Deck 4: The International Parity Conditions and Their Consequences

Question 1

Locational arbitrage ensures that bilateral exchange rates are in equilibrium.

Answer 1

True

Question 2

Arbitrageurs make their profit by identifying situations in which they can profitably put their own money at risk.

Answer 2

False

Question 3

A bank is in a long euro and short yen position when it has purchased euros and sold yen.

Answer 3

True

Question 4

Even if quoted exchange rates do not allow arbitrage, banks quoting the lowest offer prices in a currency will attract the bulk of customer purchases in that currency.

Question 5

A currency cross rate does not involve the domestic currency.

Question 6

Suppose S^SFr/€ = SFr1.50/€ and S^¥/€ = ¥135/€. The spot rate should be S^¥/SFr = ¥90/SFr.

Question 7

Pure or riskless arbitrage is defined as a profitable position obtained with no net investment and no risk.

Question 8

Prices in two currencies are related through the equation P^d = P^f / S^d/f.

Question 9

The law of one price states that "Equivalent assets sell for the same price."

Question 10

Speculators make their profit from situations in which they have no net investment and no risk.

Question 11

The following exchange rates are in equilibrium: S^SFr/€ = SFr1.7223/€, S^€/¥ = €0.009711/¥, and S^¥/SFr = ¥61.740/SFr.

Question 12

Prices in two currencies are related through the equation P^d = P^f / S^f/d.

Question 13

A bank is in a short euro and long yen position when it has purchased euros and sold yen.

Question 14

Interest rate parity (IRP) holds within the bounds of transactions costs in the international currency and Eurocurrency markets.

Question 15

Prices in two currencies are related through the equation P^d = P^fS^d/f.

Question 16

Covered interest arbitrage ensures that the ratio of forward to spot exchange rates is determined by the inflation differential between two currencies.

Question 17

The following exchange rates are in equilibrium: S^SFr/€ = SFr1.60/€, S^€/¥ = €0.0125/¥, and S^¥/SFr = ¥50.00/SFr.

Question 18

The actions of arbitrageurs promote the law of one price in currency markets.

Question 19

Forward premiums and discounts depend on interest rate differentials.

Question 20

Real assets are more likely to conform to the law of one price than financial assets.

Question 21

Empirical evidence indicates that forward parity holds in the international currency and Eurocurrency markets.

Question 22

Empirical tests indicate that persistent inflation differentials between two currencies eventually have an impact on nominal exchange rates.

Question 23

Real changes in currency values reflect changes in relative purchasing power.

Question 24

A nominal appreciation of the domestic currency raises the price of domestic goods relative to foreign goods.

Question 25

For daily measurement intervals, both nominal and real exchange rates are close to a random walk.

Question 26

Because currencies are standardized assets that are actively traded in international markets, real deviations from purchasing power parity are rare and fleeting.

Question 27

Real (inflation adjusted) exchange rate changes have little economic significance.

Question 28

An increase in the nominal exchange rate helps the domestic economy as imported goods and raw materials cost less.

Question 29

Empirical evidence indicates that relative purchasing power parity can be used to successfully predict short-term changes in spot exchange rates.

Question 30

There is no correlation between annual changes in real exchange rates.

Question 31

Relative purchasing power parity holds over the short run.

Question 32

Real exchange rates are nominal exchange rates minus the forward/spot premium or discount.

Question 33

International parity conditions are useful for predicting changes in the real exchange rate.

Question 34

Deviations from purchasing power parity in real exchange rates can persist for several years.

Question 35

Empirical evidence indicates that relative purchasing power parity holds in the international currency and Eurocurrency markets.

Question 36

The spot exchange rate between Swiss francs and dollars is S₀^SFr/$ = SFr1.7122/$. Expected inflation is 0 percent in Switzerland and 11 percent in the United States. Using relative purchasing power parity, the expected spot rate in one period is E[S₁^SFr/$] = SFr1.5425/$.

Question 37

A real appreciation of the domestic currency lowers the relative price of foreign goods.

Question 38

Real exchange rate changes are determined by inflation differentials.

Question 39

A real appreciation in the value of a currency increases the purchasing power of that currency relative to other currencies.

Question 40

An increase in the real value of foreign currencies helps the domestic economy as imported goods and raw materials cost less.

Question 41

The relation between the forward exchange rates and expected future spot rates is called ______.

A) forward parity
B) interest rate parity
C) relative purchasing power parity
D) the international Fisher relation
E) None of the above

Question 42

The current U.S. dollar value of the Hong Kong dollar is $0.1250/HK$. The 180-day forward rate is $0.12148/HK$. The difference between the two rates suggests that ______.

A) inflation in the U.S. during the past year was lower than in Hong Kong
B) interest rates are rising faster in Hong Kong than in the United States
C) prices in Hong Kong are expected to rise more rapidly than in the United States
D) the Hong Kong dollar's value is expected to rise against the U.S. dollar
E) More than one of the above

Question 43

A real appreciation of the domestic currency has each of the following effects EXCEPT

A) It helps hold down domestic inflation.
B) It helps domestic importers as imported goods and raw materials cost less.
C) It shifts resources within the domestic economy from export-oriented firms toward import-oriented firms.
D) More than one of the above
E) None of the above

Question 44

Fundamental analysis uses macroeconomic data to forecast exchange rates.

