Exam 2 Practice Questions

Question 1

If identical products or services can be sold in two different markets and no restrictions exist on the sale or transportation of product between markets, the price should be the same in both markets. .

Answer 1

Law of one price

Question 2

A primary principle of competitive markets is that prices will ________ across markets if frictions or costs of moving the products or services between markets do not exist.

Answer 2

equalize

Question 3

The theory that the exact rate of exchange between two currencies is found by equalizing the purchasing power of the two currencies

Answer 3

Absolute purchasing power parity

Question 4

A theory that if the spot exchange rate between two countries starts in ­equilibrium, any change in the differential rate of inflation between them tends to be offset over the long run by an equal but opposite change in the spot exchange rate.

Answer 4

Relative purchasing power parity

Question 5

PPP holds well over _______ periods but poorly for __________ periods

Answer 5

long; short

Question 6

The degree to which the prices of imported and exported goods change as a result of exchange rate changes.

Answer 6

Exchange rate pass through

Question 7

From economic theory, the percentage change in the quantity demanded as a result of a one percent change in the product price

Answer 7

Price elasticity of demand

Question 8

A theory that nominal interest rates in two or more countries should be equal to the required real rate of return to investors plus compensation for the expected amount of inflation in each country.

Answer 8

Fisher effect

Question 9

A theory that the spot exchange rate should change by an amount equal to the difference in interest rates between two countries.

Answer 9

International Fisher effect

Question 10

Covered interest arbitrage moves the market ________ equilibrium because ______

Answer 10

toward; purchasing a currency on the spot market and selling in the forward market narrows the differential between the two

Question 11

The theory of ______ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs

Answer 11

Interest rate parity

Question 12

What are the contract specifications for currency futures trading on an organized exchange?

Answer 12

• size of the contract
• maturity date
• last trading day

Question 13

Under relative purchasing power parity, the future spot exchange rate is a function of the initial spot rate in equilibrium…

Answer 13

and the inflation differential

Question 14

A foreign currency _______ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price

Answer 14

futures

Question 15

The degree to which the prices of imported and exported goods change as a result of exchange rate changes

Answer 15

Exchange rate passthrough

Question 16

Assume that you are a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the euro is $1.0871/euro and the 6 month forward rate is 1.0963/euro on a standard futures contract. You think the euro will move to $1.1080/euro in the next six months. You should ________ at ________ to profit from changing currency values.

Answer 16

buy euro; the forward rate

Question 17

In a perfect capital market, no arbitrage condition implies the two returns must be _____

Answer 17

the same