1. The fact that different sets of goods are consumed in different countries will have no effect on the ability of absolute PPP theory to determine whether a particular currency is over or under valued.
a. True
b. False
2. If you do not cover your foreign exchange risk and you buy a Canadian Bond, the return you expect to realize includes the yield on the bond plus the rate that you expect the dollar to depreciate (or minus the rate you expect the dollar to appreciate) during the period of time that you hold the Canadian bond.
a. True
b. False
3. Unless inflation dominates currency values over the long-run, relative PPP theory is a better predictor of exchange rate movements in the short-run.
a. True
b. False
4. The realized return from purchasing a foreign bond includes only the interest earned on the bond, but not the forward premium or discount on the foreign currency that occurs over the period of time before the bond is sold and the currency is converted back into domestic currency.
a. True
b. False
5. Given that the market has been going up lately, rational expectations means that it is a good idea to invest now.
a. True
b. False
6. If S is equal to the number of U.S. dollars that 1 Canadian dollar will buy in the spot market (i.e., S = U.S. s/1C$), P is the price level in the U.S. and P* is the price level in Canada, then arbitrage (given the free flow of goods between the two nations) will tend to create the situation where S = P/P*This means that the ratio of currency values in the spot market S is exactly equal to the ratio of price levels, thus PPP theory is a theory of exchange rates.
a. True
b. False
7. The basis for the efficient-markets hypothesis is that all market participants are assumed to be equally informed and that they assumed to know how the market functions.
a. True
b. False
8. Given that in any one country the real interest rate is the nominal interest rate minus the expected rate of inflation, for any two countries the combination of the relative PPP condition with the uncovered interest rate parity condition shows that each countries real interest rate (on equivalent bonds) should be the same.
a. True
b. False
9. If you know the inflation rates in two different countries then you should have a pretty good idea about the direction of movement in the exchange rate between these two countries' currencies by using relative PPP theory, but the exact percentage change in the exchange rate will be less accurate in the short run.
a. True
b. False
10. If a U.S. investor buys a Greek Bond in which the level of riskiness is much higher -- and so too is the yield -- the only uncovered risk is failing to predict the correct future value of the Euro.
a. True
b. False