Question 45

Technical analysis uses past price patterns to forecast exchange rates.

Question 46

A real depreciation of the domestic currency has which of the following consequences?

A) a decrease in the domestic cost of living
B) higher domestic prices for imported goods
C) higher domestic unemployment
D) lower domestic inflation
E) None of the above

Question 47

Technical analysts believe that the currency markets are weak form efficient.

Question 48

Fundamental analysts believe that the currency markets are semi-strong form efficient.

Question 49

The relation between interest rate differentials and expected inflation differentials is called ______.

A) forward parity
B) interest rate parity
C) relative purchasing power parity
D) the international Fisher relation
E) None of the above

Question 50

Annual interest rates are 6% in euros and 5% in dollars. The spot rate is S₀^$/€ = $1.20/€. What is the one-year forward exchange rate?

A) $1.18/€
B) $1.19/€
C) $1.20/€
D) $1.21/€
E) $1.22/€

Question 51

Suppose that S₀^$/SFr = $1.27/SFr and F₁^$/SFr = $1.28/Sfr for exchange between U.S. dollars and Swiss francs. These prices indicate that ______.

A) nominal interest rates are higher in the U.S. than in Switzerland
B) the inflation rate in Switzerland is declining
C) the Swiss franc has recently risen in relation to the dollar
D) the Swiss franc is expected to fall in value relative to the dollar
E) it is not possible to claim that any of the above are true without additional information

Question 52

The relation between expected future changes in the spot rate and expected inflation differentials is called ______.

A) forward parity
B) interest rate parity
C) relative purchasing power parity
D) the international Fisher relation
E) None of the above

Question 53

Empirical studies indicate that forward parity holds at each point in time.

Question 54

If annual interest rates are 10% in the U.S. and 4% in Switzerland with quarterly compounding and the 90-day forward rate for the Swiss franc is $0.3864/SFr, at what current spot rate will interest rate parity hold?

A) $0.3910/SFr
B) $0.3897/SFr
C) $0.3807/SFr
D) $0.3762/SFr
E) $0.3648/SFr

Question 55

S^$/ArPeso = $0.35/ArPeso and S^ArPeso/Rand = ArPeso0.31/Rand. What is S^Rand/$?

A) Rand0.886/$
B) Rand1.129/$
C) Rand3.226/$
D) Rand3.459/$
E) Rand9.217/$

Question 56

Empirical tests of forward parity over short forecasting periods suggest that forward exchange rates are poor predictors of future spot exchange rates.

Question 57

The relation between the forward/spot ratio and interest rate differentials is called ______.

A) forward parity
B) interest rate parity
C) relative purchasing power parity
D) the international Fisher relation
E) None of the above

Question 58

If the expected inflation rate is 5% and the real required return is 6%, then the Fisher equation says that the nominal interest rate should be exactly ______.

A) 1.0%
B) 6.0%
C) 11.0%
D) 11.3%
E) None of the above

Question 59

If expected inflation is 10% and the real required return is 8%, then the Fisher equation says that the nominal interest rate should be exactly ______.

A) 80.0%
B) 18.8%
C) 18.0%
D) 2.0%
E) None of the above

Question 60

Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%, respectively, over the next several years. If the current spot rate for the Mexican peso is $0.005/Ps, then relative purchasing power parity suggests that the peso's value in 3 years will be approximately ______.

A) $0.01088/Ps
B) $0.00346/Ps
C) $0.00321/Ps
D) $0.00102/Ps
E) $0.00024/Ps

Question 61

A technical analyst is likely to use which of the following in forecasting exchange rates?

A) growth in gross national product (GNP)
B) the Federal government deficit
C) the past history of spot exchange rate movements
D) the trade deficit
E) balance of payments statistics

Question 62

Which of statements a) through c) is FALSE?

A) Real changes in exchange rates can be forecast by the international parity conditions.
B) Real changes in exchange rates reflect changes in purchasing power.
C) Real exchange rates vary over time.
D) All of the above are false.
E) More than one of the above is true.

Question 63

Market-based exchange rate forecasts include which of a) through c)?

A) forward/spot differentials
B) inflation differentials
C) interest rate differentials
D) More than one of the above
E) None of the above

Question 64

Which of statements a) through c) is FALSE?

A) Attempts to forecast short term changes in exchange rates generally fail to beat a naive guess of today's spot exchange rate.
B) Long run forecasts of nominal exchange rates have difficulty beating the current spot rate as predictors of future spot rates of exchange.
C) Prices in the interbank foreign exchange markets are difficult to predict.
D) More than one of the above is true.
E) All of the above are false.

Question 65

A fundamental analyst is likely to use which of the following in forecasting exchange rates?

A) forward exchange rates
B) inflation differentials
C) nominal interest rate differentials
D) real interest rate differentials
E) All of the above