Ch006InternationalParityRelationshipsand

1、Eun & Resnick 4eCHAPTER 6 International Parity Relationships and Forecasting Foreign Exchange RatesInterest Rate ParityCovered Interest ArbitrageInterest Rate Parity and Exchange Rate DeterminationReasons for Deviations from Interest Rate ParityPurchasing Power ParityPPP Deviations and the Real Exch

2、ange RateInternational Finance in Practice: Big MacCurrenciesEvidence on Purchasing Power ParityFisher EffectsForecasting Exchange RatesEfficient Market ApproachFundamental ApproachTechnical ApproachPerformance of the ForecastersSummaryMINI CASE: Turkish Lira and Purchasing Power ParityAppendix 6A:

3、Purchasing Power Parity and Exchange Rate Determination1 An arbitrage is best defined as:a) A legal condition imposed by the CFTC.b) The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making reasonable profits.c) The act of simultaneously buy

4、ing and selling the same or equivalent assets or commodities for the purpose of making guaranteed profits.d) None of the aboveAnswer: c)Interest Rate Parity2 Interest Rate Parity (IRP) is best defined as:a) When a government brings its domestic interest rate in line with other major financial market

5、sb) When the central bank of a country brings its domestic interest rate in line with its major trading partnersc) An arbitrage condition that must hold when international financial markets are in equilibriumd) None of the aboveAnswer: c)3 When Interest Rate Parity (IRP) does not holda) there is usu

6、ally a high degree of inflation in at least one countryb) the financial markets are in equilibriumc) there are opportunities for covered interest arbitraged) b and cAnswer: c)4 A formal statement of IRP isa)b)c)d)Answer: a) Rationale: Equation 6.1: Covered Interest Arbitrage5 Suppose that the one-ye

7、ar interest rate is 5.0 percent in the United States, the spot exchange rate is $1.20/, and the one-year forward exchange rate is $1.16/. What must one-year interest rate be in the euro zone?a) 5.0%b) 1.09%c) 8.62%d) None of the above. Answer: c)Rationale: equation 6.1:6 Suppose that the one-year in

8、terest rate is 3.0 percent in the Italy, the spot exchange rate is $1.20/, and the one-year forward exchange rate is $1.18/. What must one-year interest rate be in the United States?a) 1.2833%b) 1.0128%c) 4.75%d) None of the above. Answer: a)Rationale: equation 6.1: 7 A currency dealer has good cred

9、it and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i = 6%. The spot exchange rate is $1.25 = 1.00 and the one-year forward exchange rate is $1.20 = 1.00. Show how to realize a certain profi

10、t via covered interest arbitrage.a) Borrow $1,000,000 at 2%. Trade $1,000,000 for 800,000; invest at i = 6%; translate proceeds back at forward rate of $1.20 = 1.00, gross proceeds = $1,017,600.b) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year;

11、 translate 848,000 back into euro at the forward rate of $1.20 = 1.00. Net profit $2,400.c) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate 850,000 back into euro at the forward rate of $1.20 = 1.00. Net profit 2,000.d) Answers c) and

12、 b) are both correctAnswer: d)Rationale: b) is true: c) is also true: Theres nothing in the problem to suggest that profits have to be in a particular currency.8 Suppose that you are the treasurer of IBM with an extra US$1,000,000 to invest for six months. You are considering the purchase of U.S. T-

13、bills that yield 1.810% (thats a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = 100, and the six month forward rate is $1.00 = 110. The interest rate in Japan (on an investment of comparable risk) is 13 percent. What is your strategy

14、?a) take $1m, invest in U.S. T-billsb) take $1m, translate into yen at the spot, invest in Japan, repatriate your yen earnings back into dollars at the spot rate prevailing in six months.c) take $1m, translate into yen at the spot, invest in Japan, hedge with a short position in the forward contract

15、d) take $1m, translate into yen at the forward rate, invest in Japan, hedge with a short position in the spot contractAnswer: c)9 A U.S.-based currency dealer has good credit and can borrow $1,000,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year i

16、nterest rate is i = 6%. The spot exchange rate is $1.25 = 1.00 and the one-year forward exchange rate is $1.20 = 1.00. Show how to realize a certain dollar profit via covered interest arbitrage.a) Borrow $1,000,000 at 2%. Trade $1,000,000 for 800,000; invest at i = 6%; translate proceeds back at for

17、ward rate of $1.20 = 1.00, gross proceeds = $1,017,600.b) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate 848,000 back into euro at the forward rate of $1.20 = 1.00. Net profit $2,400.c) Borrow 800,000 at i = 6%; translate to dollars

18、at the spot, invest in the U.S. at i$ = 2% for one year; translate 850,000 back into euro at the forward rate of $1.20 = 1.00. Net profit 2,000.d) Answers c) and b) are both correctAnswer: b)Rationale: 10 An Italian currency dealer has good credit and can borrow 800,000 for one year. The one-year in

19、terest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i = 6%. The spot exchange rate is $1.25 = 1.00 and the one-year forward exchange rate is $1.20 = 1.00. Show how to realize a certain euro-denominated profit via covered interest arbitrage.a) Borrow $1,000,000 at 2%

