$35.00

1) An arbitrage is best defined as

- A) a legal condition imposed by the CFTC.
- B) the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making reasonable profits.
- C) the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making certain guaranteed profits.
- D) none of the options

2) Interest Rate Parity (IRP) is best defined as

- A) occurring when a government brings its domestic interest rate in line with other major financial markets.
- B) occurring when the central bank of a country brings its domestic interest rate in line with its major trading partners.
- C) an arbitrage condition that must hold when international financial markets are in equilibrium.
- D) none of the options

3) When Interest Rate Parity (IRP) does not hold

- A) there is usually a high degree of inflation in at least one country.
- B) the financial markets are in equilibrium.
- C) there are opportunities for covered interest arbitrage.
- D) the financial markets are in equilibrium and there are opportunities for covered interest arbitrage.

4) Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 5% APR in the U.S. and 3% APR in the euro zone, what is the no-arbitrage 1-year forward rate?

- A) €1.0704/$
- B) $1.0704/€
- C) €1.0300/$
- D) $1.0300/€

5) Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 3 percent APR in the U.S. and 5 percent APR in the euro zone, what is the no-arbitrage 1-year forward rate?

- A) €1.0704/$
- B) $1.0704/€
- C) €1.0300/$
- D) $1.0300/€

6) Suppose you observe a spot exchange rate of $2.00/£. If interest rates are 5 percent APR in the U.S. and 2 percent APR in the U.K., what is the no-arbitrage 1-year forward rate?

- A) £2.0588/$
- B) $2.0588/£
- C) £1.9429/$
- D) $1.9429/£

7) A formal statement of IRP is

- A) = .
- B) = .
- C) = .
- D)
*F*($ / €) –*S*($ / €) = – .

8) Suppose that the one-year interest rate is 5.0 percent in the United States; the spot exchange rate is $1.20/€; and the one-year forward exchange rate is $1.16/€. What must the one-year interest rate be in the euro zone to avoid arbitrage?

- A) 5.0%
- B) 6.09%
- C) 8.62%
- D) none of the options

9) Suppose that the one-year interest rate is 3.0 percent in Italy, the spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.18/€. What must the one-year interest rate be in the United States?

- A) 1.2833%
- B) 1.0128%
- C) 4.75%
- D) none of the options

10) Suppose that the one-year interest rate is 4.0 percent in Italy, the spot exchange rate is $1.60/€, and the one-year forward exchange rate is $1.58/€. What must the one-year interest rate be in the United States?

- A) 2%
- B) 2.7%
- C) 5.32%
- D) none of the options

11) Covered Interest Arbitrage (CIA) activities will result in

- A) unstable international financial markets.
- B) restoring equilibrium prices quickly.
- C) a disintermediation.
- D) no effect on the market.

12) Suppose that the one-year 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 one-year forward exchange rate, is $1.16/€. Assume that an arbitrageur can borrow up to $1,000,000.

- A) This is an example where interest rate parity holds.
- B) This is an example of an arbitrage opportunity; interest rate parity does
*not* - C) This is an example of a Purchasing Power Parity violation and an arbitrage opportunity.
- D) none of the options

13) Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810 percent (that’s a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. The interest rate in Japan (on an investment of comparable risk) is 13 percent. What is your strategy?

- A) Take $1m, invest in U.S. T-bills.
- B) Take $1m, translate into yen at the spot, invest in Japan, and repatriate your yen earnings back into dollars at the spot rate prevailing in six months.
- C) Take $1m, translate into yen at the spot, invest in Japan, hedge with a short position in the forward contract.
- D) Take $1m, translate into yen at the forward rate, invest in Japan, hedge with a short position in the spot contract.

14) Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, and that the spot exchange rate is $1.60/€ and the forward exchange rate, with one-year maturity, is $1.58/€. Assume that an arbitrager can borrow up to $1,000,000 or €625,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?

- A) $238.65
- B) $14,000
- C) $46,207
- D) $7,000

15) A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is *i*$ = 2% and in the euro zone the one-year interest rate is *i*€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain profit via covered interest arbitrage.

- A) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at
*i*€= 6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600. - B) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit $2,400. - C) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit €2,000. - D) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400. Additionally, one may borrow €800,000 at*i*€ = 6%; translate to dollars at the spot, invest in the U.S. at*i*$ = 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000.

16) 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. If an astute trader finds an arbitrage, what is the net cash flow in one year?

- A) $10,690
- B) $15,000
- C) $46,207
- D) $21,964.29

17) A U.S.-based currency dealer has good credit and can borrow $1,000,000 for one year. The one-year interest rate in the U.S. is *i*$ = 2% and in the euro zone the one-year interest rate is *i*€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain dollar profit via covered interest arbitrage.

- A) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at
*i*€= 6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600. - B) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400. - C) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000. - D) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000. Alternatively, one could borrow €800,000 at*i*€ = 6%; translate to dollars at the spot, invest in the U.S. at*i*$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400.

18) An Italian currency dealer has good credit and can borrow €800,000 for one year. The one-year interest rate in the U.S. is *i*$ = 2% and in the euro zone the one-year interest rate is *i*€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain euro-denominated profit via covered interest arbitrage.

- A) Borrow $1,000,000 at 2%. Trade $1,000,000 for €800,000; invest at
*i*€= 6%; translate proceeds back at forward rate of $1.20 = €1.00, gross proceeds = $1,017,600. - B) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400. - C) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000. - D) Borrow €800,000 at
*i*€= 6%; translate to dollars at the spot, invest in the U.S. at*i*$= 2% for one year; translate €850,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is €2,000. Alternatively, one could borrow €800,000 at*i*€ = 6%; translate to dollars at the spot, invest in the U.S. at*i*$ = 2% for one year; translate €848,000 back into euro at the forward rate of $1.20 = €1.00. Net profit is $2,400.

19) Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (that’s a six month rate, not an annual rate) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. What must the interest rate in Japan (on an investment of comparable risk) be before you are willing to consider investing there for six months?

- A) 1.991 percent
- B) 1.12 percent
- C) 7.45 percent
- D) −7.45 percent

20) How high does the lending rate in the euro zone have to be before an arbitrageur would *not* consider borrowing dollars, trading for euro at the spot, investing in the euro zone and hedging with a short position in the forward contract?

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.40 – €1.00 | $1.43 – €1.00 | i$ | 4.20% APR | 4.10% APR | ||||

F360($/€) | $1.44 – €1.00 | $1.49 – €1.00 | i€ |

*A)*The bid-ask spreads are too wide for any profitable arbitrage when*i*€ > 0- B) 3.48%
- C) −2.09%
- D) none of the options

21) Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/€. What must the spot exchange rate be?

