Quiz 3
1. Suppose you observe a spot exchange rate of $1.50/€. If interest rates are 3% APR in the U.S.
and 5% APR in the euro zone, what is the noarbitrage 1year forward rate?
A.
€1.5291/$
B.
$1.5291/€
C.
€1.4714/$
D.
$1.4714/€
Answer: F($/€) = S($/€)×(1+i
$
)/(1+i
€
) = 1.50×(1+3%)/(1+5%) = $1.4714/€.
2. Forward Parity (essentially a variant derived from the expectations theory) 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.
Answer: The expectation theory states that F
t
= E
t
S
t+1
(F
t
 S
t
)/S
t
= (E
t
S
t+1
 S
t
)/S
t
,
where LHS is the forward premium, and RHS is the expected change in exchange rate.
3. 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
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 Spring '11
 SamiqueMarch
 Exchange Rate, Inflation, Arbitrage, Interest, Interest Rate, United States dollar, Forward contract, RHS

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