Fin

          

          

           Name: ________________

 

           Problem

Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to $.50. The following annual interest rates apply:

 

Currency	Lending Rate	Borrowing Rate
Dollars	7.10%	7.50%
New Zealand dollar (NZ$)	6.80%	7.25%

 

Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank's forecast is correct, what will its dollar profit be from speculation over the five-day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)?

 

1.	Borrow $5 million.
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2.	Convert $5 million to NZ$: ?
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    3.	    Invest the NZ$ at an annualized rate of 6.80% over five days: ?
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4.	Convert the NZ$ back to dollars: ?
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  5.	  Repay the dollars borrowed. The repayment amount is: ?
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6.	After repaying the loan, the remaining dollar profit is: ?
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QUESTIONS

 

1. The equilibrium exchange rate of the Swiss franc is $0.90. At an exchange rate $.83:

a.	U.S. demand for Swiss francs would exceed the supply of francs for sale and there would be a shortage of francs in the foreign exchange market.
b.	U.S. demand for Swiss francs would be less than the supply of francs for sale and there would be a shortage of francs in the foreign exchange market.
c.	U.S. demand for Swiss francs would exceed the supply of francs for sale and there would be a surplus of francs in the foreign exchange market.
d.	U.S. demand for Swiss francs would be less than the supply of francs for sale and there would be a surplus of Swiss francs in the foreign exchange market.

 

 

2. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of U.S. funds to purchase its securities should ____, the outflow of its funds to purchase U.S. securities should ____, and there is ____ pressure on its currency's equilibrium value.

a.	increase; decrease; downward
b.	decrease; increase; upward
c.	increase; decrease; upward
d.	decrease; increase; downward
e.	increase; increase; upward

 

 

3. To force the value of the British pound to depreciate against the dollar, the Federal Reserve should:

a.	sell dollars for pounds in the foreign exchange market and the Bank of England should sell dollars for pounds in the foreign exchange market.
b.	sell pounds for dollars in the foreign exchange market and the Bank of England should sell dollars for pounds in the foreign exchange market.
c.	sell pounds for dollars in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market.
d.	sell dollars for pounds in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market.

 

 

4. Under a managed float exchange rate system, the Fed may attempt to stimulate the U.S. economy by ____ the dollar. Such an adjustment in the dollar's value should ____ the U.S. demand for products produced by major foreign countries.

a.	weakening; increase
b.	weakening; decrease
c.	strengthening; increase
d.	strengthening; decrease

 

 

5. The currency of Country X is pegged to the currency of Country Y. Assume that Country Y's currency depreciates against the currency of Country Z. It is likely that Country X will export ____ to Country Z and import ____ from Country Z.

a.	more; more
b.	less; less
c.	more; less
d.	less; more

 

 

6. If the Fed desires to weaken the dollar without affecting the dollar money supply, it should:

a.	exchange dollars for foreign currencies, and sell some of its existing Treasury security holdings for dollars.
b.	exchange foreign currencies for dollars, and sell some of its existing Treasury security holdings for dollars.
c.	exchange dollars for foreign currencies, and buy existing Treasury securities with dollars.
d.	exchange foreign currencies for dollars, and buy existing Treasury securities with dollars.

 

 

7. An example of indirect intervention by the Bank of Japan would be for the Bank of Japan to use interest rates to increase the value of the yen vs. the dollar.

a. True

b. False

 

 

8. A central bank may attempt to stimulate a stagnant economy by weakening the value of the currency.

a. True

b. False

 

 

9. Assume that the dollar has been consistently depreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using sterilized intervention. The Fed would

a.	buy dollars with foreign currency and simultaneously sell Treasury securities for dollars.
b.	buy dollars with foreign currency and simultaneously buy Treasury securities with dollars.
c.	sell dollars for foreign currency and simultaneously sell Treasury securities for dollars.
d.	sell dollars for foreign currency and simultaneously buy Treasury securities with dollars.
e.	none of the above

 

 

10. 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.

 

 

11. If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.

a. True

b. False

 

 

 

 

 

 

 

12. Assume the following bid and ask rates of the pound for two banks as shown below:

 

Â	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.