- A) $1.1768/€
- B) $1.1434/€
- C) $1.12/€
- D) none of the options

22) A higher U.S. interest rate (*i*$ ↑) relative to interest rates abroad, *ceteris paribus*, will result in

- A) a stronger dollar.
- B) a lower spot exchange rate (expressed as foreign currency per U.S. dollar).
- C) a stronger dollar and a lower spot exchange rate (expressed as foreign currency per U.S. dollar).
- D) none of the options

23) If the interest rate in the U.S. is *i*$ = 5 percent for the next year and interest rate in the U.K. is *i*£ = 8 percent for the next year, uncovered IRP suggests that

- A) the pound is expected to depreciate against the dollar by about 3 percent.
- B) the pound is expected to appreciate against the dollar by about 3 percent.
- C) the dollar is expected to appreciate against the pound by about 3 percent.
- D) the pound is expected to depreciate against the dollar by about 3 percent and the dollar is expected to appreciate against the pound by about 3 percent.

24) A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is *i*$ = 2% and in the euro zone the one-year interest rate is *i*€ = 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities?

- A) $1.2471 = €1.00
- B) $1.20 = €1.00
- C) $1.1547 = €1.00
- D) none of the options

25) Will an arbitrageur facing the following prices be able to make money?

Borrowing | Lending | Bid | Ask | |||||

$ | 5% | 4.5% | Spot | $1.00 = €1.00 | $1.01 = €1.00 | |||

€ | 6% | 5.5% | Forward | $0.99 = €1.00 | $1.00 = €1.00 |

- A) Yes, borrow $1,000 at 5 percent; trade for € at the ask spot rate $1.01 = €1.00; Invest €990.10 at 5.5 percent; hedge this with a forward contract on €1,044.55 at $0.99 = €1.00; receive $1.034.11.
- B) Yes, borrow €1,000 at 6 percent; trade for $ at the bid spot rate $1.00 = €1.00; invest $1,000 at 4.5 percent; hedge this with a forward contract on €1,045 at $1.00 = €1.00.
- C) No; the transactions costs are too high.
- D) none of the options

26) If IRP fails to hold,

- A) pressure from arbitrageurs should bring exchange rates and interest rates back into line.
- B) it may fail to hold due to transactions costs.
- C) it may be due to government-imposed capital controls.
- D) all of the options

27) Although IRP tends to hold, it may not hold precisely all the time

- A) due to transactions costs, like the bid-ask spread.
- B) due to asymmetric information.
- C) due to capital controls imposed by governments.
- D) due to transactions costs, like the bid-ask spread, as well as capital controls imposed by governments.

28) The interest rate at which the arbitrager borrows tends to be higher than the rate at which he lends, reflecting the

- A) transaction cost paradigm.
- B) midpoint.
- C) bid-ask spread.
- D) none of the options

29) Governments sometimes restrict capital flows, inbound and/or outbound. They achieve this objective by means of

- A) jawboning.
- B) imposing taxes.
- C) bans on cross-border capital movements.
- D) all of the options

30) Will an arbitrageur facing the following prices be able to make money?

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.40 – €1.00 | $1.43 – €1.00 | i$ | 4.20%APR | 4.10%APR | ||||

F360($/€) | $1.44 – €1.00 | $1.49 – €1.00 | i€ | 3.65%APR | 3.50%APR |

*A)*Yes, borrow €1,000,000 at 3.65 percent; trade for $ at the bid spot rate $1.40 = €1.00; invest at 4.1 percent; hedge this with a long position in a forward contract.- B) Yes, borrow $1,000,000 at 4.2 percent; trade for € at the spot ask exchange rate $1.43 = €1.00; invest €699,300.70 at 3.5 percent; hedge this by going SHORT in forward (agree to sell € @ BID price of $1.44/€ in one year). Cash flow in 1 year $237.76.
- C) No; the transactions costs are too high.
- D) none of the options

31) If a foreign county experiences a hyperinflation,

- A) its currency will depreciate against stable currencies.
- B) its currency may appreciate against stable currencies.
- C) its currency may be unaffected-it’s difficult to say.
- D) none of the options

32) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the one-year forward rate that should prevail?

- A) €1.00 = $1.2379
- B) €1.00 = $1.2623
- C) €1.00 = $0.9903
- D) $1.00 = €1.2623

33) 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 depreciate 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 should be equal to the ratio of the countries’ price levels, and as the purchasing power of a currency sharply declines (due to hyperinflation) that currency will depreciate against stable currencies.

34) As of today, the spot exchange rate is €1.00 = $1.60 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the one-year forward rate that should prevail?

- A) €1.00 = $1.6157
- B) €1.6157 = $1.00
- C) €1.00 = $1.5845
- D) $1.00 × 1.03 = €1.60 × 1.02

35) 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) 0.9849.
- C) −0.0198.
- D) 4.5.

36) If the annual inflation rate is 2.5 percent in the United States and 4 percent in the U.K., and the dollar appreciated against the pound by 1.5 percent, then the real exchange rate, assuming that PPP initially held, is ________.

- A) parity
- B) 0.9710
- C) −0.0198
- D) 4.5

37) In view of the fact that PPP is the manifestation of the law of one price applied to a standard commodity basket,

- A) it will hold only if the prices of the constituent commodities are equalized across countries in a given currency.
- B) it will hold only if the composition of the consumption basket is the same across countries.
- C) it will hold only if the prices of the constituent commodities are equalized across countries in a given currency or if the composition of the consumption basket is the same across countries.
- D) none of the options

38) Some commodities never enter into international trade. Examples include

- A) nontradables.
- B) haircuts.
- C) housing.
- D) all of the options

39) Generally unfavorable evidence on PPP suggests that

- A) substantial barriers to international commodity arbitrage exist.
- B) tariffs and quotas imposed on international trade can explain at least some of the evidence.
- C) shipping costs can make it difficult to directly compare commodity prices.
- D) all of the options

40) The price of a McDonald’s Big Mac sandwich

- A) is about the same in the 120 countries that McDonalds does business in.
- B) varies considerably across the world in dollar terms.
- C) supports PPP.
- D) none of the options.

41) The Fisher effect can be written for the United States as:

*i*$=*ρ*$+*E*(π$) +*ρ*$ ×*E*(π$)

*ρ*$=*i*$+*E*(π$) +*i*$ ×*E*(π$)*q*=- =
- A) Option A
- B) Option B
- C) Option C
- D) Option D

42) Forward parity states that

- A) any forward premium or discount is equal to the expected change in the exchange rate.
- B) any forward premium or discount is equal to the actual change in the exchange rate.
- C) the nominal interest rate differential reflects the expected change in the exchange rate.
- D) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.

