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
ANSWER:   c
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   d
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

4. If interest rate parity exists, then ____ is not feasible.

  a.  forward realignment arbitrage
  b.  triangular arbitrage
  c.  covered interest arbitrage
  d.  locational arbitrage
ANSWER:   c
DIFFICULTY:   Easy
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Chapter 07: International Arbitrage and Interest Rate Parity

LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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.
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

6. When using ____, funds are not tied up for any length of time
  a.  covered interest arbitrage
  b.  locational arbitrage
  c.  triangular arbitrage
  d.  B and C
ANSWER:   d
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

7. When using ____, funds are typically tied up for a significant period of time
  a.  covered interest arbitrage
  b.  locational arbitrage
  c.  triangular arbitrage
  d.  B and C
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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.
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Chapter 07: International Arbitrage and Interest Rate Parity

  c.  should be zero (i.e., it should equal its spot rate).

  d.  B or C
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
Copyright Cengage Learning. Powered by Cognero. Page 3
Chapter 07: International Arbitrage and Interest Rate Parity

STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02

KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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.
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   a
RATIONALE:   $1,000,000/$.325 = NZ$3,076,923 ´ $.33 = $1,015,385. Thus, the profit is $15,385.
DIFFICULTY:   Challenging
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application
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Chapter 07: International Arbitrage and Interest Rate Parity
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.
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   a
RATIONALE:   $1,000,000/$1.30 = 769,231 pounds ´ (1.04) = 800,000 pounds ´ 1.28 = $1,024,000
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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.
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
Copyright Cengage Learning. Powered by Cognero. Page 5
Chapter 07: International Arbitrage and Interest Rate Parity

NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03

STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   e
RATIONALE:  
$500,000/$.41 = NZ$1,219,512 ´ (1.08)
= NZ$1,317,073 ´ .42 = $553,171
Yield = ($553,171 - $500,000)/$500,000 = 10.63%
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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.
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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
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Chapter 07: International Arbitrage and Interest Rate Parity
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?
  a.  $11,764.
  b.  -$11,964.
  c.  $36,585.
  d.  $24,390.
  e.  $18,219.
ANSWER:   d
RATIONALE:   $1,000,000/$.41 = S2,439,024 ´ $.42 = $1,024,390
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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.
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

23. Assume the following information:

Spot rate today of Swiss franc = $.60
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Chapter 07: International Arbitrage and Interest Rate Parity
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 ____
percent.
  a.  5.00
  b.  12.35
  c.  15.50
  d.  14.13
  e.  11.22
ANSWER:   b
RATIONALE:  
$1,000,000/$.60 = SF1,666,667 ´ (1.07)
= SF1,783,333 ´ $.63 = $1,123,500
Yield = ($1,123,500 - $1,000,000)/$1,000,000 = 12.35%
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   d
DIFFICULTY:   Challenging
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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?
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Chapter 07: International Arbitrage and Interest Rate Parity

  a. 
2.0.
  b. 
2.40.
  c. 
.80.
  d. 
.50.
  e. 
none of the above
ANSWER:   d
RATIONALE:   $.80/$1.60 = 0.50
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   e
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

28. Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered
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Chapter 07: International Arbitrage and Interest Rate Parity
interest arbitrage puts ____ pressure on the pound's spot rate and ____ pressure on the pound's forward rate.
  a.  downward; downward
  b.  downward; upward
  c.  upward; downward
  d.  upward; upward
ANSWER:   c
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   a
RATIONALE:   $1,000,000/$.566 = SF1,766,784 ´ $.57 = $1,007,067. Thus, the profit is $7,067.
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
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Chapter 07: International Arbitrage and Interest Rate Parity
3-month deposit rate in U.S. = 3%
3-month deposit rate in U.K. = 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.  $1,020,500
  b.  $1,045,600
  c.  $1,073,330
  d.  $1,094,230
  e.  $1,116,250
ANSWER:   a
RATIONALE:   $1,000,000/$1.60 = 625,000 pounds ´ (1.04) = 650,000 pounds ´ 1.57 = $1,020,500
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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.
ANSWER:   b
RATIONALE:   $1,000,000/$.60 = SF1,666,667 ´ (1.1) = SF1,833,333 ´ $.62 = $1,136,667
Yield = ($1,136,667 - $1,000,000)/$1,000,000 = 13.7%
This yield exceeds what is possible domestically.

DIFFICULTY:   Challenging
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

33. Assume the following information:

Current spot rate of Australian dollar = $.64
Forecasted spot rate of Australian dollar 1 year from now = $.59
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Chapter 07: International Arbitrage and Interest Rate Parity
1-year forward rate of Australian dollar = $.62
Annual interest rate for Australian dollar deposit = 9%
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
ANSWER:   e
RATIONALE:   $500,000/$.64 = A$781,250 ´ (1.09)
= A$851,563 ´ $.62 = $527,969
Yield = ($527,969 - $500,000)/$500,000 = 5.59%

DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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.
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
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Chapter 07: International Arbitrage and Interest Rate Parity

  e.  $18,219
ANSWER:   d
RATIONALE:  
$1,000,000/$.61 = A$1,639,344 ´ $.62 = $1,016,393. Thus, the profit is $16,393.
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   b
DIFFICULTY:   Challenging
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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
ANSWER:   d
RATIONALE:   $500,000/$.305 = MYR1,639,344 ´ $.306 = $501,639. Thus, the profit is $1,639.
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02

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Chapter 07: International Arbitrage and Interest Rate Parity