 

 

13. 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

 

 

14. 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?

a.	2.0.
b.	2.40.
c.	.80.
d.	.50.
e.	none of the above            Â

 

 

   15.   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.

 

 

 

16.  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

 

 

17. Assume that interest rate parity holds. U.S. interest rate is 13% and British interest rate is 10%. 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

 

 

18. The interest rate on yen is 7%. The interest rate in the U.S. is 9%. The yen's forward rate should exhibit a premium of about 2%.

a. True

b. False

 

 

19. Assume a two-country world: Country A and Country B. Which of the following is correct about purchasing power parity (PPP) as related to these two countries?

a.	If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken.
b.	If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will weaken.
c.	If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will strengthen.
d.	If Country B's inflation rate exceeds Country A's inflation rate, Country A's currency will weaken.

 

 

20. According to the IFE, if British interest rates exceed U.S. interest rates:

a.	the British pound's value will remain constant.
b.	the British pound will depreciate against the dollar.
c.	the British inflation rate will decrease.
d.	the forward rate of the British pound will contain a premium.
e.	today's forward rate of the British pound will equal today's spot rate.

 

 

 

 

 

 

 

21. According to the international Fisher effect, if U.S. investors expect a 5% rate of domestic inflation over one year, and a 2% rate of inflation in European countries that use the euro, and require a 3% real return on investments over one year, the nominal interest rate on one-year U.S. Treasury securities would be:

a.	2%.
b.	3%.
c.	2%.
d.	5%.
e.	8%.

 

 

22. Assume that U.S. and British investors require a real return of 2%. If the nominal U.S. interest rate is 15%, and the nominal British rate is 13%, then according to the IFE, the British inflation rate is expected to be about ____ the U.S. inflation rate, and the British pound is expected to ____.

a.	2 percentage points above; depreciate by about 2%
b.	3 percentage points above; depreciate by about 3%
c.	3 percentage points below; appreciate by about 3%
d.	3 percentage points below; depreciate by about 3%
e.	2 percentage points below; appreciate by about 2%

 

 

23. Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%.

a.	appreciate; 4.85
b.	depreciate; 3.11
c.	appreciate; 3.11
d.	depreciate; 4.85

 

 

24. The inflation rate in the U.S. is 3%, while the inflation rate in Japan is 10%. The current exchange rate for the Japanese yen (Â¥) is $0.0075. After supply and demand for the Japanese yen has adjusted in the manner suggested by purchasing power parity, the new exchange rate for the yen will be:

a.	$0.0076.
b.	$0.0073.
c.	$0.0070.
d.	$0.0066.

 

 

25. Which of the following is not true regarding IRP, PPP, and the IFE?

a.	IRP suggests that a currency's forward rate will differ from spot rate according to interest rate differentials.
b.	PPP suggests that a currency's spot rate will change according to inflation differentials.
c.	The IFE suggests that a currency's spot rate will change according to interest rate differentials.
d.	All of the above are true.

 

 

 

 

 

 

26. Assume that the interest rate in the home country of Currency X is a much higher interest rate 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.
c.	should be zero (i.e., it should equal its spot rate).
d.	B or C

 

27. If inflation in New Zealand suddenly increased while U.S. inflation stayed the same, there would be:

a.	an inward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for NZ$.
b.	an outward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for NZ$.
c.	an outward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for NZ$.
d.	an inward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for NZ$.

 

 

28. Assume that British corporations begin to purchase more supplies from the U.S. as a result of several labor strikes by British suppliers. This action reflects:

a.	an increased demand for British pounds.
b.	a decrease in the demand for British pounds.
c.	an increase in the supply of British pounds for sale.
d.	a decrease in the supply of British pounds for sale.

 

29. Any event that increases the U.S. demand for euros should result in a(n) ____ in the value of the euro with respect to ____, other things being equal.

a.	increase; U.S. dollar
b.	increase; nondollar currencies
c.	decrease; nondollar currencies
d.	decrease; U.S. dollar

 

 

30. An increase in U.S. inflation relative to Singapore inflation places upward pressure on the Singapore dollar.

a. True

b. False

 

 

31. The value of euro was $1.30 last week. During last week the euro depreciated by 5%. What is the value of euro today?

a.	$1.365
b.	$1.235
c.	$1.330
d.	$1.30