foreign exchange rate determination

Question 1

Because the spot and forward markets are not always in a

state of equilibrium as described by IRP, the opportunity for __________ profit exists

Answer 1

“risk-less” or arbitrage

Question 2

def. purchasing power parity

Answer 2

– forecasts the change in the spot rate based on differences in
expected rates of inflation

Question 3

def. fisher effect

Answer 3

nominal interest rates are the required real rate of return (r) plus expected inflation (pi)

Question 4

def. international fisher effect

Answer 4

the spot exchange rate should change in an amount equal to but in the opposite direction of the difference in interest rates between
countries

Question 5

def. interest rate parity

Answer 5

the difference in the national interest rates should be equal to, but opposite in sign to, the forward rate discount or premium for the foreign currency, except for transaction costs
• Covered: Use of forward contract, Uncovered: no forward contract

Question 6

def. forward rate as an unbiased predictor

Answer 6

the forward rate is an efficient predictor of the future spot rate