43) The International Fisher Effect suggests that

- A) any forward premium or discount is equal to the expected change in the exchange rate.
- B) any forward premium or discount is equal to the actual change in the exchange rate.
- C) the nominal interest rate differential reflects the expected change in the exchange rate.
- D) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.

44) The Fisher effect states that

- A) any forward premium or discount is equal to the expected change in the exchange rate.
- B) any forward premium or discount is equal to the actual change in the exchange rate.
- C) the nominal interest rate differential reflects the expected change in the exchange rate.
- D) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.

45) Decision-making for multinational corporations formulating international sourcing, production, financing, and marketing strategies depends, primarily, on

- A) risk management techniques.
- B) expertise of staff attorneys.
- C) luck.
- D) forecasting exchange rates as accurately as possible.

46) The main approaches to forecasting exchange rates are

- A) Efficient market, Fundamental, and Technical approaches.
- B) Efficient market and Technical approaches.
- C) Efficient market and Fundamental approaches.
- D) Fundamental and Technical approaches.

47) The benefit to forecasting exchange rates

- A) are greatest during periods of fixed exchange rates.
- B) are nonexistent now that the euro and dollar are the biggest game in town.
- C) accrue to, and are a vital concern for, MNCs formulating international sourcing, production, financing, and marketing strategies.
- D) all of the options

48) The Efficient Markets Hypothesis states

- A) markets tend to evolve to low transactions costs and speedy execution of orders.
- B) current asset prices (e.g., exchange rates) fully reflect all the available and relevant information.
- C) current exchange rates cannot be explained by such fundamental forces as money supplies, inflation rates and so forth.
- D) none of the options

49) Good, inexpensive, and fairly reliable predictors of future exchange rates include

- A) today’s exchange rate.
- B) current forward exchange rates (e.g., the six-month forward rate is a pretty good predictor of the spot rate that will prevail six months from today).
- C) esoteric fundamental models that take an econometrician to use and no one can explain.
- D) today’s exchange rate, as well as current forward exchange rates (e.g. the six-month forward rate is a pretty good predictor of the spot rate that will prevail six months from today).

50) Which of the following is a true statement?

- A) While researchers found it difficult to reject the random walk hypothesis for exchange rates on empirical grounds, there is no theoretical reason why exchange rates should follow a pure random walk.
- B) While researchers found it easy to reject the random walk hypothesis for exchange rates on empirical grounds, there are strong theoretical reasons why exchange rates should follow a pure random walk.
- C) While researchers found it difficult to reject the random walk hypothesis for exchange rates on empirical grounds, there are compelling theoretical reasons why exchange rates should follow a pure random walk.
- D) none of the options

51) If the exchange rate follows a *random walk*

*A)*the future exchange rate is unpredictable.- B) the future exchange rate is expected to be the same as the current exchange rate,
*St*=*E*(*St*+ 1). - C) the best predictor of future exchange rates is the forward rate
*Ft*=*E*(*St*+ 1/*It*). - D) the future exchange rate is expected to be the same as the current exchange rate,
*St*=*E*(*St*+ 1), and the best predictor of future exchange rates is the forward rate*Ft*=*E*(*St*+ 1/*It*).

52) One implication of the random walk hypothesis is

- A) given the efficiency of foreign exchange markets, it is difficult to outperform the market-based forecasts unless the forecaster has access to private information that is not yet reflected in the current exchange rate.
- B) given the efficiency of foreign exchange markets, it is difficult to outperform the market-based forecasts unless the forecaster has access to private information that is already reflected in the current exchange rate.
- C) given the relative inefficiency of foreign exchange markets, it is difficult to outperform the technical forecasts unless the forecaster has access to private information that is not yet reflected in the current futures exchange rate.
- D) none of the options

53) The random walk hypothesis suggests that

- A) the best predictor of the future exchange rate is the current exchange rate.
- B) the best predictor of the future exchange rate is the current forward rate.
- C) the best predictors of the future exchange rate are the current exchange rate and the current forward rate.
- D) none of the options

54) With regard to fundamental forecasting versus technical forecasting of exchange rates

- A) the technicians tend to use “cause and effect” models.
- B) the fundamentalists tend to believe that “history will repeat itself” is the best model.
- C) the technicians tend to use “cause and effect” models and the fundamentalists tend to believe that “history will repeat itself” is the best model.
- D) none of the options

55) Generating exchange rate forecasts with the fundamental approach involves

- A) looking at charts of the exchange rate and extrapolating the patterns into the future.
- B) estimation of a
*structural model.* *C)*substituting the estimated values of the independent variables into the estimated structural model to generate the forecast.- D) estimation of a
*structural model*and substitution of the estimated values of the independent variables into the estimated structural model to generate the forecast.

56) Which of the following issues are difficulties for the fundamental approach to exchange rate forecasting?

- A) One has to forecast a set of independent variables to forecast the exchange rates. Forecasting the former will certainly be subject to errors and may not be necessarily easier than forecasting the latter.
- B) The parameter values, that is the α’s and β’s, that are estimated using historical data may change over time because of changes in government policies and/or the underlying structure of the economy. Either difficulty can diminish the accuracy of forecasts even if the model is correct.
- C) The model itself can be wrong.
- D) none of the options

57) Researchers have found that the fundamental approach to exchange rate forecasting

- A) outperforms the efficient market approach.
- B) fails to more accurately forecast exchange rates than either the random walk model or the forward rate model.
- C) fails to more accurately forecast exchange rates than the random walk model but is better than the forward rate model.
- D) outperforms the random walk model, but fails to more accurately forecast exchange rates than the forward rate model.

58) Academic studies tend to discredit the validity of technical analysis. Which of the following is true?

- A) This can be viewed as support technical analysis.
- B) It can be rational for individual traders to use technical analysis—if enough traders use technical analysis the predictions based on it can become self-fulfilling to some extent, at least in the short-run.
- C) The statement can be explained by the difficulty professors may have in differentiating between technical analysis and fundamental analysis.
- D) none of the options

59) The moving average crossover rule

- A) is a fundamental approach to forecasting exchange rates.
- B) states that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is appreciating.
- C) states that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is depreciating.
- D) none of the options

60) According to the technical approach, what matters in exchange rate determination

- A) is the past behavior of exchange rates.
- B) is the velocity of money.
- C) is the future behavior of exchange rates.
- D) is the beta.

61) Studies of the accuracy of paid exchange rate forecasters

- A) tend to support the view that “you get what you pay for”.
- B) tend to support the view that forecasting is easy, at least with regard to major currencies like the euro and Japanese yen.
- C) tend to support the view that banks do their best forecasting with the yen.
- D) none of the options

62) According to the research in the accuracy of paid exchange rate forecasters,

- A) as a group, they do not do a better job of forecasting the exchange rate than the forward rate does.
- B) the average forecaster is better than average at forecasting.
- C) the forecasters do a better job of predicting the future exchange rate than the market does.
- D) none of the options

63) According to the research in the accuracy of paid exchange rate forecasters,

- A) you can make more money selling forecasts than you can following forecasts.
- B) the average forecaster is better than average at forecasting.
- C) the forecasters do a better job of predicting the future exchange rates than the market does.
- D) none of the above.

