ECO 410 Week 5 Quiz – Strayer
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Week 5 Quiz 4 Chapter 7 and 8
Chapter 7
International Parity Conditions
7.1 Prices and Exchange Rates
Multiple Choice
1) If an
identical product can be sold in two different markets, and no restrictions
exist on the sale or transportation costs, the product's price should be the
same in both markets. This is known as:
A)
relative purchasing power parity.
B)
interest rate parity.
C) the
law of one price.
D)
equilibrium.
2) The
Economist publishes annually the "Big Mac Index" by which they
compare the prices of the McDonald's Corporation's Big Mac hamburger around the
world. The index estimates the exchange rates for currencies based on the
assumption that the burgers in question are the same across the world and
therefore, the price should be the same. If a Big Mac costs $2.54 in the United
States and 294 yen in Japan, what is the estimated exchange rate of yen per
dollar as hypothesized by the Hamburger index?
A)
$0.0086/¥
B)
¥124/$
C)
$0.0081/¥
D)
¥115.75/$
3) If
the current exchange rate is 113 Japanese yen per U.S. dollar, the price of a
Big Mac hamburger in the United States is $3.41, and the price of a Big Mac
hamburger in Japan is 280 yen, then other things equal, the Big Mac hamburger
in Japan is:
A)
correctly priced.
B) under
priced.
C) over
priced.
D) There
is not enough information to determine if the price is appropriate or not.
4) The
price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0.
What is the implied PPP of the Peso per dollar?
A) Peso
8.50/$1
B) Peso
10.8/$1
C) Peso
11.76/$1
D) None
of the above
5)
Assume the implied PPP rate of exchange of Mexican Pesos per U.S. dollar is
8.50 according to the Big Mac Index. Further, assume the current exchange rate
is Peso 10.80/$1. Thus, according to PPP and the Law of One Price, at the
current exchange rate the peso is:
A)
overvalued.
B)
undervalued.
C)
correctly valued.
D) There
is not enough information to answer this question.
6)
According to the Big Mac Index, the implied PPP exchange rate is Mexican peso
8.50/$1 but the actual exchange rate is peso10.80/$1. Thus, at current exchange
rates the peso appears to be ________ by ________.
A)
overvalued; approximately 21%
B)
overvalued; approximately 27%
C)
undervalued; approximately 21%
D)
undervalued; approximately 27%
7) Other
things equal, and assuming efficient markets, if a Honda Accord costs $24,682
in the U.S., then at an exchange rate of $1.57/£, the Honda Accord should cost
________ in Great Britain.
A)
£24,682
B)
£38,751
C)
£10,795
D)
£15,721
8) One
year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since
that time the rate of inflation in the U.S. has been 4% greater than that in
Canada. Based on the theory of Relative PPP, the current spot exchange rate of
U.S. dollars for Canadian dollars should be approximately:
A)
$0.96/C$
B) $1/C$
C)
$1.04/C$
D)
Relative PPP provides no guide for this type of question.
9)
________ states that differential rates of inflation between two countries tend
to be offset over time by an equal but opposite change in the spot exchange
rate.
A) The
Fisher Effect
B) The
International Fisher Effect
C)
Absolute Purchasing Power Parity
D)
Relative Purchasing Power Parity
10) Two
general conclusions can be made from the empirical tests of purchasing power
parity (PPP):
A) PPP
holds up well over the short run but poorly for the long run, and the theory
holds better for countries with relatively low rates of inflation.
B) PPP
holds up well over the short run but poorly for the long run, and the theory
holds better for countries with relatively high rates of inflation.
C) PPP
holds up well over the long run but poorly for the short run, and the theory
holds better for countries with relatively low rates of inflation.
D) PPP
holds up well over the long run but poorly for the short run, and the theory
holds better for countries with relatively high rates of inflation.
11) A
country's currency that strengthened relative to another country's currency by
more than that justified by the differential in inflation is said to be
________ in terms of PPP.
A)
overvalued
B) over
compensating
C)
undervalued
D) under
compensating
12) If
we set the real effective exchange rate index between Canada and the United
States equal to 100 in 1998, and find that the U.S. dollar has risen to a value
of 112.6, then from a competitive perspective the U.S. dollar is:
A)
overvalued.
B)
undervalued.
C) very
competitive.
D) There
is not enough information to answer this question.
13) If
we set the real effective exchange rate index between the United Kingdom and
the United States equal to 100 in 2005, and find that the U.S. dollar has
changed to a value of 91.4, then from a competitive perspective the U.S. dollar
is:
A)
overvalued.
B)
undervalued.
C)
equally valued.
D) There
is not enough information to answer this question.
