土豆妮

Suppose that the current interest rates in the U.S. and the European Union are 13.665% and 8.500%, respectively. Also, the spot rate for the dollar is 1.1975 US$/euro, and the 1-year forward rate is 1.2545 US$/euro. If $100 is invested, what is the total arbitrage profit that a U.S. investor could earn?

A) No arbitrage profit can be made.

B) $5.7000.

C) $23.0670.

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Interest rate parity requires that:
(Forward/Spot) = [(1+r_D)/(1+r_F)]
(1.2545/1.1975) = [1.13665/1.085]
So, interest rate parity holds and no arbitrage opportunity exists.

Alternately:

(1 + 0.13665) = [(1 + 0.085)(1.2545) / 1.1975]

1.13665 = [(1.085)(1.2545) / 1.1975]

1.13665 = 1.36113 / 1.1975

1.13665 = 1.13665, therefore no arbitrage profit can be made.

土豆妮

If 1 + the domestic interest rate < (1 + the foreign interest rate × the forward rate) / spot rate, an investor seeking arbitrage profits should borrow:

A) foreign, convert to domestic, lend out domestic, and convert back to foreign.

B) domestic, convert to foreign, borrow foreign, and convert back to domestic.

C) domestic, lend out foreign, and convert back to domestic.

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If 1 + r_D < (1 + r_F)(forward rate) / spot rate, then borrow domestic, lend out foreign, and convert back to domestic.

土豆妮

An investor can invest in Tunisian dinar at r = 6.25% or in Swiss francs at r = 5.15%. She is a resident of Tunisia and the current spot rate is CHF:TND 0.8105. What is the approximate one-year forward rate expressed in CHF:TND?

A) 0.8016.

B) 0.8194.

C) 0.8215.

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The approximate forward premium/discount is given by the interest rate differential. This differential is: 6.25% ? 5.15% = 1.10%. Since Tunisia has higher interest rates, its currency will be at a discount in the forward market. This discount equals: 0.011 × 0.8105 = 0.0089. Since the exchange rate is quoted in CHF:TND, as a depreciating currency, it will take more TND to buy one CHF. The forward rate is thus: 0.8105 + 0.0089 = CHF:TND 0.8194. In other words, the CHF is stronger in the forward market.

土豆妮

 

If (r_D ? r_F) > Forward premium, which is (Forward D/F) ? Spot(D/F) / Spot(D/F), then:

A) borrow domestic currency and lend out foreign currency.

B) arbitrage opportunities don't exist.

C) borrow foreign currency and lend out domestic currency.

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If (r_D ? r_F) > Forward premium, which is (Forward D/F) ? Spot(D/F) / Spot(D/F), then you would borrow foreign currency and lend out local currency. If the domestic rate is high relative to the hedged foreign rate, you would borrow foreign currency units and then sell them for domestic currency units at the spot rate, lend these domestic currency units at the domestic interest rate and simultaneously sell just enough domestic currency forward so that you can repay your foreign loan.

土豆妮

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) 3.98.

B) 4.08.

C) 3.93.

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F/S = (1 + r_domestic) / (1 + r_foreign). Note in this equation exchange rates are quoted as Domestic/Foreign.

S = F (1 + r_F) / (1 + r_D) = (4.00)(1.06) / (1.08) = 3.93

土豆妮

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) $1.9450 / JOD.

B) $0.5142 / 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

土豆妮

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 + r_domestic) / (1 + r_foreign)]

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

(80)(0.99528)

= 79.6226

土豆妮

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:

Forward_DC/FC=Spot_DC/FC × [(1 + r_domestic) / (1 + r_foreign )] 

Solving for the forward rate:  Forward_DC/FC = 4 × [(1 + 0.08) / (1 + 0.06)]

= 4(1.08) / (1.06)

= 4(1.01887)

= 4.07547

土豆妮

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) 5.09.

C) 5.72.

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Using the following IRP equation: Forward_FCC = Spot_FCC × [(1 + r_domestic) / (1 + r_foreign )] 

Solving for the spot rate: Spot_FCC = Forward_FCC × [(1 + r_foreign) / (1 + r_domestic)] 

                                    = [(1 + 0.09) / (1 + 0.07)](5)

                                    = (1.09 / 1.07)(5)

                                    = 5.09

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土豆妮

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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Forward_FCC / Spot_FCC = (1 + r_domestic) / (1 + r_foreign).

Spot_FCC = Forward_FCC (1 + r_foreign) / (1 + r_domestic) = (5.00)(1.07) / (1.09) = 4.908

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