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Multiple choice questions on currencies

1. Donna Ackerman, CFA, is an analyst in the currency trading department at State Bank. Ackerman is training a new hire, Fred Bos, a recent college graduate with a BA in economics.
Ackerman and Bos have the following information available to them:

Spot Rates
Euro/US\$ 1.0000 1.0015
British Pound/US\$ £2.0000 £2.0100

Ackerman and Bos are interested in pursuing profitable arbitrage opportunities for State Bank. Using the appropriate bid or ask rates for the Euro/US\$ and the British pound/US\$, and assuming the Euro/British pound rate is 0.4000/£, what will be the profits from triangular arbitrage, starting with \$1,000?

A) \$250.
B) \$1,250.
C) \$0.
D) \$243.78.

2. Now, Ackerman and Bos note there is a larger observed spread for British pounds versus Euros in the spot market. Which of the following statements is NOT consistent with this situation? Consider each statement individually.

A) The British pound is more volatile than the Euro.
B) The proportion of trading volume related to currency arbitrage is greater in the British pound than in the Euro.
C) Spot market transactions tend to be smaller on average in the British pound than in the Euro.
D) The total volume of spot market transactions is higher in the Euro than in the British pound.

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3.
? Spot bid rate: \$0.745
? 3-month forward bid rate: \$0.752
? 3-month forward ask rate: \$0.754
Which of the following statements concerning the currencies is CORRECT?

A) The AUD is selling at a forward discount of 4.83%.
B) The AUD is selling at a forward premium of 3.21%.
C) The USD is selling at a forward premium of 2.82%.
D) The AUD is selling at a forward premium of 4.83%

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4. Forward rates tend to:

A) be a biased predictor of future spot rates, but are generally effective as a forecasting tool.
B) be an unbiased predictor of future spot rates, but are generally not effective as a forecasting tool.
C) overestimate the value of future spot rates.
D) underestimate the value of future spot rates.

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5. John Dolan, CFA, is an international fund manager with the Borderless Fund. Dolan is considering an investment in the country of Kenya. He is concerned with the inflationary environment in Kenya, but he feels that it is mitigated by the degree of high economic growth over the next year. Based on his research, Dolan found that Kenya is expecting inflation rates of 17 percent while the European Economic Community is expecting 9 percent. The current exchange rate is 90.772 Kenyan Shillings (KS) per euro (EUR). Dolan assumes that relative purchasing power parity applies. If Dolan wants to compute an exchange rate at the end of the year so that he can use it for purposes of portfolio valuation, the closest exchange rate (KS/EUR) would be:

A) 97.4342 KS/EUR.
B) 84.5654 KS/EUR.
C) 106.2032 KS/EUR.
D) 98.9415 KS/EUR.
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6. Chao Wong, CFA, is the portfolio manager for the China Current Fund in Switzerland. The current spot exchange rate is 9.6246 Chinese yuan per euro. Wong believes that there is an opportunity to speculate on the Chinese yuan. Wong wants to check the one-year forward rate. Assuming the one-year risk-free rate for the European Economic Community is 11.76 percent and the Chinese one-year risk-free interest rate is 10.2 percent, what should the one-year forward rate be for the Chinese yuan?

A) 9.4903 CY/EUR.
B) 9.7608 CY/EUR.
C) 9.6246 CY/EUR.
D) 9.4884 CY/EUR.

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Solution Preview

1. Donna Ackerman, CFA, is an analyst in the currency trading department at State Bank. Ackerman is training a new hire, Fred Bos, a recent college graduate with a BA in economics.
Ackerman and Bos have the following information available to them:

Spot Rates
Euro/US\$ 1.0000 1.0015
British Pound/US\$ £2.0000 £2.0100

Ackerman and Bos are interested in pursuing profitable arbitrage opportunities for State Bank. Using the appropriate bid or ask rates for the Euro/US\$ and the British pound/US\$, and assuming the Euro/British pound rate is 0.4000/£, what will be the profits from triangular arbitrage, starting with \$1,000?

A) \$250.
B) \$1,250.
C) \$0.
D) \$243.78.

Convert \$ to Euro at the Euro/ US\$ bid price of 1.0000 = ? 1000

Convert ? 1000 to £ at the Euro/British pound rate is 0.4000/£ = ? 1000 / 0.4000 ? /£ = £2,500

Convert £2,500 back to \$ at the British Pound/US\$ ask rate of £2.0100 = £2,500 / £2.0100
= \$ 1243.78

Therefore, profits from triangular arbitrage = \$ 1,243.78 - \$1,000 = \$243.78

2. Now, Ackerman and Bos note there is a larger observed spread for British pounds versus Euros in the spot market. Which of the following statements is NOT consistent with this situation? Consider each statement individually.

A) The British pound is more volatile than the Euro.
B) The proportion of trading volume ...

Solution Summary

Answers to 6 multiple choice questions on currencies dealing with profits from triangular arbitrage, spread, bid rate, ask rate, Forward rates, exchange rate for portfolio valuation, interest rate parity.

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