20、. Trade $1,000,000 for 800,000; invest at i = 6%; translate proceeds back at forward rate of $1.20 = 1.00, gross proceeds = $1,017,600.b) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate 848,000 back into euro at the forward rate of $1

21、.20 = 1.00. Net profit $2,400.c) Borrow 800,000 at i = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 2% for one year; translate 850,000 back into euro at the forward rate of $1.20 = 1.00. Net profit 2,000.d) Answers c) and b) are both correctAnswer: c)Rationale:11 Suppose that you

22、 are the treasurer of IBM with an extra US$1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (thats a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = 100, and the six month forward

23、rate is $1.00 = 110. What must the interest rate in Japan (on an investment of comparable risk) be before you are willing to consider investing there for six months?a) 11.991%b) 1.12%c) 7.45%d) 7.45%Answer: a)Rationale: The no-arbitrage condition is $1,000,000 (1.0181) = $1,000,000 (1 + i ) 1.0181 =

24、 (1 + i ) i = 1.0181 1i = 11.991%12 Covered Interest Arbitrage (CIA) activities will result in a) an unstable international financial marketsb) restoring equilibrium quite quicklyc) a disintermediationd) no effect on the marketAnswer: b).13 Suppose that the one-year interest rate is 5.0 percent in t

25、he United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/ and the one-year forward exchange rate, is $1.16/. Assume that an arbitrageur can borrow up to $1,000,000.a) This is an example where interest rate parity holds.b) This is an example of an arbitrage opportunity; i

26、nterest rate parity does NOT hold.c) This is an example of a Purchasing Power Parity violation and an arbitrage opportunity.d) None of the above. Answer: b)Rationale: equation 6.1: 14 Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the s

27、pot exchange rate is $1.12/ and the forward exchange rate, with one-year maturity, is $1.16/. Assume that an arbitrager can borrow up to $1,000,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?a) $10,690b) $15,000c) $46,207d) $21,964.29Answer: d)Rationale: $21,964.2

28、9 = $1,000,000 (1.05) + $1,000,000 (1.035) Interest Rate Parity and Exchange Rate Determination15 Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/. What must the spot exchange rate be? a) $1.1768/

29、 b) $1.1434/.c) $1.12/ d) None of the above. Answer: b)Rationale: equation 6.1:16 A higher U.S. interest rate (i$ ) will result in a) a stronger dollarb) a lower spot exchange rate (expressed as foreign currency per U.S. dollar)c) both a) and b)d) None of the aboveAnswer: a)Rationale: all else equal

30、, a higher U.S. interest rate will attract capital to the U.S., increasing demand for dollars, which leads to a stronger dollar (and a lower spot rate when the sport rate is quoted as the number of U.S. dollars per unit of foreign currency).17 If the interest rate in the U.S. is i$ = 5 percent for t

31、he next year and interest rate in the U.K. is i = 8 percent for the next year, uncovered IRP suggests that a) The pound is expected to depreciate against the dollar by about 3 percent.b) The pound is expected to appreciate against the dollar by about 3 percent.c) The dollar is expected to appreciate

32、 against the pound by about 3 percent.d) a) and c) are both trueAnswer: d)18 A currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i = 6%. The one-year forward e

33、xchange rate is $1.20 = 1.00; what must the spot rate be to eliminate arbitrage opportunities?a) $1.2471 = 1.00b) $1.20 = 1.00c) $1.1547 = 1.00d) none of the aboveAnswer:Rationale: Reasons for Deviations from Interest Rate Parity19 Will an arbitrageur facing the following prices be able to make mone

34、y?borrowing lendingBidAsk$5%4.5%Spot$1.00 = 1.00$1.01 = 1.006%5.5%Forward$0.99 = 1.00$1.00 = 1.00a) Yes, borrow $1,000 at 5%; Trade for at the ask spot rate $1.01 = 1.00; Invest 990.10 at 5.5%; Hedge this with a forward contract on 1,044.55 at $0.99 = 1.00; Receive $b) Yes, borrow 1,000 at 6%; Trade

35、 for $ at the bid spot rate $1.00 = 1.00; Invest $1,000 at 4.5%; Hedge this with a forward contract on 1,045 at $1.00 = 1.00.c) No; the transactions costs are too highd) None of the aboveAnswer: c)20 If IRP fails to holda) Pressure from arbitrageurs should bring exchange rates and interest rates bac

36、k into lineb) It may fail to hold due to transactions costsc) It may be due to government-imposed capital controlsd) All of the aboveAnswer d)21 Although IRP tends to hold, it may not hold precisely all the timea) Due to transactions costs, like the bid ask spreadb) Due to asymmetric informationc) D

37、ue to capital controls imposed by governmentsd) a) and c)Answer: d)Purchasing Power Parity22 If a foreign county experiences a hyperinflationa) Its currency will depreciate against stable currenciesb) Its currency may appreciate against stable currenciesc) Its currency may be unaffectedits difficult

