Question 1

Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount.

Accepted Answer

A) True 
 B)False

Question 2

Assume that interest rate parity holds, and the euro's interest rate is 9% while the U.S. interest rate is 12%. Then the euro's interest rate increases to 11% while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity.

Accepted Answer

A)  discount; increase 
B)  discount; decrease 
C)  premium; increase 
D)  premium; decrease

Question 3

Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage.

Accepted Answer

A) True 
 B)False

Question 4

Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.

Accepted Answer

A)  forward realignment arbitrage 
B)  triangular arbitrage 
C)  covered interest arbitrage 
D)  locational arbitrage

Question 5

Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian ringgit (MYR). Bank B quotes a bid rate of $.306 and an ask rate of $.310 for the ringgit. What will be the profit for an investor who has $500,000 available to conduct locational arbitrage?

Accepted Answer

A)  $2,041,667. 
B)  $9,804. 
C)  $500. 
D)  $1,639.

Question 6

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:

Accepted Answer

A)  larger will be the forward discount of the foreign currency. 
B)  larger will be the forward premium of the foreign currency. 
C)  smaller will be the forward premium of the foreign currency. 
D)  smaller will be the forward discount of the foreign currency.

Question 7

Which of the following is not true regarding covered interest arbitrage?

Accepted Answer

A)  Covered interest arbitrage is a reason for observing interest rate parity (IRP). 
B)  If the forward rate is equal to the spot rate, conducting covered interest arbitrage will yield a return that is exactly equal to the interest rate in the foreign country. 
C)  When interest rate parity holds, covered interest arbitrage is not possible. 
D)  When interest rate disparity exists, covered interest arbitrage may not be profitable. 
E)  All of the above are true.

Question 8

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

Accepted Answer

A) True 
 B)False

Question 9

Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from the act of this covered interest arbitrage?

Accepted Answer

A)  downward pressure on the euro's spot rate. 
B)  downward pressure on the euro's forward rate. 
C)  downward pressure on the U.S. interest rate. 
D)  upward pressure on the euro's interest rate.

Question 10

Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume the bid rate of an Australian dollar is $.62 while the ask rate is $.625 at Bank V. 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?

Accepted Answer

A)  $10,003. 
B)  $12,063. 
C)  $14,441. 
D)  $16,393. 
E)  $18,219.

Question 11

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Accepted Answer

A) True 
 B)False

Question 12

The yield curve of every country has its own unique shape.

Accepted Answer

A) True 
 B)False

Question 13

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Accepted Answer

A) True 
 B)False

Question 14

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts ____ pressure on the pound's spot rate, and ____ pressure on the pound's forward rate.

Accepted Answer

A)  downward; downward 
B)  downward; upward 
C)  upward; downward 
D)  upward; upward

Question 15

Assume the following information:
You have $400,000 to invest:
$$\begin{array}{l}
\text { You have } \$ 400,000 \text { to invest: }\
\begin{array} { l l r } 
\text { Current spot rate of Sudanese dinar (SDD) } & = & \$ .00570 \
\text { 90-day forward rate of the dinar } & = & \$ .00569 \
\text { 90-day interest rate in the U.S. } & = & 4.0 \% \
\text { 90-day interest rate in Sudan } & = & 4.2 \%
\end{array}
\end{array}$$
If you conduct covered interest arbitrage, what amount will you have after 90 days?

Accepted Answer

A)  $416,000.00. 
B)  $416,800.00. 
C)  $424,242.86. 
D)  $416,068.77. 
E)  none of the above

Question 16

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following is not true regarding interest rate parity (IRP)?

Accepted Answer

A)  When interest rate parity holds, covered interest arbitrage is not possible. 
B)  When the interest rate in the foreign country is higher than that in the home country, the forward rate of that country's currency should exhibit a discount. 
C)  When the interest rate in the foreign country is lower than that in the home country, the forward rate of that country's currency should exhibit a premium. 
D)  When covered interest arbitrage is not feasible, interest rate parity must hold. 
E)  All of the above are true.

Question 18

Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then:

Accepted Answer

A)  British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the U.S. 
B)  U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the U.S. 
C)  U.S. investors will earn 15% whether they use covered interest arbitrage or invest in the U.S. 
D)  U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S.

Question 19

In which case will locational arbitrage most likely be feasible?

Accepted Answer

A)  One bank's ask price for a currency is greater than another bank's bid price for the currency. 
B)  One bank's bid price for a currency is greater than another bank's ask price for the currency. 
C)  One bank's ask price for a currency is less than another bank's ask price for the currency. 
D)  One bank's bid price for a currency is less than another bank's bid price for the currency.

Question 20

Assume the bid rate of a Singapore dollar is $.40 while the ask rate is $.41 at Bank X. Assume the bid rate of a Singapore dollar is $.42 while the ask rate is $.425 at Bank Z. 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?

Accepted Answer

A)  $11,764. 
B)  -$11,964. 
C)  $36,585. 
D)  $24,390. 
E)  $18,219.

Exam 7: International Arbitrage and Interest Rate Parity

Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount.

Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.

Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian ringgit (MYR) . Bank B quotes a bid rate of $.306 and an ask rate of $.310 for the ringgit. What will be the profit for an investor who has $500,000 available to conduct locational arbitrage?

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:

Which of the following is not true regarding covered interest arbitrage?

If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from the act of this covered interest arbitrage?

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

The yield curve of every country has its own unique shape.

If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.

Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts pressure on the pound's spot rate, and pressure on the pound's forward rate.

For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.

Which of the following is not true regarding interest rate parity (IRP) ?

Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then:

In which case will locational arbitrage most likely be feasible?