14) The
government just released international exchange rate statistics and reported
that the real effective exchange rate index for the U.S. dollar vs the Japanese
yen decreased from 105 last year to 95 currently and is expected to fall still
further in the coming year. Other things equal U.S. ________ to/from Japan
think this is good news and U.S. ________ to/from Japan think this is bad news.
A)
importers; exporters
B)
importers; importers
C)
exporters; exporters
D)
exporters; importers
True/False
1) If a
market basket of goods cost $100 is the US and €70 in France, then the PPP
exchange rate would be $.70/€.
2) The
assumptions for relative PPP are more rigid than the assumptions for absolute PPP.
3)
Empirical tests prove that PPP is an accurate predictor of future exchange
rates.
4)
Consider the price elasticity of demand. If a product has price elasticity less
than one it is considered to have relatively elastic demand.
Essay
1) The
authors state that empirical tests of purchasing power parity "have, for
the most part, not proved PPP to be accurate in predicting future exchange
rates." The authors then state that PPP does hold up reasonably well in
two situations. What are some reasons why PPP does not accurately predict
future exchange rates, and under what conditions might we reasonably expect PPP
to hold?
7.2 Exchange Rate Pass-Through
Multiple Choice
1)
________ states that nominal interest rates in each country are equal to the
required real rate of return plus compensation for expected inflation.
A)
Absolute PPP
B)
Relative PPP
C) The
Law of One Price
D) The
Fisher Effect
2) In
its approximate form the Fisher effect may be written as ________. Where: i =
the nominal rate of interest, r = the real rate of return and π = the expected
rate of inflation.
A) i =
(r)(π)
B) i = r
+ π + (r)(π)
C) i = r
+ π
D) i = r
+ 2π
3)
Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a
real rate of interest of 1.00%. Using the Fisher Effect Equation, what is the
approximate expected rate of inflation in the U.S. over the next year?
A) 2.10%
B) 2.05%
C) 1.60%
D) 1.00%
4)
Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a
real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the
exact expected rate of inflation in the U.S. over the next year?
A) 1.84%
B) 1.80%
C) 1.76%
D) 1.72%
5) The
relationship between the percentage change in the spot exchange rate over time
and the differential between comparable interest rates in different national
capital markets is known as:
A)
absolute PPP.
B) the
law of one price.
C)
relative PPP.
D) the
international Fisher Effect.
6)
According to the international Fisher Effect, if an investor purchases a
five-year U.S. bond that has an annual interest rate of 5% rather than a
comparable British bond that has an annual interest rate of 6%, then the
investor must be expecting the ________ to ________ at a rate of at least 1%
per year over the next 5 years.
A)
British pound; appreciate
B)
British pound; revalue
C) U.S.
dollar; appreciate
D) U.S.
dollar; depreciate
7)
________ states that the spot exchange rate should change in an equal amount
but in the opposite direction to the difference in interest rates between two
countries.
A)
Fisher-open
B)
Fisher-closed
C) The
Fisher Effect
D) none
of the above
8)
Exchange rate pass-through may be defined as:
A) the
bid/ask spread on currency exchange rate transactions.
B) the
degree to which the prices of imported and exported goods change as a result of
exchange rate changes.
C) the
PPP of lesser-developed countries.
D) the
practice by Great Britain of maintaining the relative strength of the
currencies of the Commonwealth countries under the current floating exchange
rate regime.
9)
Phillips NV produces DVD players and exports them to the United States. Last
year the exchange rate was $1.25/euro and Plillips charged 120 euro per player
in Euroland and $150 per DVD player in the United States. Currently the spot
exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What
is the degree of pass through by Phillips NV on their DVD players?
A) 92%
B) 33.3%
C) 41.7%
D) 4.1%
10)
Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell
the S-type in the UK with a 20% margin for a price of £27,363. Today these cars
are available in the US for $55,000 which is the UK price multiplied by the
current exchange rate of $2.01/£. Jaguar has committed to keeping the US price
at $55,000 for the next six months. If the UK pound appreciates against the USD
to an exchange rate of $2.15/£, and Jaguar has not hedged against currency
changes, what is the amount the company will receive in pounds at the new
exchange rate?
A)
£22,803
B)
£25,581
C)
£27,363
D)
£55,000
11)
Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell
the S-type in the UK with a 20% margin for a price of £27,363. Today these cars
are available in the US for $55,000 which is the UK price multiplied by the
current exchange rate of $2.01/£. Jaguar has committed to keeping the US price
at $55,000 for the next six months. If the UK pound appreciates against the USD
to an exchange rate of $2.15/£, and Jaguar has not hedged against currency
changes, what is the percentage margin the company will realize given the new
exchange rate?