64) According to the monetary approach, what matters in exchange rate determination are

- A) the relative money supplies.
- B) the relative velocities of monies.
- C) the relative national outputs.
- D) all of the options

65) According to the monetary approach, the exchange rate can be expressed as

- A)
*S*= × × - B) =
- C)
*S*= × × - D) none of the options

66) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.60 | = | € | 1.00 | i$ | 2 | % | |||||||

F360($/€) | $ | 1.58 | = | € | 1.00 | i€ | 4 | % | |||||||

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

67) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.60 | = | € | 1.00 | i$ | 2 | % | |||||||

F360($/€) | $ | 1.58 | = | € | 1.00 | i€ | 4 | % | |||||||

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

68) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.60 | = | € | 1.00 | i$ | 2 | % | |||||||

F360($/€) | $ | 1.58 | = | € | 1.00 | i€ | 4 | % | |||||||

If you had borrowed $1,000,000 and traded for euro at the spot rate, how many € do you receive?

69) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.60 | = | € | 1.00 | i$ | 2 | % | |||||||

F360($/€) | $ | 1.58 | = | € | 1.00 | i€ | 4 | % | |||||||

If you had €1,000,000 and traded it for USD at the spot rate, how many USD will you get?

70) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | |||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | i€ | 3 | % | |||||||

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

71) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | |||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | i€ | 3 | % | |||||||

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

72) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | |||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | i€ | 3 | % | |||||||

If you had borrowed $1,000,000 and traded for euro at the spot rate, how many € do you receive?

73) Use the information below to answer the following question.

Exchange Rate | Interest Rate | APR | |||||||||||||

S0($/€) | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | |||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | i€ | 3 | % | |||||||

If you had €1,000,000 and traded it for USD at the spot rate, how many USD will you get?

74) Assume that you are a retail customer (i.e., you buy at the ask and sell at the bid). Use the information below to answer the following question.

Bid | Ask | APR | |||||||||||||||||||||||||||

S0($/€) | $ | 1.42 | = | € | 1.00 | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | ||||||||||||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | $ | 1.50 | = | € | 1.00 | i€ | 3 | % | ||||||||||||||||

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

75) Assume that you are a retail customer (i.e., you buy at the ask and sell at the bid). Use the information below to answer the following question.

Bid | Ask | APR | |||||||||||||||||||||||||||

S0($/€) | $ | 1.42 | = | € | 1.00 | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | ||||||||||||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | $ | 1.50 | = | € | 1.00 | i€ | 3 | % | ||||||||||||||||

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

76) Assume that you are a retail customer (i.e., you buy at the ask and sell at the bid). Use the information below to answer the following question.

Bid | Ask | APR | |||||||||||||||||||||||||||

S0($/€) | $ | 1.42 | = | € | 1.00 | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | ||||||||||||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | $ | 1.50 | = | € | 1.00 | i€ | 3 | % | ||||||||||||||||

If you had borrowed $1,000,000 and traded for euro at the spot rate, how many € do you receive?

77) Assume that you are a retail customer (i.e., you buy at the ask and sell at the bid). Use the information below to answer the following question.

Bid | Ask | APR | |||||||||||||||||||||||||||

S0($/€) | $ | 1.42 | = | € | 1.00 | $ | 1.45 | = | € | 1.00 | i$ | 4 | % | ||||||||||||||||

F360($/€) | $ | 1.48 | = | € | 1.00 | $ | 1.50 | = | € | 1.00 | i€ | 3 | % | ||||||||||||||||

If you had €1,000,000 and traded it for USD at the spot rate, how many USD will you get?

78) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.42 = €1.00 | $1.45 = €1.00 | i$ | 4.25% APR | 4% APR | ||||

F360($/€) | $1.48 = €1.00 | $1.50 = €1.00 | i€ | 3.10% APR | 3% APR |

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

79) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.42 = €1.00 | $1.45 = €1.00 | i$ | 4.25% APR | 4% APR | ||||

F360($/€) | $1.48 = €1.00 | $1.50 = €1.00 | i€ | 3.10% APR | 3% APR |

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

80) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.42 = €1.00 | $1.45 = €1.00 | i$ | 4.25% APR | 4% APR | ||||

F360($/€) | $1.48 = €1.00 | $1.50 = €1.00 | i€ | 3.10% APR | 3% APR |

If you had borrowed $1,000,000 and traded for euro at the spot rate, how many € do you receive?

81) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.42 = €1.00 | $1.45 = €1.00 | i$ | 4.25% APR | 4% APR | ||||

F360($/€) | $1.48 = €1.00 | $1.50 = €1.00 | i€ | 3.10% APR | 3% APR |

If you had €1,000,000 and traded it for USD at the spot rate, how many USD will you get?

82) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.40 = €1.00 | $1.43 = €1.00 | i$ | 4.20% APR | 4.10% APR | ||||

F360($/€) | $1.44 = €1.00 | $1.49 = €1.00 | i€ | 3.65% APR | 3.50% APR |

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

83) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.40 = €1.00 | $1.43 = €1.00 | i$ | 4.20% APR | 4.10% APR | ||||

F360($/€) | $1.44 = €1.00 | $1.49 = €1.00 | i€ | 3.65% APR | 3.50% APR |

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

84) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.40 = €1.00 | $1.43 = €1.00 | i$ | 4.20% APR | 4.10% APR | ||||

F360($/€) | $1.44 = €1.00 | $1.49 = €1.00 | i€ | 3.65% APR | 3.50% APR |

If you had borrowed $1,000,000 and traded for euro at the spot rate, how many € do you receive?

85) Assume that you are a retail customer. Use the information below to answer the following question.

Bid | Ask | Borrowing | Lending | ||||||

S0($/€) | $1.40 = €1.00 | $1.43 = €1.00 | i$ | 4.20% APR | 4.10% APR | ||||

F360($/€) | $1.44 = €1.00 | $1.49 = €1.00 | i€ | 3.65% APR | 3.50% APR |

If you had €1,000,000 and traded it for USD at the spot rate, how many USD will you get?

*International Financial Management, 8e* (Eun)

**Chapter 7 Futures and Options on Foreign Exchange**

1)A put option on $15,000 with a strike price of €10,000 is the same thing as a call option on €10,000 with a strike price of $15,000.

2) A CME contract on €125,000 with September delivery

- A) is an example of a forward contract.
- B) is an example of a futures contract.
- C) is an example of a put option.
- D) is an example of a call option.

