1. You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.20 = €1.00 and the dollar-pound exchange rate is quoted at $1.80 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.50 how much money can an astute trader make?
A. No arbitrage is possible
B. $1,160,000
C. $500,000
D. $250,000
2. The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. Based on your analysis of the exchange rate, you are confident that the spot exchange rate will be $1.52/€ in three months. Assume that you would like to buy or sell €1,000,000. What actions do you need to take to speculate in the forward market?
A. Take a long position in a forward contract on €1,000,000 at $1.50/€.
B. Take a short position in a forward contract on €1,000,000 at $1.50/€.
C. Buy euro today at the spot rate, sell them forward.
D. Sell euro today at the spot rate, buy them forward.
3. 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 hold.
C. This is an example of a Purchasing Power Parity violation and an arbitrage opportunity.
D. None of the above
4. The direct spot quote for the British pound is $1.5/£ and the one-year forward rate is $1.48/£. The difference between the two rates is likely to mean that ________.
A. inflation in the U.S. during the past year was lower than in the UK
B. real interest rates are rising faster in the UK than in the U.S.
C. prices in The UK are expected to rise more rapidly than in the U.S.
D. the British pound's spot rate is expected to rise in terms of the U.S. dollar
5. Yesterday, you entered into a futures contract to sell €125,000 at $1.50 per €. Your initial performance bond is $3,000 and your maintenance level is $1,000. 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. $1.1840 per €.
6. From the perspective of the writer of a put option written on €10,000. If the strike price is $1.55/€, and the option premium is $300, at what exchange rate will you break even?
A. $1.52/€
B. $1.55/€
C. $1.58/€
D. None of the above
7. If the implied volatility of a call option is lower than your estimated fair value of the option’s volatility,
A. The call option is overpriced.
B. The call option is underpriced.
C. The call option is correctly priced.
D. None of the above, since volatility is constant.