Midterm 2 Flashcards
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?
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.
d) upward pressure on the Swiss franc’s forward rate.
Assume the following information for a bank quoting on spot exchange rates:
Exchange rate of Singapore dollar in U.S. $ = $0.32
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?
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.
Assume the British pound is worth $1.60, and the Canadian dollar is worth $0.80. What is the value of the Canadian dollar in pounds?
a) 2.0
b) 2.40
c) 0.80
d) 0.50
e) none of these
D) 0.50
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 = $0.62
Spot rate of Swiss franc= $0.60
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.
SOLUTION:$1,000,000/$.60 = SF 1,666,667 (1+0.10) = SF 1,833,333 $.62 = $1,136,667 Yield = ($1,136,667 $1,000,000)/$1,000,000 = 13.7%
This yield exceeds what is possible domestically
Answer: B
Bank A quotes a bid rate of $0.300 and an ask rate of $0.305 for the Malaysian ringgit (MYR). Bank B quotes a bid rate of $0.306 and an ask rate of $0.310 for the ringgit. What will be the profit for an investor that has $500,000 available to conduct locational arbitrage?
Purchasing MYR= $500,000/0.305 = 1,639,344.262.
Transaction with Bank B:
Selling MYR = 1,639,344.62*0.306 = 501,639.34
Profit = 501,639.34 - 500,000
Profit- $1,639.24
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.
True or False
True
Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.
True or False
False
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.
True or False
True
The interest rate on pounds in the U.K. is 8%. The interest rate in the U.S. is 5%. interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.
True or False?
True
Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount.
True or False?
True
