bapswarrior

Given a forward exchange rate of 5 DC/FC, a spot rate of 5.102 DC/FC, domestic interest rates of 8%, and foreign rates of 10%, which of the following statements is CORRECT based on the approximation formula?

A) Arbitrage opportunities do not exist.

B) Arbitrage opportunities exist.

C) Borrow local currency and lend foreign currency.

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If (rD − rF) is approximately equal to the forward premium, which is (Forward D/F) − Spot(D/F) / Spot(D/F), then no arbitrage opportunities exist.
0.08 − 0.10 ≅ (5 − 5.102) / 5.102.
-0.02 ≅ -0.01999.

bapswarrior

Suppose the Argentina peso is at a 1-year forward premium of 4% relative to the Brazilian real and that Argentina’s 1-year interest rate is 7%. If interest rate parity holds, then the Brazilian interest rate is closest to:

A) 6.60%.

B) 11.00%.

C) 3.00%.

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According to interest rate parity the currency with the lower interest rate is expected to appreciate so the Argentina rate of 7% is approximately 4% less than the Brazilian rate of 7 + 4 = 11%.

bapswarrior

Given the following information, what is the forward exchange rate implied by interest rate parity?

• U.S. interest rate = 9%.
• North Korea interest rate = 10%.
• Spot rate = 1.65 KPW/$.

A) 0.612 KPW/$.

B) 1.635 KPW/$.

C) 1.665 KPW/$.

Forward rate (DC/FC) = Spot Rate (DC/FC) × [(1 + domestic rate) / (1 + foreign rate)],
Forward rate = 1 / 1.65 (KPW/$) × (1.09 / 1.10) = 0.60055 $/KPW, or 1.665 KPW/$.
Alternatively, forward rate = 1.65 (KPW/$) × (1.10 / 1.09) = 1.665 (KPW/$).

bapswarrior

The domestic interest rate is 8% and the foreign interest rate is 6%. If the spot rate is 4 domestic units/foreign unit, what should the forward exchange rate be for interest rate parity to hold?

A) 3.930.

B) 4.075.

C) 4.250.

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Using the following interest rate parity equation:
ForwardDC/FC=SpotDC/FC × [(1 + rdomestic) / (1 + rforeign )]  
Solving for the forward rate:  ForwardDC/FC = 4 × [(1 + 0.08) / (1 + 0.06)]

= 4(1.08) / (1.06)
= 4(1.01887)
= 4.07547

bapswarrior

The domestic interest rate is 7% and the foreign interest rate is 9%. If the forward exchange rate is 5 domestic units per foreign unit, what spot exchange rate is consistent with interest rate parity (IRP)?

A) 4.91.

B) 5.72.

C) 5.09.

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Using the following IRP equation: ForwardFCC = SpotFCC × [(1 + rdomestic) / (1 + rforeign )]  
Solving for the spot rate: SpotFCC = ForwardFCC × [(1 + rforeign) / (1 + rdomestic)]  
                                    = [(1 + 0.09) / (1 + 0.07)](5)
                                    = (1.09 / 1.07)(5)
                                    = 5.09

bapswarrior

The domestic interest rate is 9% and the foreign interest rate is 7%. If the forward exchange rate is FCC 5.00, what spot exchange rate is consistent with interest rate parity?

A) 4.83.

B) 4.91.

C) 5.09.

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ForwardFCC / SpotFCC = (1 + rdomestic) / (1 + rforeign).
SpotFCC = ForwardFCC (1 + rforeign) / (1 + rdomestic) = (5.00)(1.07) / (1.09) = 4.908

bapswarrior

One-year interest rates are 7.5% in the U.S. and 6.0% in New Zealand. The current spot exchange rate is NZD:USD 0.5500. If interest rate parity holds, today’s one-year forward rate (NZD:USD) must be closest to:

A) NZD:USD 0.55778.

B) NZD:USD 0.54233.

C) NZD:USD 0.56675.

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Interest rate parity is given by:

ForwardFCC = 0.5500 × (1.075/1.06) = NZD:USD 0.55778

bapswarrior

Lance Tuipuloto, CFA, is reviewing interest rate parity for a client meeting on a planned foreign investment. The domestic interest rate is 8% and the foreign interest rate is 6%. If the forward rate is 4.00 domestic units per foreign unit, what should the spot exchange rate be for interest rate parity to hold?

A) 3.93.

B) 3.98.

C) 4.08.

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F/S = (1 + rdomestic) / (1 + rforeign). Note in this equation exchange rates are quoted as Domestic/Foreign.S = F (1 + rF) / (1 + rD) = (4.00)(1.06) / (1.08) = 3.93

bapswarrior

The U.S. interest rate is 4%, the Jordan interest rate is 7% and the $/JOD spot rate is 2.0010. What is the $/JOD forward rate that satisfies interest rate parity?

A) $0.5142 / JOD.

B) $1.9450 / JOD.

C) $1.0936 / JOD.

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Forward(DC/FC) = Spot (DC/FC)[(1 + r domestic) / (1 + r foreign)]

(2.0010)(1.04/1.07)

(2.0010)(0.972)
= 1.9450

bapswarrior

A resident of China can invest in Chinese yuan at 5.5% or in Egyptian pounds at 6%. The current spot rate is 80 CY/EGP. What is the one-year forward rate expressed in CY/EGP?

A) 79.6226.

B) 80.3792.

C) 88.9876.

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Forward (DC/FC) = Spot (DC/FC)[(1 + rdomestic) / (1 + rforeign)]

(80 CY/EGP)[(1 + 0.055) / (1 + 0.06)]

(80)(0.99528)
= 79.6226