Q: If the spot rate for USD/EUR is 1.20 and the spot rate for CAD/USD is 1.30, what is the cross-rate for CAD/EUR?

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

Question 1

Suppose the spot exchange rate is $$1.30/€ and the 3-month forward rate is 1.32$$/€. If the 3-month interest rate in the US is 2% per annum and in the Eurozone is 4% per annum (both on a 360-day basis), is there an arbitrage opportunity? Use the covered interest parity formula to justify your answer.

Accepted Answer

Yes, because the forward rate is too high relative to interest differentials, allowing arbitrage profits.

Question 2

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

Accepted Answer

The dollar has depreciated relative to the euro.

Question 3

Given the following information: spot rate $$/£ = 1.50, interest rate in the US = 3%, interest rate in the UK = 5%, and the expected future spot rate $$/£ = 1.55. What is the expected dollar rate of return on pound deposits?

Accepted Answer

$0.05 + (1.55 - 1.50)/1.50 = 0.0833 or 8.33%

Question 4

Which of the following best describes the effect of a domestic currency appreciation on imports and exports?

Accepted Answer

Imports become less expensive and exports become more expensive.

Question 5

If the spot rate for USD/EUR is 1.20 and the spot rate for CAD/USD is 1.30, what is the cross-rate for CAD/EUR?

Accepted Answer

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

Question 6

Suppose 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

13%

Question 7

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

Accepted Answer

Local city governments

Question 8

If the interest rate on euro deposits is 4% and the expected rate of depreciation of the euro against the dollar is -3%, what is the approximate expected dollar rate of return on euro deposits?

Accepted Answer

1%

Question 9

Covered interest parity can be expressed as $$R_d = R_f + \frac{F_{f/d} - S_{f/d}}{S_{f/d}}. If $$the forward rate is above the spot rate, what does this imply about the interest rate differential?

Accepted Answer

The foreign interest rate is higher than the domestic interest rate.

Question 10

A rise in the interest rate paid on dollar deposits will have what effect on the dollar in the foreign exchange market, according to the asset approach?

Accepted Answer

It will cause the dollar to appreciate.

Question 11

If investors expect the euro to appreciate in the future, what is the likely immediate effect in the foreign exchange market?

Accepted Answer

The euro will appreciate now due to increased demand for euro-denominated assets.

Question 12

Which of the following best describes a carry trade involving the Japanese yen and US dollar?

Accepted Answer

Borrowing yen at low interest rates and investing in US dollar assets with higher interest rates.

Question 13

If the spot rate for USD/EUR is 1.2000 and the 3-month forward points are +80, what is the 3-month forward rate?

Accepted Answer

$$1.2000 + 0.0080 = 1.2080$$

Question 14

Which of the following is a real-world example of arbitrage in the foreign exchange market?

Accepted Answer

Buying euros in New York at $$1.10 and selling them in London at 1.20.$$

Question 15

If the real exchange rate increases, what happens to the purchasing power of domestic consumers for foreign goods?

Accepted Answer

It decreases, as foreign goods become more expensive in real terms.

Question 16

Which of the following best describes the relationship between spot and forward exchange rates over time, as shown in historical data?

Accepted Answer

They tend to move together closely most of the time.

Question 17

If the expected future spot rate for $$/€ is 1.10$$, the current spot rate is $1.05, and the interest rate on euro deposits is 5%, what is the expected dollar return on euro deposits?

Accepted Answer

$$0.05 + (1.10 - 1.05)/1.05 = 0.0976 or 9.76$$%

Question 18

Which of the following is NOT a function of the foreign exchange market?

Accepted Answer

Setting domestic interest rates.

Exchange Rates and the Foreign Exchange Market: An Asset Approach

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