CHAPTER 6 International Parity Relationships and.docx
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CHAPTER 6 International Parity Relationships and.docx
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CHAPTER6InternationalParityRelationshipsand
CHAPTER6InternationalParityRelationshipsand
ForecastingForeignExchangeRates
InterestRateParity
CoveredInterestArbitrage
InterestRateParityandExchangeRateDetermination
ReasonsforDeviationsfromInterestRateParity
PurchasingPowerParity
PPPDeviationsandtheRealExchangeRate
InternationalFinanceinPractice:
BigMacCurrencies
EvidenceonPurchasingPowerParity
FisherEffects
ForecastingExchangeRates
EfficientMarketApproach
FundamentalApproach
TechnicalApproach
PerformanceoftheForecasters
Summary
MINICASE:
TurkishLiraandPurchasingPowerParity
Appendix6A:
PurchasingPowerParityandExchangeRateDetermination
1Anarbitrageisbestdefinedas:
a)AlegalconditionimposedbytheCFTC.
b)Theactofsimultaneouslybuyingandsellingthesameorequivalentassetsorcommoditiesforthepurposeofmakingreasonableprofits.
c)Theactofsimultaneouslybuyingandsellingthesameorequivalentassetsorcommoditiesforthepurposeofmakingguaranteedprofits.
d)Noneoftheabove
Answer:
c)
InterestRateParity
2InterestRateParity(IRP)isbestdefinedas:
a)Whenagovernmentbringsitsdomesticinterestrateinlinewithothermajorfinancialmarkets
b)Whenthecentralbankofacountrybringsitsdomesticinterestrateinlinewithitsmajortradingpartners
c)Anarbitrageconditionthatmustholdwheninternationalfinancialmarketsareinequilibrium
d)Noneoftheabove
Answer:
c)
3WhenInterestRateParity(IRP)doesnothold
a)thereisusuallyahighdegreeofinflationinatleastonecountry
b)thefinancialmarketsareinequilibrium
c)thereareopportunitiesforcoveredinterestarbitrage
d)bandc
Answer:
c)
4AformalstatementofIRPis
a)
b)
c)
d)
Answer:
a)
Rationale:
Equation6.1:
CoveredInterestArbitrage
5Supposethattheone-yearinterestrateis5.0percentintheUnitedStates,thespotexchangerateis$1.20/€,andtheone-yearforwardexchangerateis$1.16/€.Whatmustone-yearinterestratebeintheeurozone?
a)5.0%
b)1.09%
c)8.62%
d)Noneoftheabove.
Answer:
c)
Rationale:
equation6.1:
6Supposethattheone-yearinterestrateis3.0percentintheItaly,thespotexchangerateis$1.20/€,andtheone-yearforwardexchangerateis$1.18/€.Whatmustone-yearinterestratebeintheUnitedStates?
a)1.2833%
b)1.0128%
c)4.75%
d)Noneoftheabove.
Answer:
a)
Rationale:
equation6.1:
7Acurrencydealerhasgoodcreditandcanborroweither$1,000,000or€800,000foroneyear.Theone-yearinterestrateintheU.S.isi$=2%andintheeurozonetheone-yearinterestrateisi€=6%.Thespotexchangerateis$1.25=€1.00andtheone-yearforwardexchangerateis$1.20=€1.00.Showhowtorealizeacertainprofitviacoveredinterestarbitrage.
a)Borrow$1,000,000at2%.Trade$1,000,000for€800,000;investati€=6%;translateproceedsbackatforwardrateof$1.20=€1.00,grossproceeds=$1,017,600.
b)Borrow€800,000ati€=6%;translatetodollarsatthespot,investintheU.S.ati$=2%foroneyear;translate€848,000backintoeuroattheforwardrateof$1.20=€1.00.Netprofit$2,400.
c)Borrow€800,000ati€=6%;translatetodollarsatthespot,investintheU.S.ati$=2%foroneyear;translate€850,000backintoeuroattheforwardrateof$1.20=€1.00.Netprofit€2,000.
d)Answersc)andb)arebothcorrect
Answer:
d)
Rationale:
b)istrue:
c)isalsotrue:
There’snothingintheproblemtosuggestthatprofitshavetobeinaparticularcurrency.
8SupposethatyouarethetreasurerofIBMwithanextraUS$1,000,000toinvestforsixmonths.YouareconsideringthepurchaseofU.S.T-billsthatyield1.810%(that’sasixmonthrate,notanannualratebytheway)andhaveamaturityof26weeks.Thespotexchangerateis$1.00=¥100,andthesixmonthforwardrateis$1.00=¥110.TheinterestrateinJapan(onaninvestmentofcomparablerisk)is13percent.Whatisyourstrategy?
a)take$1m,investinU.S.T-bills
b)take$1m,translateintoyenatthespot,investinJapan,repatriateyouryenearningsbackintodollarsatthespotrateprevailinginsixmonths.
c)take$1m,translateintoyenatthespot,investinJapan,hedgewithashortpositionintheforwardcontract
d)take$1m,translateintoyenattheforwardrate,investinJapan,hedgewithashortpositioninthespotcontract
Answer:
c)
9AU.S.-basedcurrencydealerhasgoodcreditandcanborrow$1,000,000foroneyear.Theone-yearinterestrateintheU.S.isi$=2%andintheeurozonetheone-yearinterestrateisi€=6%.Thespotexchangerateis$1.25=€1.00andtheone-yearforwardexchangerateis$1.20=€1.00.Showhowtorealizeacertaindollarprofitviacoveredinterestarbitrage.
a)Borrow$1,000,000at2%.Trade$1,000,000for€800,000;investati€=6%;translateproceedsbackatforwardrateof$1.20=€1.00,grossproceeds=$1,017,600.
