MBA 7427 Sample Questions CH 5

Multiple Choice
Identify the choice that best completes the statement or answers the question.

____ 1. Interest Rate Parity (IRP) is best defined as:

a. when a government brings its domestic interest rate in line with other major
financial markets.
b. when the central bank of a country brings its domestic interest rate in line with its
major trading partners.
c. a zero arbitrage condition that must hold when international financial markets are
in equilibrium.
d.
None of these

____ 2. When Interest Rate Parity (IRP) holds between two different countries X and Y, your decision to
invest your money will:
a. be indifferent between country X and country Y
b. not involve forward hedging.
c. depend on which country initiated the IRP.
d. not involve the foreign exchange rates.

____ 3. When Interest Rate Parity (IRP) does not hold:

a. there is a high degree of inflation.
b. the financial markets are in equilibrium.
c. there are opportunities for covered interest arbitrage.
d. there are no opportunities for arbitrage.

____ 4. Covered Interest Arbitrage (CIA) activities will result in:

a. unstable international financial markets
b. restoration of equilibrium quite quickly.
c. disintermediation.
d. no changes in the markets.

____ 5. If U.S. nominal interest rate is lower than U.K. interest rate (assuming real interest rate stays same
between the countries), you can say that:
a. US$ is expected to depreciate.
b. US$ is expected to appreciate.
c. PPP is violated but RPPP may be satisfied.
d. RPPP is violated.

____ 6. Uncovered interest rate parity:

a. is an arbitrage condition.
b. holds most of the time.
c. is based on expectations.
d. will provide guaranteed but small profits.

____ 7. Deviations from interest rate parity exist for all of the following reasons except:
 a. transaction costs.
b. spreads.
c. interest rate differentials.
d. capital controls.
____ 8. 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 purchasing power of a currency sharply declines (due to hyperinflation) that
currency will appreciate against stable currencies.
c. the prices of standard commodity baskets in two countries are not related.
d. the exchange rate between currencies of two countries will not be equal to the ratio
of the countries' price levels.
____ 9. If the PPP is satisfied then:
a. the nominal exchange rate stays constant over time.
b. the nominal exchange rate may depreciate or appreciate over time but the rate of
this depreciation/appreciation stays constant.
c. SP*/P = 1, where S = nominal exchange rate, P* = foreign country price level, P =
home country price level.
d. SP*/P = constant (not necessary 1), where S = nominal exchange rate, P* = foreign
country price level, P = home country price level.
____ 10. Which statement about real exchange rates is not true?
a. Real exchange rate changes are caused by changes in nominal exchange rates.
b. Real exchange rates measure deviations from PPP.
c. Real exchange rates are always unity.
d. Real exchange rates affect the international competitive positions of countries.

____ 11. Germany has a higher rate of inflation than Japan. The nominal exchange rate is constant. In this
scenario, which of the following statement is true?
a. Germany experiences an increase in its real exchange rate.
b. Germany experiences a decrease in its real exchange rate.
c. Japan experiences an increase in its real exchange rate.
d. German goods are cheaper now.

____ 12. International Fisher Effect connects the expected depreciation or appreciation of the currency with:
a. Nominal interest rates.
b. Real interest rates.Inflation levels.
c. Inflation levels.
d. Forward exchange rate.

____ 13. Forward exchange rate.

a. uncovered interest rate parity.
b. covered interest rate parity
c. purchasing power parity.
d. efficient Fisher effect.
____ 14. According to the fundamental approach, if all of the regression coefficients are already estimated, all
of the following matters in the exchange rate determination except:
a. The expected rate of growth of domestic money.
b. The expected rate of growth of foreign money.
c. The historical rate of growth of domestic money.
d. The expected rate of real economic growth in the domestic economy.

____ 15. The main approaches to forecasting exchange rates are:

a. Efficient market, Fundamental, and Technical approaches.
b. Efficient market and Non-Technical approaches.
c. Efficient market and Fundamental approaches only.
d. Fundamental and Non-Technical approaches.

____ 16. If foreign exchange markets are efficient, all of the following will hold except:
a. Exchange rates change only when new information arrives.
b. Exchange rates change randomly
c. Incremental changes of exchange rates depend on the current level of the exchange
rate.
d. The current exchange rate reflects all relevant information.

____ 17. Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany,
and that the spot 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 or €892,857 (which is the
equivalent of $1,000,000 at the spot exchange rate of $1.12/€). The above mentioned scenario:
a. is an example of covered interest arbitrage (CIA), and interest rate parity (IRP)
holds.
b. is an example of covered interest arbitrage (CIA), and interest rate parity (IRP)
holds.
c. is an example of Purchasing Power Parity (PPP), and hyperinflation.
d. none of these

____ 18. The net cash flow in one year is

a. $10,690.
b. $15,873.
c. $46,207.
d. $21,964.

____ 19. Covered interest arbitrage would not be possible if the forward rate would be:
a. $1.1093/€.
b. $1.1248/€.
c. $1.1362/€.
d. $1.1611/€.

____ 20. If the annual inflation rate is 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. 0.07
b. 0.98
c. 1.05.
d. 1.20

____ 21. Canada's competitive position will:

a. strengthen when the dollar appreciates more than is warranted by PPP.
b. not be affected when the dollar appreciates more than is warranted by PPP.
c. weaken when the dollar appreciates more than is warranted by PPP.
d. weaken when the dollar depreciates more than is warranted by PPP.

____ 22. PPP does not hold well because of the following except:
a. barriers to international commodity arbitrage.
b. the existence of non-tradables.
c. commodity prices are different in different countries.
d. the CPI index is calculated using the same basket of goods.

____ 23. The forward expectations parity states that:

a. any forward premium or discount is equal to the expected change in the exchange
rate.
b. any forward rate is equal to the expected change in the exchange rate.
c. the forward premium or discount is equal to the expected change in the real
exchange rates.
d. the forward premium or discount is equal to the expected change in purchasing
power parity.
MBA 7427 Sample Questions CH 5
Answer Section

MULTIPLE CHOICE

1. ANS: C PTS: 1
2. ANS: A PTS: 1
3. ANS: C PTS: 1
4. ANS: B PTS: 1
5. ANS: B PTS: 1
6. ANS: C PTS: 1
7. ANS: C PTS: 1
8. ANS: A PTS: 1
9. ANS: C PTS: 1
10. ANS: C PTS: 1
11. ANS: A PTS: 1
12. ANS: A PTS: 1
13. ANS: A PTS: 1
14. ANS: C PTS: 1
15. ANS: A PTS: 1
16. ANS: C PTS: 1
17. ANS: B PTS: 1
18. ANS: D PTS: 1
19. ANS: C PTS: 1
20. ANS: B PTS: 1
21. ANS: C PTS: 1
22. ANS: D PTS: 1
23. ANS: A PTS: 1