3) Yesterday, you entered into a futures contract to buy €62,500 at $1.50 per €. Suppose the futures price closes today at $1.46. How much have you made/lost?

- A) Depends on your margin balance.
- B) You have made $2,500.00.
- C) You have lost $2,500.00.
- D) You have neither made nor lost money, yet.

4) In reference to the futures market, a “speculator”

- A) attempts to profit from a change in the futures price.
- B) wants to avoid price variation by locking in a purchase price of the underlying asset through a long position in the futures contract or a sales price through a short position in the futures contract.
- C) stands ready to buy or sell contracts in unlimited quantity.
- D) wants to avoid price variation by locking in a purchase price of the underlying asset through a long position in the futures contract or a sales price through a short position in the futures contract, and also stands ready to buy or sell contracts in unlimited quantity.

5) Comparing “forward” and “futures” exchange contracts, we can say that

- A) they are both “marked-to-market” daily.
- B) their major difference is in the way the underlying asset is priced for future purchase or sale: futures settle daily and forwards settle at maturity.
- C) a futures contract is negotiated by open outcry between floor brokers or traders and is traded on organized exchanges, while forward contract is tailor-made by an international bank for its clients and is traded OTC.
- D) their major difference is in the way the underlying asset is priced for future purchase or sale: futures settle daily and forwards settle at maturity, and a futures contract is negotiated by open outcry between floor brokers or traders and is traded on organized exchanges, while a forward contract is tailor-made by an international bank for its clients and is traded OTC.

6) Comparing “forward” and “futures” exchange contracts, we can say that

- A) delivery of the underlying asset is seldom made in futures contracts.
- B) delivery of the underlying asset is usually made in forward contracts.
- C) delivery of the underlying asset is seldom made in either contract—they are typically cash settled at maturity.
- D) delivery of the underlying asset is seldom made in futures contracts and delivery of the underlying asset is usually made in forward contracts.

7) In which market does a clearinghouse serve as a third party to all transactions?

- A) Futures
- B) Forwards
- C) Swaps
- D) none of the options

8) In the event of a default on one side of a futures trade,

- A) the clearing member stands in for the defaulting party.
- B) the clearing member will seek restitution for the defaulting party.
- C) if the default is on the short side, a randomly selected long contract will not get paid. That party will then have standing to initiate a civil suit against the defaulting short.
- D) the clearing member stands in for the defaulting party and will seek restitution for the defaulting party.

9) Yesterday, you entered into a futures contract to buy €62,500 at $1.50 per €. Your initial performance bond is $1,500 and your maintenance level is $500. At what settle price will you get a demand for additional funds to be posted?

- A) $1.5160 per €.
- B) $1.208 per €.
- C) $1.1920 per €.
- D) $1.4840 per €.

10) Yesterday, you entered into a futures contract to sell €75,000 at $1.79 per €. Your initial performance bond is $1,500 and your maintenance level is $500. At what settle price will you get a demand for additional funds to be posted?

- A) $1.7767 per €.
- B) $1.2084 per €.
- C) $1.6676 per €.
- D) $1.1840 per €.

11) Yesterday, you entered into a futures contract to buy €62,500 at $1.50/€. Your initial margin was $3,750 (= 0.04 × €62,500 × $1.50/€ = 4 percent of the contract value in dollars). Your maintenance margin is $2,000 (meaning that your broker leaves you alone until your account balance falls to $2,000). At what settle price (use 4 decimal places) do you get a margin call?

- A) $1.4720/€
- B) $1.5280/€
- C) $1.500/€
- D) none of the options

12) Three days ago, you entered into a futures contract to sell €62,500 at $1.50 per €. Over the past three days the contract has settled at $1.50, $1.52, and $1.54. How much have you made or lost?

- A) Lost $0.04 per € or $2,500
- B) Made $0.04 per € or $2,500
- C) Lost $0.06 per € or $3,750
- D) none of the options

13) Today’s settlement price on a Chicago Mercantile Exchange (CME) yen futures contract is $0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days’ settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of one CME yen contract is ¥12,500,000). If you have a short position in one futures contract, the changes in the margin account from daily marking-to-market will result in the balance of the margin account after the third day to be

- A) $1,425.
- B) $2,000.
- C) $2,325.
- D) $3,425.

14) Today’s settlement price on a Chicago Mercantile Exchange (CME) yen futures contract is $0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days’ settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of one CME yen contract is ¥12,500,000). If you have a long position in one futures contract, the changes in the margin account from daily marking-to-market, will result in the balance of the margin account after the third day to be

- A) $1,425.
- B) $1,675.
- C) $2,000.
- D) $3,425

15) Suppose the futures price is below the price predicted by IRP. What steps would assure an arbitrage profit?

- A) Go short in the spot market, go long in the futures contract.
- B) Go long in the spot market, go short in the futures contract.
- C) Go short in the spot market, go short in the futures contract.
- D) Go long in the spot market, go long in the futures contract.

16) What paradigm is used to define the futures price?

- A) IRP
- B) Hedge Ratio
- C) Black Scholes
- D) Risk Neutral Valuation

17) Suppose you observe the following one-year interest rates, spot exchange rates and futures prices. Futures contracts are available on €10,000. How much risk-free arbitrage profit could you make on one contract at maturity from this mispricing?

Exchange Rate | Interest Rate | APR | ||||

S0($/€) | $1.45 = €1.00 | i$ | 4% | |||

F360($/€) | $1.48 = €1.00 | i€ | 3% |

- A) $159.22
- B) $153.10
- C) $439.42
- D) none of the options

18) Which equation is used to define the futures price?

- A) =
- B) =
- C) =
- D)
*F*($ / €) –*S*($ / €) = –

19) Which equation is used to define the futures price?

- A) =
- B) =
- C) =
- D) =

20) If a currency futures contract (direct quote) is priced below the price implied by Interest Rate Parity (IRP), arbitrageurs could take advantage of the mispricing by simultaneously

- A) going short in the futures contract, borrowing in the domestic currency, and going long in the foreign currency in the spot market.
- B) going short in the futures contract, lending in the domestic currency, and going long in the foreign currency in the spot market.
- C) going long in the futures contract, borrowing in the domestic currency, and going short in the foreign currency in the spot market.
- D) going long in the futures contract, borrowing in the foreign currency, and going long in the domestic currency, investing the proceeds at the local rate of interest.

21) Open interest in currency futures contracts

- A) tends to be greatest for the near-term contracts.
- B) tends to be greatest for the longer-term contracts.
- C) typically decreases with the term to maturity of most futures contracts.
- D) tends to be greatest for the near-term contracts, and typically decreases with the term to maturity of most futures contracts.

