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# Forward rates, law of one price

1. A currency trader has compiled the following currency quotes:

USD/EUR (\$/Euro USD/GBP (\$/£) JPY/USD (¥)
Spot rate \$1.2139 \$1.7730 115.674
6-month forward rate \$1.2067 \$1.7894 114.867

Which of the following statements regarding currencies is CORRECT?
A) The pound is strong relative to the dollar and the dollar is strong relative to the yen.
B) The euro is strong relative to the dollar and the yen is weak relative to the dollar.
C) The euro is weak relative to the dollar and the yen is strong relative to the dollar.
D) The dollar is strong relative to the pound and the dollar is weak relative to the euro.

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2. Mary Beth Morgan and Shaban Shoshi are currency traders for Mercury Forex Inc. They have compiled the following information concerning currencies in Sweden (SEK), New Zealand (NZD), and United States (USD).

SEK/USD USD/NZD
Spot bid rate 7.8927 \$0.6994
3-month forward bid rate 7.8780 \$0.7010
3-month forward ask rate 7.8794 \$0.7020

As they are reviewing the information in the currency quotes, Morgan states, "the Swedish Krona is trading at a forward premium, however that premium is less than 1 percent." Shoshi replies, I'll have to double check that, but it looks like the NZD is weak relative to the USD."
With regard to their statements:

A) Morgan's statement is correct; Shoshi's statement is correct.
B) Morgan's statement is incorrect; Shoshi's statement is incorrect.
C) Morgan's statement is correct; Shoshi's statement is incorrect.
D) Morgan's statement is incorrect; Shoshi's statement is correct.

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3. The law of one price applies with respect to:
A) relative PPP, but does not apply to absolute PPP.
B) both absolute and relative PPP.
C) absolute purchasing power parity (PPP), but does not apply to relative PPP. D) all competitive markets around the world efficiently.

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4.

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

Ackerman and Bos are asked to consider how transaction costs might affect an arbitrage opportunity. Starting with \$1,000, use ONLY the appropriate bid rates for the Euro/US\$ and the British pound/US\$, assume the Euro/British pound rate is 0.4000/Pound;, and assume transaction costs are 1.0 percent per transaction. What will be the profits from triangular arbitrage?

A) \$247.50.
B) \$245.02.
C) \$242.57.
D) \$212.87.

#### Solution Preview

1. A currency trader has compiled the following currency quotes:

USD/EUR (\$/Euro) USD/GBP (\$/£) JPY/USD (¥)
Spot rate \$1.2139 \$1.7730 115.674
6-month forward rate \$1.2067 \$1.7894 114.867

Which of the following statements regarding currencies is CORRECT?
A) The pound is strong relative to the dollar and the dollar is strong relative to the yen.
B) The euro is strong relative to the dollar and the yen is weak relative to the dollar.
C) The euro is weak relative to the dollar and the yen is strong relative to the dollar.
D) The dollar is strong relative to the pound and the dollar is weak relative to the euro.

Answer: C) The euro is weak relative to the dollar and the yen is strong relative to the dollar.

USD/EUR (\$/Euro): Spot: \$1.2139, Forward : \$1.2067 (Since forward < spot ; Base currency i.e.Euro is depreciating with respect to \$)
USD/GBP (\$/£): Spot: \$1.7730 , Forward : \$1.7894 (Since forward > spot ; Pound is appreciating with respect to \$)
JPY/USD (¥): Spot: 115.674 , Forward : 114.867 (Since ...

#### Solution Summary

Answers to 4 questions on Forward rates, law of one price.

\$2.19