Quiz 2 Practice Problems

Question 1

If an identical product can be sold in two different​ markets, and no restrictions exist on the sale or transportation of the product between​ markets, the​ product’s price should be the same in both markets. This is known​ as:

Answer 1

The law of one price

Question 2

The Economist publishes annually the​ “Big Mac​ Index” by which they compare the prices of the​ McDonald’s Corporation’s Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and​ therefore, the price should be the same. If a Big Mac costs​ $2.54 in the United States and 294 yen in​ Japan, what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger​ index?

Answer 2

¥​115.75/$

Question 3

According to the Big Mac​ Index, the implied PPP exchange rate is Mexican peso​ 8.50/$1 but the actual exchange rate is peso​ 10.80/$1. Thus, at current exchange rates the peso appears to be​ ________ by​ ________.

Answer 3

undervalued; approximately 21%

Question 4

​________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.

Answer 4

Relative Purchasing Power Parity

Question 5

Exchange rate pass−through may be defined​ as:

Answer 5

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

Question 6

If a market basket of goods cost​ $100 in the U.S. and €70 in​ France, then the PPP exchange rate would be ​$.70/€.

Answer 6

False. It would be 1.43 because you divide 100 by 70 to get the correct exchange rate.

Question 7

In its approximate form the Fisher effect may be written as​ ________, where i​ = the nominal rate of​ interest, r​ = the real rate of return and π ​= the expected rate of inflation.

Answer 7

i=(r)(π)

Question 8

Assume the current U.S. dollar−British spot rate is £​0.6993/$. If the current nominal one−year interest rate in the U.S. is​ 5% and the comparable rate in Britain is​ 6%, what is the approximate forward exchange rate for 360​ days?

Answer 8

Spot rate = 0.6993

interest rate of variable currency (Britain) = 6%

interest rate of base currency (U.S) = 5%

Forward exchange rate = 0.6993 * (1+0.06) / (1+ 0.05) = 0.7060

SO the second option is correct answer is £0.7060/$

Question 9

With covered interest​ arbitrage:

Answer 9

• the arbitrageur trades in both the spot and future currency exchange markets.
• the market must be out of equilibrium.
• a​ “riskless” arbitrage opportunity exists.

Question 10

According to the International Fisher​ Effect, the forecast change in the spot rate between two countries is equal​ to:

Answer 10

the opposite sign to the difference between nominal interest rates.

Question 11

Nominal interest rates in Cyprus are​ 7%, while nominal interest rates in the U.S. are​ 5%. The spot rate for the Cyprus pound​ (CYP) is​ $1.50. According to the international Fisher effect​ (IFE), the Cyprus pound should adjust to a new level​ of:

Answer 11

0.05−0.07/1.07= ES1−$1.50/$1.50
​E(S1) =​ $1.472

Question 12

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

Answer 12

futures

Question 13

A speculator in the futures market wishing to lock in a price at which they could​ ________ a foreign currency will​ ________ a futures contract.

Answer 13

buy; buy

Question 14

What are the differences between a currency futures contract and a forward contract

Answer 14

• The futures contract is marked to market​ daily, whereas the forward contract is only due to be settled at maturity.
• A single sales commission covers both the purchase and sale of a futures​ contract, whereas there is no specific sales commission with a forward contract because banks earn a profit through the bid−ask spread.
• The counterparty to the futures participant is unknown with the clearinghouse stepping into each​ transaction, whereas the forward contract participants are in direct contact setting the forward specifications.

Question 15

Jasper Pernik is a currency speculator who enjoys​ “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥​129.87/$ and the 6−month forward rate is ¥​128.53/$. Jasper thinks the yen will move to ¥​128.00/$ in the next six months. Jasper should​ ________ at​ ________ to profit from changing currency values.

Answer 15

buy yen; the forward rate