A) 20.0%
B) 15.3%
C) 12.4%
D) 7.2%
12) The
price elasticity of demand for DVD players manufactured by Sony of Japan is
greater than one. If the Japanese yen appreciates against the U.S. dollar by
10% and the price of the Sony DVD players in the U.S also rises by 10%, then
other things equal, the total dollar sales revenues of Sony DVDs would:
A)
decline.
B) increase.
C) stay
the same.
D)
insufficient information
True/False
1) The
final component of the equation for the Fisher Effect, (r)(π), where r = the
real rate of return and π = the expected rate of inflation, is often dropped
from the equation because the number is simply too large for most Western
economies.
2)
Empirical studies show that the Fisher Effect works best for short-term
securities.
3) The
current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange
rate is ¥127/$ then the yen is at a forward premium.
4) The
premium or discount on forward currency exchange rates between any two
countries is visually obvious when you plot the interest rates of each country
on the same yield curve. The currency of the country with the higher yield
curve should be selling at a forward discount.
5) Use
interest rate parity to answer this question. A U.S. investor has a choice
between a risk-free one-year U.S. security with an annual return of 4%, and a
comparable British security with a return of 5%. If the spot rate is $1.43/£,
the forward rate is $1.44/£, and there are no transaction costs, the investor
should invest in the U.S. security.
6) Both
covered and uncovered interest arbitrage are risky operations in the sense that
even without default in the securities, the returns are unknown until all
transactions are complete.
7) All
that is required for a covered interest arbitrage profit is for interest rate
parity to not hold.
Essay/Short Answer
1) The authors
describe an application of uncovered interest arbitrage (UIA) known as
"yen carry trade." Define UIA and describe the example of yen carry
trade. Why would an investor engage in the practice of yen carry trade and is
there any risk of loss or lesser profit from this investment strategy?
2) The
Fisher Effect is a familiar economic theory in the domestic market. In words,
define the Fisher Effect and explain why you think it is also appropriately
applied to international markets.
7.3 The Forward Rate
Multiple Choice
1) If
the forward rate is an unbiased predictor of the expected spot rate, which of
the following is NOT true?
A) The
expected value of the future spot rate at time 2 equals the present forward
rate for time 2 delivery, available now.
B) The
distribution of possible actual spot rates in the future is centered on the
forward rate.
C) The
future spot rate will actually be equal to what the forward rate predicts.
D) All
of the above are true.
2) Which
of the following is NOT an assumption of market efficiency?
A)
Instruments denominated in other currencies are perfect substitutes for one
another.
B)
Transaction costs are low or nonexistent.
C) All
relevant information is quickly reflected in both spot and forward exchange
markets.
D) All
of the above are true.
3)
Empirical tests have yielded ________ evidence about market efficiency with a
general consensus that developing foreign markets are ________.
A)
conflicting; not efficient
B)
conflicting; efficient
C)
consistent; inefficient
D) none
of the above
4) A
________ is an exchange rate quoted today for settlement at some time in the
future.
A) spot
rate
B)
forward rate
C)
currency rate
D) yield
curve
5)
Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current
nominal one-year interest rate in the U.S. is 5% and the comparable rate in
Britain is 6%, what is the approximate forward exchange rate for 360 days?
A)
£1.42/$
B)
£1.43/$
C)
£0.6993/$
D)
£0.7060/$
6)
Assume the current U.S. dollar-yen spot rate is 90 ¥/$. Further, the current
nominal 180-day rate of return in Japan is 1% and 2% in the United States. What
is the approximate forward exchange rate for 180 days?
A)
¥89.12/$
B)
¥89.55/$
C)
¥90.89/$
D)
¥90.45/$
7) The
current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange
rate is 127 ¥/$ then the yen is selling at a per annum ________ of ________.
A)
premium; 1.57%
B)
premium; 6.30%
C)
discount; 1.57%
D)
discount; 6.30%
8) The
theory of ________ states that the difference in the national interest rates
for securities of similar risk and maturity should be equal to but opposite in
sign to the forward rate discount or premium for the foreign currency, except
for transaction costs.
A)
international Fisher Effect
B) absolute
PPP
C)
interest rate parity
D) the
law of one price
9) With
covered interest arbitrage:
A) the
market must be out of equilibrium.
B) a
"riskless" arbitrage opportunity exists.
C) the
arbitrageur trades in both the spot and future currency exchange markets.
D) all
of the above
10)
Covered interest arbitrage moves the market ________ equilibrium because
________.
A)
toward; purchasing a currency on the spot market and selling in the forward
market narrows the differential between the two
B)
toward; investors are now more willing to invest in risky securities
C) away
from; purchasing a currency on the spot market and selling in the forward
market increases the differential between the two
D) away
from; demand for the stronger currency forces up interest rates on the weaker
security
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