b)Borrow€800,000ati€=6%;translatetodollarsatthespot,investintheU.S.ati$=2%foroneyear;translate€848,000backintoeuroattheforwardrateof$1.20=€1.00.Netprofit$2,400.
c)Borrow€800,000ati€=6%;translatetodollarsatthespot,investintheU.S.ati$=2%foroneyear;translate€850,000backintoeuroattheforwardrateof$1.20=€1.00.Netprofit€2,000.
d)Answersc)andb)arebothcorrect
Answer:
b)
Rationale:
10AnItaliancurrencydealerhasgoodcreditandcanborrow€800,000foroneyear.Theone-yearinterestrateintheU.S.isi$=2%andintheeurozonetheone-yearinterestrateisi€=6%.Thespotexchangerateis$1.25=€1.00andtheone-yearforwardexchangerateis$1.20=€1.00.Showhowtorealizeacertaineuro-denominatedprofitviacoveredinterestarbitrage.
a)Borrow$1,000,000at2%.Trade$1,000,000for€800,000;investati€=6%;translateproceedsbackatforwardrateof$1.20=€1.00,grossproceeds=$1,017,600.
b)Borrow€800,000ati€=6%;translatetodollarsatthespot,investintheU.S.ati$=2%foroneyear;translate€848,000backintoeuroattheforwardrateof$1.20=€1.00.Netprofit$2,400.
c)Borrow€800,000ati€=6%;translatetodollarsatthespot,investintheU.S.ati$=2%foroneyear;translate€850,000backintoeuroattheforwardrateof$1.20=€1.00.Netprofit€2,000.
d)Answersc)andb)arebothcorrect
Answer:
c)
Rationale:
11SupposethatyouarethetreasurerofIBMwithanextraUS$1,000,000toinvestforsixmonths.YouareconsideringthepurchaseofU.S.T-billsthatyield1.810%(that’sasixmonthrate,notanannualratebytheway)andhaveamaturityof26weeks.Thespotexchangerateis$1.00=¥100,andthesixmonthforwardrateis$1.00=¥110.WhatmusttheinterestrateinJapan(onaninvestmentofcomparablerisk)bebeforeyouarewillingtoconsiderinvestingthereforsixmonths?
a)11.991%
b)1.12%
c)7.45%
d)–7.45%
Answer:
a)
Rationale:
Theno-arbitrageconditionis
$1,000,000×(1.0181)=$1,000,000×
×(1+i¥)×
1.0181=
×(1+i¥)×
i¥=1.0181×
×
–1
i¥=11.991%
12CoveredInterestArbitrage(CIA)activitieswillresultin
a)anunstableinternationalfinancialmarkets
b)restoringequilibriumquitequickly
c)adisintermediation
d)noeffectonthemarket
Answer:
b).
13Supposethattheone-yearinterestrateis5.0percentintheUnitedStatesand3.5percentinGermany,andthatthespotexchangerateis$1.12/€andtheone-yearforwardexchangerate,is$1.16/€.Assumethatanarbitrageurcanborrowupto$1,000,000.
a)Thisisanexamplewhereinterestrateparityholds.
b)Thisisanexampleofanarbitrageopportunity;interestrateparitydoesNOThold.
c)ThisisanexampleofaPurchasingPowerParityviolationandanarbitrageopportunity.
d)Noneoftheabove.
Answer:
b)
Rationale:
equation6.1:
14
Supposethattheannualinterestrateis5.0percentintheUnitedStatesand3.5percentinGermany,andthatthespotexchangerateis$1.12/€andtheforwardexchangerate,withone-yearmaturity,is$1.16/€.Assumethatanarbitragercanborrowupto$1,000,000.Ifanastutetraderfindsanarbitrage,whatisthenetcashflowinoneyear?
a)$10,690
b)$15,000
c)$46,207
d)$21,964.29
Answer:
d)
Rationale:
$21,964.29=–$1,000,000×(1.05)+$1,000,000×
×(1.035)×
InterestRateParityandExchangeRateDetermination
15Supposethattheone-yearinterestrateis5.0percentintheUnitedStatesand3.5percentinGermany,andtheone-yearforwardexchangerateis$1.16/€.Whatmustthespotexchangeratebe?
a)$1.1768/€
b)$1.1434/€.
c)$1.12/€
d)Noneoftheabove.
Answer:
b)
Rationale:
equation6.1:
16AhigherU.S.interestrate(i$↑)willresultin
a)astrongerdollar
b)alowerspotexchangerate(expressedasforeigncurrencyperU.S.dollar)
c)botha)andb)
d)Noneoftheabove
Answer:
a)
Rationale:
allelseequal,ahigherU.S.interestratewillattractcapitaltotheU.S.,increasingdemandfordollars,whichleadstoastrongerdollar(andalowerspotratewhenthesportrateisquotedasthenumberofU.S.dollarsperunitofforeigncurrency).
17IftheinterestrateintheU.S.isi$=5percentforthenextyearandinterestrateintheU.K.isi£=8percentforthenextyear,uncoveredIRPsuggeststhat
a)Thepoundisexpectedtodepreciateagainstthedollarbyabout3percent.
b)Thepoundisexpectedtoappreciateagainstthedollarbyabout3percent.
c)Thedollarisexpectedtoappreciateagainstthepoundbyabout3percent.
d)a)andc)arebothtrue
Answer:
d)
18
Acurrencydealerhasgoodcreditandcanborroweither$1,000,000or€800,000foroneyear.Theone-yearinterestrateintheU.S.isi$=2%andintheeurozonetheone-yearinterestrateisi€=6%.Theone-yearforwardexchangerateis$1.20=€
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