Q: If the nominal spot exchange rate (GBP/EUR) increases by 10%, the Eurozone price level increases by 5%, and the UK price level increases by 2%, what is the approximate percentage change in the real exchange rate?

$$(1 + 0.10) \times \frac{1 + 0.05}{1 + 0.02} - 1 \approx 1.10 \times 1.0294 - 1 \approx 1.1323 - 1 = 0.1323 or 13.23$$%

Q: Suppose the spot rate for CAD/USD is 1.30 and the spot rate for USD/EUR is 1.20. What is the implied cross-rate for CAD/EUR?

$$1.30 \times 1.20 = 1.56$$ CAD/EUR

Q: If the spot rate is 1.6555, the 30-day domestic risk-free rate is 2% per year, the 30-day foreign risk-free rate is 3% per year, and $$\tau = 30/360$$, what is the 30-day forward rate?

$$1.6555 \times \frac{1 + 0.03 \times \frac{30}{360}}{1 + 0.02 \times \frac{30}{360}} = 1.6555 \times \frac{1.0025}{1.0017} \approx 1.6569$$

Question 1

Suppose the spot exchange rate is $$1.30/€ and the expected future spot rate is 1.20$$/€. If the interest rate on euro deposits is 4% and the interest rate on dollar deposits is 2%, what is the expected rate of return on euro deposits in dollar terms?

Accepted Answer

$$0.04 + \frac{1.20 - 1.30}{1.30} = 0.04 - 0.0769 = -0.0369 or -3.69$$%

Question 2

If the exchange rate moves from $$1.10/€ to 1.20$$/€, which of the following statements is correct?

Accepted Answer

The dollar has depreciated against the euro.

Question 3

Given the following information: Spot rate (USD/EUR) = 1.15885, 3-month forward points = +80.9. What is the 3-month forward rate?

Accepted Answer

$$1.15885 + \frac{80.9}{10,000} = 1.15885 + 0.00809 = 1.16694$$

Question 4

If the nominal spot exchange rate (GBP/EUR) increases by 10%, the Eurozone price level increases by 5%, and the UK price level increases by 2%, what is the approximate percentage change in the real exchange rate?

Accepted Answer

$$(1 + 0.10) 	imes \frac{1 + 0.05}{1 + 0.02} - 1 \approx 1.10 	imes 1.0294 - 1 \approx 1.1323 - 1 = 0.1323 or 13.23$$%

Question 5

Which of the following best describes the effect of a rise in the domestic interest rate on the domestic currency, according to the asset approach?

Accepted Answer

It causes the domestic currency to appreciate.

Question 6

Covered interest parity can be expressed as $$R_{\$$} = R_{€} + \frac{F_{\$$/€} - E_{\$$/€}}{E_{\$$/€}}. $$What does this equation imply?

Accepted Answer

The returns on dollar deposits and covered euro deposits are equal when using the forward rate.

Question 7

Suppose the spot rate for CAD/USD is 1.30 and the spot rate for USD/EUR is 1.20. What is the implied cross-rate for CAD/EUR?

Accepted Answer

$$1.30 	imes 1.20 = 1.56$$ CAD/EUR

Question 8

If the euro is expected to appreciate in the future, what is the likely effect on the current exchange rate and euro-denominated assets?

Accepted Answer

The expected rate of return on euro assets increases, leading to an actual appreciation of the euro.

Question 9

Which of the following is NOT a major participant in the foreign exchange market?

Accepted Answer

Local retail stores

Question 10

If the spot rate is 1.6555, the 30-day domestic risk-free rate is 2% per year, the 30-day foreign risk-free rate is 3% per year, and $$	au = 30/360$$, what is the 30-day forward rate?

Accepted Answer

$$1.6555 	imes \frac{1 + 0.03 	imes \frac{30}{360}}{1 + 0.02 	imes \frac{30}{360}} = 1.6555 	imes \frac{1.0025}{1.0017} \approx 1.6569$$

Question 11

Which of the following best describes a foreign exchange swap?

Accepted Answer

A combination of a spot sale with a forward repurchase.

Question 12

If the domestic currency appreciates, what happens to the price of imports and exports?

Accepted Answer

Imports become less expensive and exports become more expensive.

Question 13

Which of the following is the correct formula for the real exchange rate?

Accepted Answer

$$	ext{Real exchange rate}_{d/f} = S_{d/f} 	imes \frac{P_f}{P_d}$$

Question 14

If the interest rate on yen deposits is 0.1% and the interest rate on USD deposits is 2.5%, what is the main incentive for a carry trade using yen funding?

Accepted Answer

Borrowing yen at a low rate and investing in USD assets at a higher rate to earn the interest differential.

Question 15

Which of the following best describes the effect of arbitrage in the FX market if the same currency is selling for $$1.10 in New York and 1.20 in $$London?

Accepted Answer

Arbitrageurs will buy in New York and sell in London, eliminating the price difference.

Exchange Rates and the Foreign Exchange Market: An Asset Approach

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