Deck 6: Interest Rate Parity

Question 1

The term covered means the investment is ________ transaction foreign exchange risk.

A) hedged against
B) exposed to
C) completely free from
D) structured to activate forward contracts that free it from

Answer 1

A

Question 2

The difference between the interest rate that a bank charges on its loans and the interest rate that the banks pay their depositors is known as the

A) percent spread.
B) arbitrage opportunity.
C) bid-ask spread.
D) covered interest arbitrage opportunity.

Answer 2

C

Question 3

When there are no intervening cash flows between the time a deposit is made and the maturity of the deposit,the interest rates are said to be ________.

A) discount rate
B) compound interest rate
C) covered interest rate
D) spot interest rates

Answer 3

D

Question 4

When the forward premium or discount on the foreign currency equals the interest differential between the domestic and foreign interest rates divided by one plus the foreign interest rate,what is being satisfied?

A) covered interest arbitrage
B) interest rate parity
C) domestic and foreign interest rates
D) spot and forward exchange rates

Question 5

A bond that promises to pay the owner a single payment denominated in euros or pounds is known as a ________ bond.

A) debenture
B) variable interest rate
C) pure discount
D) foreign

Question 6

Which one of the following is NOT a reason for using hedges such as a synthetic forward?

A) In some currency markets, forward contracts may not be available, but they can be manufactured using a money market hedge.
B) Individual companies are not able to borrow and lend at the interest rates available in the interbank market.
C) When time horizons are long, forward contracts can be expensive as the bid-ask spread widens substantially.
D) It may be unfavorable to consider borrowing and lending to hedge one's currency risk.

Question 7

What is the name of the interbank interest rate used in external currency markets that is the most important and used in various cities globally in contractual loan agreements?

A) the fed funds rate
B) twelfth district interest rate
C) LIBOR
D) the U.S. prime rate

Question 8

If interest rate parity is in effect,there are ________.

A) no profitable opportunities for covered interest arbitrage
B) many opportunities for covered interest arbitrage
C) currency dealers will arbitrage interest rate differentials in different countries
D) currency dealers will be motivated to arbitrage forward market contracts

Question 9

If the underlying transaction gives you a liability,denominated in foreign currency,the general principal behind a money market hedge states you need an equivalent ________ in the money market to provide a hedge.

A) liability
B) asset
C) forward contract
D) foreign bank account

Question 10

When the possibility exists that the government of a nation may impose some form of exchange controls or tax on foreign investment,the risk is known as ________ risk.

A) political
B) exchange controls
C) business risk
D) government

Question 11

Interbank interest rates in various cities around the world are often the basis for interest rates in contractual loan agreements.What is the most important of these rates?

A) London Interbank Offer Rate (LIBOR)
B) Frankfurt Interbank Offer Rate (FIBOR)
C) Hong Kong Interbank Offer Rate (HIBOR)
D) Euro Interbank Offer Rate (EURIBOR)

Question 12

An example of an external currency market that was the first to form was the market where the dollar-denominated deposits were known as

A) Euros.
B) Eurodollars.
C) petrodollars.
D) exchange traded funds.

Question 13

What is the name for the bank market for deposits and loans that is denominated in a currency different to the currency of the country in which a bank is operating?

A) internal currency market
B) foreign exchange market
C) external currency market
D) interbank market

Question 14

Which one of the following would be the most logical reason to use a synthetic forward contract to hedge?

A) forward contracts are not available in the currency of choice
B) when time horizons are short, forward contracts can be expensive
C) the underlying transaction is too risky
D) the underlying transaction gives you an asset

Question 15

When one of the counterparties to an agreement globally may possibly fail to honor its contract,it is known as ________ risk.

A) interest rate
B) business
C) transaction
D) default

Question 16

If interest rate parity is satisfied,there are no opportunities for covered interest arbitrage.What does this imply about the relationship between spot and forward exchange rates when the foreign currency money market investment offers a higher return than the domestic money market investment?

Question 17

Identify an external currency market and how it operates?

Question 18

When it is said that there exists covered interest arbitrage opportunities,the term covered means the arbitrage is not exposed to

A) exchange rate risk.
B) manipulation by speculators.
C) central bank interventions.
D) government actions against the arbitrageurs.

Question 19

The empirical evidence indicates that interest rate parity is the norm,especially during periods of financial market ________.

A) arbitrage
B) turbulence
C) profit-taking
D) tranquility

Question 20

When parity conditions are not in effect in currency and money markets,traders could make extraordinary profits from a practice known as ________.

A) covered interest rate parity
B) covered interest rate arbitrage
C) triangular arbitrage
D) forward market arbitrage

Question 21

Given an example of how a money market hedge is constructed?

Question 22

Describe the sequence of transactions required to do a covered interest arbitrage out of British pound and into U.S.dollars.

Question 23

Explain the bid-ask spread in the external currency market?

Question 24

If volatility in foreign exchange markets,what is the relationship to the bid-ask spread?

Question 25

It is often said that interest rate parity is satisfied when the differential between the interest rates denominated in two currencies equals the forward premium or discount between the two currencies.Explain why this is an imprecise statement when the interest rates are not continuously compounded.