rates, which in turn place ____ pressure on U.S. bond prices. b. downward; downward; upward 96. The currency of Country X is pegged to the currency of Country Y. Assume that Country Y's currency appreciates against the currency of Country Z. It is likely that Country X will export ____ to Country Z and import ____ from Country Z. d. less; more 98. One of the best-known pegged exchange rate arrangements that was established by several European countries in April 1972 and was difficult to maintain is called the: b. snake agreement. 111. Which of the following is not true regarding the Mexican peso crisis? b. Many speculators based in the U.S. speculated on the potential decline in the peso by investing their funds in Mexico. 112. Which of the following is true regarding the euro? d. All of the above are true. 113. Among the reasons for government intervention are: d. all of the above 114. Which of the following is not true regarding government intervention? a. Under the direct method of intervention, an appreciation of the dollar would be accomplished by exchanging dollars for foreign currencies. 115. Assume that the dollar has been consistently depreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using sterilized intervention. The Fed would b. buy dollars with foreign currency and simultaneously buy Treasury securities with dollars. 116. Assume that the dollar has been consistently appreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using nonsterilized intervention. The Fed would e. none of the above ANS: E PTS: 1 117. Which of the following is an appropriate form of indirect intervention? c. To strengthen the dollar in the long run, the Fed attempts to reduce U.S. inflation. Chapter 7—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. c. covered interest arbitrage 2. Due to ____, market forces should realign the spot rate of a currency among banks. 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. b. triangular arbitrage 4. If interest rate parity exists, then ____ is not feasible. c. covered interest arbitrage 5. In which case will locational arbitrage most likely be feasible? b. One bank's bid price for a currency is greater than another bank's ask price for the currency. 6. When using ____, funds are not tied up for any length of time. d. B and C 7. When using ____, funds are typically tied up for a significant period of time. a. covered interest arbitrage 8. Assume that the interest rate in the home country of Currency X is a much higher interest rate than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X: a. should exhibit a discount. 9. If the interest rate is higher in the U.S. 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: b. British investors could possibly benefit from covered interest arbitrage. 10. If the interest rate is lower in the U.S. 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. 11. Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from the act of this covered interest arbitrage? b. downward pressure on the euro's forward 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 the act of this covered interest arbitrage? 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 U.S. at 12% or invest funds in Mexico at 14%. 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. 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. 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. 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 U.S. = 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. 17. Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then: d. U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S. 18. Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered on U.S. dollars = 12% 1-year deposit rate offered on Singapore dollars = 10% 1-year forward rate of Singapore dollars = $.412 Spot rate of Singapore dollar = $.400 Given this information: b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. 19. 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 ____%. e. about 10.63 20. 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: d. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will increase. 21. 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 started with? d. $24,390. 22. Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the: b. larger will be the forward premium of the foreign currency. 23. 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 24. 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 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 ____%. b. 12.35 25. 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? 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. [Show Less]