KEYWORDS:   Bloom's: Application

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
ANSWER:   c
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   a
RATIONALE:   $.023/$.576 ´ THB1,000 = A$39.93.
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   c

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Chapter 07: International Arbitrage and Interest Rate Parity

RATIONALE:  
$10,000/$1.62 = £6,172.84 ´ 2.95
= NZ$18,209.88 ´ $.55
= $10,015.43.
Thus, the profit is $15.43.
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   a
RATIONALE:   $900,000/$.62 = A$1,451,612 ´ (1.03) = A$1,495,161 ´ $.64 = $956,903. Thus, the profit is
$56,903.
DIFFICULTY:   Moderate
LEARNING OBJECTIVE INFM.MADU.15.07.01
S:  
NATIONAL STANDARDSUnited States - BUSPROG.INFM.MADU.15.03
:  
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
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Chapter 07: International Arbitrage and Interest Rate Parity

  d.  $323,888.90
  e.  none of the above
ANSWER:   a
RATIONALE:  
$300,000/$1.10 = €277,777.80 ´ (1.08)
= €294,444.40 ´ $1.08
= $318,109.10
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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.  7.96 percent; feasible
  b.  6.04 percent; feasible
  c.  6.04 percent; not feasible
  d.  4.07 percent; not feasible
  e.  10.00 percent; feasible
ANSWER:   b
RATIONALE:   $318,109.10/$300,000 - 1 = 6.04%. Since this rate is slightly higher than the U.S. interest rate of
6%, covered interest arbitrage is feasible.
DIFFICULTY:   Moderate
LEARNING OBJEC INFM.MADU.15.07.01
TIVES:  
NATIONAL STAND United States - BUSPROG.INFM.MADU.15.03
ARDS:  
STATE STANDAR United States - OH - DISC.INFM.MADU.15.02
DS:  
KEYWORDS:   Bloom's: Application

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.
ANSWER:   d
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
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Chapter 07: International Arbitrage and Interest Rate Parity

KEYWORDS:   Bloom's: Comprehension

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
  d.  premium; decrease
ANSWER:   c
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
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Chapter 07: International Arbitrage and Interest Rate Parity

STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02

KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03

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Chapter 07: International Arbitrage and Interest Rate Parity

STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02

KEYWORDS:   Bloom's: Knowledge

53. Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in
forward contracts
  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

56. If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.
  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge
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Chapter 07: International Arbitrage and Interest Rate Parity

57. Forward rates are driven by the government rather than market forces
  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

59. The yield curve of every country has its own unique shape
  a.  True
  b.  False
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.03
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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.

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Chapter 07: International Arbitrage and Interest Rate Parity

  d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what
is possible domestically.
ANSWER:   a
RATIONALE:   $1,000,000/$1.30 = 793,651 pounds ´ (1.135) = 900,794 ´ $1.26 = $1,100,076.
Yield: ($1,100,076 - $1,000,000)/($1,000,000) = 10%.

DIFFICULTY:   Challenging
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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.
ANSWER:   c
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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.
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Chapter 07: International Arbitrage and Interest Rate Parity

  d. covered interest arbitrage is feasible for neither domestic nor foreign investors.
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

64. Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?
  a.  transaction costs
  b.  political risk
  c.  differential tax laws
  d.  all of the above
ANSWER:   d
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   c
RATIONALE:   Exchange dollars for euros = $1,000,000/$1.4 = 714.286; exchange euros for yen =
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Chapter 07: International Arbitrage and Interest Rate Parity

714,286 ´ 140 = 100,000,000 yen. Exchange yen for dollars = 100,000,000 yen ´
$.011 = $1,100,000. Yield = ($1,100,000 - $1,000,000)/$1,000,000 = 10%

DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   b
RATIONALE:   $100,000/$.077 = 1,298,701 pesos/8.5 = A$152,788 ´ $0.67 = $102,368
Profit = $102,368 - $100,000

DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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

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Chapter 07: International Arbitrage and Interest Rate Parity

ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

71. Triangular arbitrage involves 3 transactions that must be executed at a single bank.

  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

72. Locational arbitrage is focused on capitalizing on the difference in nominal interest rates in two different locations
  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Easy
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Chapter 07: International Arbitrage and Interest Rate Parity

LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
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Chapter 07: International Arbitrage and Interest Rate Parity

NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03

STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

78. The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).
  a.  True
  b.  False
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
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Chapter 07: International Arbitrage and Interest Rate Parity

KEYWORDS:   Bloom's: Application

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
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

84. If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.
  a.  True
  b.  False
ANSWER:   b
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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Chapter 07: International Arbitrage and Interest Rate Parity
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.
ANSWER:   c
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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.
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Knowledge

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
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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
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Chapter 07: International Arbitrage and Interest Rate Parity

  c.  $6,090.13
  d.  Triangular arbitrage is not possible in this case.
ANSWER:   b
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Application

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

  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.
ANSWER:   c
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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.
ANSWER:   a
DIFFICULTY:   Easy
LEARNING OBJECTIVES:   INFM.MADU.15.07.01
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Analysis

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.
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Chapter 07: International Arbitrage and Interest Rate Parity

  d. When covered interest arbitrage is not feasible, interest rate parity must hold.
  e. All of the above are true.
ANSWER:   d
DIFFICULTY:   Moderate
LEARNING OBJECTIVES:   INFM.MADU.15.07.02
NATIONAL STANDARDS:   United States - BUSPROG.INFM.MADU.15.03
STATE STANDARDS:   United States - OH - DISC.INFM.MADU.15.02
KEYWORDS:   Bloom's: Comprehension

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