Purchasing power parity, Interest rate parity

1. Smith knows that if the forward rate is lower than what interest rate parity indicates, the appropriate strategy would be to borrow:

A) pounds, convert to dollars at the spot rate, and lend the dollars.
B) pounds, convert to dollars at the forward rate, and lend the dollars.
C) dollars, convert to pounds at the forward rate, and lend the pounds.
D) dollars, convert to pounds at the spot rate, and lend the pounds.

2. Smith also knows that if the forward rate is higher than what interest rate parity indicates, the appropriate strategy would be borrow:

A) pounds, convert to dollars at the spot rate, and lend the dollars.
B) dollars, convert to pounds at the spot rate, and lend the pounds.
C) pounds, convert to dollars at the forward rate, and lend the dollars.
D) dollars, convert to pounds at the forward rate, and lend the pounds.

3. Now, suppose Smith has the following information available to him: the current spot exchange rate for Indian Rupees is $0.02046. Inflation over the next 5 years is expected to be 3 percent in the U.S. and 5 percent in India. Smith must calculate the U.S. Dollar / Indian Rupee expected future spot exchange rate in 5 years implied by purchasing power parity (PPP). The answer is:

A) $0.02010.
B) $0.02250.
C) $0.01858.
D) $0.01946.

4. Smith routinely calculates the expected spot rate for the Japanese Yen per U.S. dollar. He knows that the current spot exchange rate is $189.76 Yen/USD. He is also aware that the interest rates in Japan, Great Britain, and the U.S. are 8 percent, 4 percent, and 5 percent respectively. Calculate the expected spot rate for Yen/USD in a one year period.

A) 187.95 Yen / USD.
B) 189.76 Yen / USD.
C) 195.18 Yen / USD.
D) 184.49 Yen / USD.

5. Smith observes that the $/ spot exchange rate was 0.9857 two years ago. What does a comparison of the spot rate predicted by PPP with the current spot rate, i.e., 0.9808, tell us about changes in the relative cost advantage of U.S. exporters vs. German exporters? Since the spot rate predicted by the PPP relationship is:

A) $1.0615 per euro, U.S. exporters have a competitive advantage relative to German exporters.
B) $0.9153 per euro, U.S. exporters have a competitive disadvantage relative to German exporters.
C) $1.0615 per euro, U.S. exporters have a competitive disadvantage relative to German exporters.
D) $0.9153 per euro, U.S. exporters have a competitive advantage relative to German exporters.