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Exam 7: International Arbitrage and Interest Rate Parity

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Question 1

True/False

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

A) True
B) False

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Question 2

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National Bank quotes the following for the British pound and the New Zealand dollar: $\begin{array}{lll} & \underline{\text { Quoted Bid Price}} & \underline{\text {Quoted Ask Price}} \\\text { Value of a British pound (£) in \$ } & \$ 1.61 & \$ 1.62 \\\text { Value of a New Zealand dollar (NZS) in \(\$\) } & \$ .55 & \$ .56\\\text {Value of a British pound in} & & \\\text { New Zealand dollars } & NZ\$2.95 & NZ\$ 2.96\\\end{array}$ Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy?

A) $77.64.
B) $197.53.
C) $15.43.
D) $111.80.

E) B) and C)
F) All of the above

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Question 3

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Assume the following information: You have $900,000 to invest: $\begin{array}{l}\text { You have } \$ 900,000 \text { to invest: }\\\begin{array} { l l l } \text { Current spot rate of Australian dollar (AS) } & = & \$ .62 \\\text { 180-day forward rate of the Australian dollar } & = & \$ .64 \\\text { 180-day interest rate in the U.S. } & = & 3.5 \% \\\text { 180-day interest rate in Australia } & = & 3.0 \%\end{array}\end{array}$ If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days?

Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in Mexico at 14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur?

Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.

Forward rates are driven by the government rather than market forces.

Which of the following is an example of triangular arbitrage initiation?

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.

If interest rate parity exists, then ____ is not feasible.

National Bank quotes the following for the British pound and the New Zealand dollar: $\begin{array}{ll}&\text { Quoted Bid Price } & \text {Quoted Ask Price } \\\text {Value of a British pound (£) in \$ } & \text { \$ 1.61 }&\text { \$1.62 } \\\text {Value of a New Zealand dollar (NZ\$) in \(\$\) } &\text { \$ .55 }&\text { \$ 0.56 } \\\text {Value of a British pound in } && \\\text {New Zealand dollars } &\text NZ\$2.95&\text NZ\$2.96 \\\end{array}$ Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy?

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

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?

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:

Hewitt Bank quotes a value for the Japanese yen (¥) of $0.007, and a value for the Canadian Dollar (C$) of $0.821. The cross exchange rate quoted by the bank for the Canadian dollar is ¥118.00. You have $5,000 to conduct triangular arbitrage. How much will you end up with if you conduct triangular arbitrage?

Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in forward contracts.

Assume the following information: $\begin{array} { l l r } \text { Current spot rate of New Zealand dollar } & = & \$ .41 \\\text { Forecasted spot rate of New Zealand dollar 1 year from now } & = & \$ .43 \\\text { One-year forward rate of the New Zealand dollar } & = & \$ .42 \\\text { Annual interest rate on New Zealand dollars } & = & 8 \% \\\text { Annual interest rate on U.S. dollars } & = & 9 \%\end{array}$ Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____%.

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?

Exhibit 7-1 Assume the following information: You have $300,000 to invest: The spot bid rate for the euro (€) is $1.08 The spot ask quote for the euro is $1.10 The 180-day forward rate (bid) of the euro is $1.08 The 180-day forward rate (ask) of the euro is $1.10 The 180-day interest rate in the U.S. is 6% The 180-day interest rate in Europe is 8% -Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what amount will you have after 180 days?

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?

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 ____.