22) The “open interest” shown in currency futures quotations is

- A) the total number of people indicating interest in buying the contracts in the near future.
- B) the total number of people indicating interest in selling the contracts in the near future.
- C) the total number of people indicating interest in buying or selling the contracts in the near future.
- D) the total number of long or short contracts outstanding for the particular delivery month.

23) If you think that the dollar is going to appreciate against the euro, you should

- A) buy put options on the euro.
- B) sell call options on the euro.
- C) buy call options on the euro.
- D) none of the options

24) From the perspective of the writer of a put option written on €62,500. If the strike price is $1.55/€, and the option premium is $1,875, at what exchange rate do you start to lose money?

- A) $1.52/€
- B) $1.55/€
- C) $1.58/€
- D) none of the options

25) A European option is different from an American option in that

- A) one is traded in Europe and one in traded in the United States.
- B) European options can only be exercised at maturity; American options can be exercised prior to maturity.
- C) European options tend to be worth more than American options,
*ceteris paribus*. - D) American options have a fixed exercise price; European options’ exercise price is set at the average price of the underlying asset during the life of the option.

26) An “option” is

- A) a contract giving the seller (writer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future.
- B) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future.
- C) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put) or sell (call) a given quantity of an asset at a specified price at some time in the future.
- D) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put) or sell (sell) a given quantity of an asset at a specified price at some time in the future.

27) An investor believes that the price of a stock, say IBM’s shares, will increase in the next 60 days. If the investor is correct, which combination of the following investment strategies will show a profit in all the choices?

(i) buy the stock and hold it for 60 days

(ii) buy a put option

(iii) sell (write) a call option

(iv) buy a call option

(v) sell (write) a put option

- A) (i), (ii), and (iii)
- B) (i), (ii), and (iv)
- C) (i), (iv), and (v)
- D) (ii) and (iii)

28) Most exchange traded currency options

- A) mature every month, with daily resettlement.
- B) have original maturities of 1, 2, and 3 years.
- C) have original maturities of 3, 6, 9, and 12 months.
- D) mature every month, without daily resettlement.

29) The volume of OTC currency options trading is

- A) much smaller than that of organized-exchange currency option trading.
- B) much larger than that of organized-exchange currency option trading.
- C) larger, because the exchanges are only repackaging OTC options for their customers.
- D) none of the options

30) In the CURRENCY TRADING section of *The Wall Street Journal*, the following appeared under the heading OPTIONS:

Philadelphia Exchange | Puts | ||

Swiss France | 69.33 | ||

62,500 Swiss Francs-cents per unit | Vol. | Last | |

68 May | 12 | 0.30 | |

69 May | 50 | 0.50 |

Which combination of the following statements are true?

(i) The time values of the 68 May and 69 May put options are respectively .30 cents and .50 cents.

(ii) The 68 May put option has a lower time value (price) than the 69 May put option.

(iii) If everything else is kept constant, the spot price and the put premium are inversely related.

(iv) The time values of the 68 May and 69 May put options are, respectively, 1.63 cents and 0.83 cents.

(v) If everything else is kept constant, the strike price and the put premium are inversely related.

- A) (i), (ii), and (iii)
- B) (ii), (iii), and (iv)
- C) (iii) and (iv)
- D) (iv) and (v)

31) With currency futures options the underlying asset is

- A) foreign currency.
- B) a call or put option written on foreign currency.
- C) a futures contract on the foreign currency.
- D) none of the options

32) Exercise of a currency futures option results in

- A) a long futures position for the call buyer or put writer.
- B) a short futures position for the call buyer or put writer.
- C) a long futures position for the put buyer or call writer.
- D) a short futures position for the call buyer or put buyer.

33) A currency futures option amounts to a derivative on a derivative. Why would something like that exist?

- A) For some assets, the futures contract can have lower transaction costs and greater liquidity than the underlying asset.
- B) Tax consequences matter as well, and for some users an option contract on a future is more tax efficient.
- C) Transaction costs and liquidity
- D) all of the options

34) The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500. For this option to be considered at-the-money, the strike price must be

- A) $1.60 = €1.00.
- B) $1.55 = €1.00.
- C) $1.55 × = €1.00 × .
- D) none of the options

35) The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. Immediate exercise of this option will generate a profit of

- A) $6,125.
- B) $6,125/(1 + )3/12.
- C) negative profit, so exercise would not occur.
- D) $3,125.

36) The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. If you pay an option premium of $5,000 to buy this call, at what exchange rate will you break-even?

- A) $1.58 = €1.00
- B) $1.62 = €1.00
- C) $1.50 = €1.00
- D) $1.68 = €1.00

37) Consider this graph of a call option. The option is a three-month American call option on €62,500 with a strike price of $1.50 = €1.00 and an option premium of $3,125. What are the values of A, B, and C, respectively?

- A) A = $3,125 (or $.05 depending on your scale); B = $1.50; C = $1.55
- B) A = €3,750 (or €.06 depending on your scale); B = $1.50; C = $1.55
- C) A = $.05; B = $1.55; C = $1.60
- D) none of the options

38) Which of the lines is a graph of the profit at maturity of writing a call option on €62,500 with a strike price of $1.20 = €1.00 and an option premium of $3,125?

- A) A
- B) B
- C) C
- D) D

39) The current spot exchange rate is $1.55 = €1.00; the three-month U.S. dollar interest rate is 2 percent. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. What is the least that this option should sell for?

- A) $0.05 × 62,500 = $3,125
- B) $3,125/1.02 = $3,063.73
- C) $0.00
- D) none of the options

40) Which of the follow options strategies are consistent in their belief about the future behavior of the underlying asset price?

- A) Selling calls and selling puts
- B) Buying calls and buying puts
- C) Buying calls and selling puts
- D) none of the options

41) American call and put premiums

- A) should be at least as large as their intrinsic value.
- B) should be no larger than their intrinsic value.
- C) should be exactly equal to their time value.
- D) should be no larger than their speculative value.

42) Which of the following is correct?

- A) Time value = intrinsic value + option premium
- B) Intrinsic value = option premium + time value
- C) Option premium = intrinsic value – time value
- D) Option premium = intrinsic value + time value

43) Which of the following is correct?

- A) European options can be exercised early.
- B) American options can be exercised early.
- C) Asian options can be exercised early.
- D) all of the options

44) Assume that the dollar–euro spot rate is $1.28 and the six-month forward rate is = $1.28= $1.2864*. *The six-month U.S. dollar rate is 5 percent and the Eurodollar rate is 4 percent. The minimum price that a six-month American call option with a striking price of $1.25 should sell for in a rational market is

- A) 0 cents.
- B) 3.47 cents.
- C) 3.55 cents.
- D) 3 cents.

45) For European options, what is the effect of an increase in *St*?