38、 to say.d) None of the aboveAnswer: a)23 As of today, the spot exchange rate is 1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?a) 1.00 = $1.2379b) 1.00 = $1.2623c) 1.00 = $

39、0.9903d) $1.00 = 1.2623Answer: a)Rationale: Take the spot rate and gross up each side by the respective inflation rates24 Purchasing Power Parity (PPP) theory states that:a) The exchange rate between currencies of two countries should be equal to the ratio of the countries price levels.b) As the pur

40、chasing power of a currency sharply declines (due to hyperinflation) that currency will depreciate against stable currencies.c) The prices of standard commodity baskets in two countries are not related.d) a) and b)Answer: d)PPP Deviations and the Real Exchange Rate25 If the annual inflation rate is

41、5.5 percent in the United States and 4 percent in the U.K., and the dollar depreciated against the pound by 3 percent, then the real exchange rate, assuming that PPP initially held, is: a) 0.07b) 0.98c) 0.0198d) 4.5Answer: b)Rationale: Equation 6.14:Evidence on Purchasing Power Parity26 In view of t

42、he fact that PPP is the manifestation of the law of one price applied to a standard commodity basket, a) It will hold only if the prices of the constituent commodities are equalized across countries in a given currencyb) It will hold only if the composition of the consumption basket is the same acro

43、ss countries.c) Both a) and b)d) None of the aboveAnswer: c)27 Some commodities never enter into international trade. Examples include:a) Nontradablesb) Haircutsc) Housingd) All of the aboveAnswer: d)28 Generally unfavorable evidence on PPP suggests thata) Substantial barriers to international commo

44、dity arbitrage existb) Tariffs and quotas imposed on international trade can explain at least some of the evidencec) Shipping costs can make it difficult to directly compare commodity pricesd) All of the aboveAnswer: d)29 The price of a McDonalds Big Mac sandwicha) Is about the same in the 120 count

45、ries that McDonalds does business inb) Varies considerably across the world in dollar terms c) Supports PPPd) None of the aboveAnswer: b)Rationale: One explanation is that a big mac will cost more in Hawaii than Iowa because you first have to buy the cow an airplane ticket. Fisher Effects30 The Fish

46、er effect can be written for the United States as:a) i$ = r$ + E(p$) + r$ E(p$)b) r$ = i$ + E(p$) + i$ E(p$)c)d)Answer: a)31 Forward parity states thata) Any forward premium or discount is equal to the expected change in the exchange rate. b) Any forward premium or discount is equal to the actual ch

47、ange in the exchange ratec) The nominal interest rate differential reflects the expected change in the exchange rate. d) An increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.Answer: a)32 The Internationa

48、l Fisher Effect suggests thata) Any forward premium or discount is equal to the expected change in the exchange rate. b) Any forward premium or discount is equal to the actual change in the exchange ratec) The nominal interest rate differential reflects the expected change in the exchange rate. d) A

49、n increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.Answer: c)33 The Fisher effect states that:a) Any forward premium or discount is equal to the expected change in the exchange rate. b) Any forward prem

50、ium or discount is equal to the actual change in the exchange ratec) The nominal interest rate differential reflects the expected change in the exchange rate. d) An increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in

51、the country.Answer: d)Forecasting Exchange Rates34 If you could accurately and consistently forecast exchange ratesa) This would be a very handy thing.b) You could impress your dates.c) You could make a great deal of money.d) All of the aboveAnswer: d)Rationale: What date wouldnt be impressed with “

52、Hey baby, in three months the euro will appreciate by 5 percent against the dollar.”?35 The main approaches to forecasting exchange rates are:a) Efficient market, Fundamental, and Technical approachesb) Efficient market and Technical approachesc) Efficient market and Fundamental approachesd) Fundame

53、ntal and Technical approachesAnswer: a)36 The benefit to forecasting exchange rates:a) Are greatest during periods of fixed exchange ratesb) Are nonexistent now that the euro and dollar are the biggest game in townc) Accrue to and are a vital concern for MNCs formulating international sourcing, prod

54、uction, financing and marketing strategies.d) All of the above.Answer: c)Efficient Market Approach37 The Efficient Markets Hypothesis statesa) Markets tend to evolve to low transactions costs and speedy execution of orders.b) Current asset prices (e.g. exchange rates) fully reflect all the available

55、 and relevant information.c) Current exchange rates cannot be explained by such fundamental forces as money supplies, inflation rates and so forth.d) None of the aboveAnswer: b)38 Good, inexpensive, and fairly reliable predictors of future exchange rates include:a) Todays exchange rate.b) Current fo

56、rward exchange rates (e.g. the six-month forward rate is a pretty good predictor of the spot rate that will prevail six months from today).c) Esoteric fundamental models that take an econometrician to use and no one can explain.d) Both a) and b)Answer: d)39 If the exchange rate follows a random walk

57、a) The future exchange rate is unpredictableb) The future exchange rate is expected to be the same as the current exchange rate, St = E(St+1)c) The best predictor of future exchange rates is the forward rate Ft = E(St+1|It).d) b) and c)Answer: b)Rationale: c) is wrong because the forward rate model is distinct from the rando