- A) Decrease the value of calls and puts
*ceteris paribus* *B)*Increase the value of calls and puts*ceteris paribus**C)*Decrease the value of calls, increase the value of puts*ceteris paribus**D)*Increase the value of calls, decrease the value of puts*ceteris paribus*

46)For an American call option, A and B in the graph are

- A) time value and intrinsic value.
- B) intrinsic value and time value.
- C) in-the-money and out-of-the money.
- D) none of the options

47) For European options, what is the effect of an *increase* in the strike price *E*?

- A) Decrease the value of calls and puts
*ceteris paribus* - B) Increase the value of calls and puts
*ceteris paribus*

C)Decrease the value of calls, increase the value of puts *ceteris paribus*

D)Increase the value of calls, decrease the value of puts *ceteris paribus*

48)For European currency options written on euro with a strike price in dollars, what is the effect of an increase in *r*$ relative to *r*€?

- A) Decrease the value of calls and puts
*ceteris paribus* - B) Increase the value of calls and puts
*ceteris paribus*

C)Decrease the value of calls, increase the value of puts *ceteris paribus*

D)Increase the value of calls, decrease the value of puts *ceteris paribus*

49)For European currency options written on euro with a strike price in dollars, what is the effect of an increase in *r*$?

- A) Decrease the value of calls and puts
*ceteris paribus*

B)Increase the value of calls and puts *ceteris paribus*

C)Decrease the value of calls, increase the value of puts *ceteris paribus*

- D) Increase the value of calls, decrease the value of puts
*ceteris paribus*

50) For European currency options written on euro with a strike price in dollars, what is the effect of an increase in *r*€?

- A) Decrease the value of calls and puts
*ceteris paribus* - B) Increase the value of calls and puts
*ceteris paribus* - C) Decrease the value of calls, increase the value of puts
*ceteris paribus*

D)Increase the value of calls, decrease the value of puts *ceteris paribus*

51)For European currency options written on euro with a strike price in dollars, what is the effect of an increase in the exchange rate S($/€)?

- A) Decreases the value of calls and puts
*ceteris paribus*

B)Increases the value of calls and puts *ceteris paribus*

C)Decreases the value of calls, increases the value of puts *ceteris paribus*

D)Increases the value of calls, decreases the value of puts *ceteris paribus*

52)For European currency options written on euro with a strike price in dollars, what is the effect of an *increase* in the exchange rate S(€/$)?

- A) Decreases the value of calls and puts
*ceteris paribus* - B) Increases the value of calls and puts
*ceteris paribus*

C)Decreases the value of calls, increases the value of puts *ceteris paribus*

- D) Increases the value of calls, decreases the value of puts
*ceteris paribus*

*53) *The hedge ratio

- A) Is the size of the long (short) position the investor must have in the underlying asset per option the investor must write (buy) to have a risk-free offsetting investment that will result in the investor perfectly hedging the option.
- B)
- C) Is related to the number of options that an investor can write without unlimited loss while holding a certain amount of the underlying asset.
- D) all of the options

54) Find the value of a call option written on €100 with a strike price of $1.00 = €1.00. In one period, there are two possibilities: the exchange rate will move up by 15 percent or down by 15 percent (i.e. $1.15 = €1.00 or $0.85 = €1.00). The U.S. risk-free rate is 5 percent over the period. The risk-neutral probability of dollar depreciation is 2/3 and the risk-neutral probability of the dollar strengthening is 1/3.

- A) $9.5238
- B) $0.0952
- C) $0
- D) $3.1746

55) Use the binomial option pricing model to find the value of a call option on £10,000 with a strike price of €12,500. The current exchange rate is €1.50/£1.00 and in the next period the exchange rate can increase to €2.40/£ or decrease to €0.9375/€1.00 (i.e.*u* = 1.6 and *d* = 1/*u* = 0.625). The current interest rates are *i*€ = 3% and are *i*£ = 4%. *Choose the answer closest to yours*.

- A) €3,275
- B) €2,500
- C) €3,373
- D) €3,243

56) Find the hedge ratio for a call option on £10,000 with a strike price of €12,500. The current exchange rate is €1.50/£1.00 and in the next period the exchange rate can increase to €2.40/£ or decrease to €0.9375/€1.00 (i.e. *u* = 1.6 and *d* = 1/*u* = 0.625).

The current interest rates are *i*€ = 3% and are *i*£ = 4%.

*Choose the answer closest to yours*.

- A) 5/9
- B) 8/13
- C) 2/3
- D) 3/8
- E) none of the options

57) You have written a call option on £10,000 with a strike price of $20,000. The current exchange rate is $2.00/£1.00 and in the next period the exchange rate can increase to $4.00/£1.00 or decrease to $1.00/€1.00 (i.e. *u* = 2 and *d* = 1/*u* = 0. 5). The current interest rates are *i*$ = 3% and are *i*£ = 2%. Find the hedge ratio and use it to create a position in the underlying asset that will hedge your option position.

- A) Enter into a short position in a futures contract on £6,666.67
- B) Lend the present value of £6,666.67 today at
*i*£= 2% - C) Enter into a long position in a futures contract on £6,666.67
- D) Lending the present value of £6,666.67 today at
*i*£= 2% or entering into a long position in a futures contract on £6,666.67 would both work.

58) Draw the tree for a put option on $20,000 with a strike price of £10,000. The current exchange rate is £1.00 = $2.00 and in one period the dollar value of the pound will either double or be cut in half. The current interest rates are *i*$ = 3% and are *i*£ = 2%.

- A)
- B)
- C) both of the options
- D) none of the options

59) Draw the tree for a call option on $20,000 with a strike price of £10,000. The current exchange rate is £1.00 = $2.00 and in one period the dollar value of the pound will either double or be cut in half. The current interest rates are *i*$ = 3% and are *i*£ = 2%.

- A)
- B)
- C) both of the options
- D) none of the options

60) A binomial call option premium is calculated as

- A)
*C0= [qCuT*+*(1*–*q)CdT] / (1 + r$)* - B)
*C0= [qCdT+ (1 – q)CuT] / (1 + r$)* - C)
*C0= [qCuT+ (1 – q)CdT] / (1*–*r$)* - D)
*C0= [qCdT+ (1 – q)CuT] / (1*–*r$)*

61) The one-step binomial model assumes that at the end of the option period, the call will have appreciated to *SuT* = *S0u* or depreciated to *SdT* = *S0d*. How is *u* calculated?

- A) 1/
*d* - B) e^(σt5)
- C) both 1/
*d*and e^(σt5) - D) none of these options

62) Find the dollar value today of a 1-period at-the-money call option on €10,000. The spot exchange rate is €1.00 = $1.25. In the next period, the euro can increase in dollar value to $2.00 or fall to $1.00. The interest rate in dollars is *i*$ = 27.50%; the interest rate in euro is .

- A) $3,308.82
- B) $0
- C) $3,294.12
- D) $4,218.75

63) Suppose that you have written a call option on €10,000 with a strike price in dollars. Suppose further that the hedge ratio is 1/2. Which of the following would be an appropriate hedge for a short position in this call option?

- A) Buy €5,000 today at today’s spot exchange rate.
- B) Agree to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today (
*e*., go long in a forward contract on €5,000). - C) Buy the present value of €5,000 discounted at i€ for the maturity of the option.
- D) Agree to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today (
*e*., go long in a forward contract on €5,000) or buy the present value of €5,000 discounted at i€ for the maturity of the option.

64) With regard to expiration date,

- A) futures contracts do not have delivery dates.
- B) forward contracts have standardized delivery dates.
- C) futures contracts have tailor-made delivery dates that meet the needs of the investor.
- D) futures contracts have standardized delivery dates.

65) With regard to trading location,

- A) forward contracts are traded competitively on organized exchanges.
- B) futures contracts are traded competitively on organized exchanges.
- C) futures contracts are traded by bank dealers via a network of telephones and computerized dealing systems.
- D) none of the options

66) With regard to contractual size,

- A) forward contracts are characterized by a standardized amount of the underlying asset.
- B) futures contracts are tailor-made to the needs of the participant.
- C) futures contracts are characterized by a standardized amount of the underlying asset.
- D) none of the options

67) With regard to trading costs,

- A) forward contracts involve the bid-ask spread plus the broker’s commission.
- B) futures contracts involve the bid-ask spread plus the broker’s commission.
- C) futures contracts involve the bid-ask spread plus indirect bank charges via compensating balance requirements.
- D) none of the options

68) Which of the following is correct?

- A) The value (in dollars) of a call option on £5,000 with a strike price of $10,000 is equal to the value (in dollars) of a put option on $10,000 with a strike price of £5,000 only when the spot exchange rate is $2 = £1.
- B) The value (in dollars) of a call option on £5,000 with a strike price of $10,000 is equal to the value (in dollars) of a put option on $10,000 with a strike price of £5,000.

69) Find the input *d*1 of the Black-Scholes price of a six-month call option written on €100,000 with a strike price of $1.00 = €1.00. The current exchange rate is $1.25 = €1.00; The U.S. risk-free rate is 5% over the period and the euro-zone risk-free rate is 4%. The volatility of the underlying asset is 10.7 percent.

- A)
*d*1= 0.103915 - B)
*d*1= 2.9871 - C)
*d*1= 0.0283 - D) none of the options

70) Find the input *d*1 of the Black-Scholes price of a six-month call option on Japanese yen. The strike price is $1 = ¥100. The volatility is 25 percent per annum; *r*$ = 5.5% and *r*¥ = 6%.

- A)
*d*1= 0.074246 - B)
*d*1= 0.005982 - C)
*d*1= $0.006137/¥ - D) none of the options

71) The Black-Scholes option pricing formula

- A) is used widely in practice, especially by international banks in trading OTC options.
- B) is not widely used outside of the academic world.
- C) works well enough, but is not used in the real world because no one has the time to flog their calculator for five minutes on the trading floor.
- D) none of the options

72) Find the Black-Scholes price of a six-month call option written on €100,000 with a strike price of $1.00 = €1.00. The current exchange rate is $1.25 = €1.00; The U.S. risk-free rate is 5 percent over the period and the euro-zone risk-free rate is 4 percent. The volatility of the underlying asset is 10.7 percent.

- A)
*C*e= $0.63577 - B)
*C*e= $0.0998 - C)
*C*e= $1.6331 - D) none of the options

73) Use the European option pricing formula to find the value of a six-month call option on Japanese yen. The strike price is $1 = ¥100. The volatility is 25 percent per annum; *r*$ = 5.5% and *r*¥ = 6%.

- A) 0.005395
- B) 0.005982
- C) $0.006137/¥
- D) none of the options

74) Empirical tests of the Black-Scholes option pricing formula

- A) shows that binomial option pricing is used widely in practice, especially by international banks in trading OTC options.
- B) works well for pricing American currency options that are
*at-the-money*or*out-of-the-money*. - C) does not do well in pricing
*in-the-money*calls and puts. - D) works well for pricing American currency options that are
*at-the-money*or*out-of-the-money*, but does not do well in pricing*in-the-money*calls and puts.

75) Empirical tests of the Black-Scholes option pricing formula

- A) have faced difficulties due to nonsynchronous data.
- B) suggest that when using simultaneous price data and incorporating transaction costs they conclude that the PHLX American currency options are efficiently priced.
- C) suggest that the European option-pricing model works well for pricing American currency options that are at- or out-of-the money, but does not do well in pricing in-the-money calls and puts.
- D) all of the options

76) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Calculate the current €/£ spot exchange rate.

77) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Find the risk neutral probability of an “up” move.

78) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

USING RISK NEUTRAL VALUATION (i.e., the binomial option pricing model) find the value of the call (in euro).

79) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Calculate the hedge ratio.

80) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

State the composition of the replicating portfolio; your answer should contain “trading orders” of what to buy and what to sell at time zero.

81) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Find the value today of your replicating today’s portfolio in euro.

82) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

If the call finishes out-of-the-money what is your replicating portfolio cash flow?

83) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

If the call finishes in-the-money what is your replicating portfolio cash flow?

84) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

FInd the value of the call.

85) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Calculate the current €/£ spot exchange rate.

86) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Find the risk neutral probability of an “up” move.

87) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

USING RISK NEUTRAL VALUATION, find the value of the call (in pounds)

88) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Calculate the hedge ratio.

89) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

State the composition of the replicating portfolio; your answer should contain “trading orders” of what to buy and what to sell at time zero.

90) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Find the cost today of your hedge portfolio in pounds.

91) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

If the call finishes out-of-the-money what is your portfolio cash flow?

92) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

If the call finishes in-the-money what is your portfolio cash flow?

93) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent.

*Big hint:* don’t round, keep exchange rates out to at least 4 decimal places.

Spot Rates | Risk-Free Rates | ||||

S0($/€) | $1.60 = €1.00 | i$ | 3.00% | ||

S0($/£) | $2.00 = £1.00 | i€ | 4.00% | ||

S0(€/£) | €1.25 = £1.00 | i£ | 4.00% |

Find the value of the call.

94) Find the dollar value today of a 1-period at-the-money __call__ option on ¥300,000. The spot exchange rate is ¥100 = $1.00. In the next period, the yen can increase in dollar value by 15 percent or decrease by 15 percent. The risk-free rate in dollars is *i*$ = 5%; The risk-free rate in yen is *i*¥ = 1%.

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