Shapiro’s Multinational Financial Management, Test Bank
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CHAPTER 4
Parity Conditions in International Finance and Currency Forecasting
EASY (definitional)
4.1 In its absolute version, purchasing power parity states that price levels worldwide should be
_______when expressed in a common currency.
a) equal
b) roughly equal
c) different
d) opportunities for arbitrage
Ans: a
Section: Purchasing power parity
Level: Easy
4.2 The theory of relative purchasing power parity states that, between two nations, the
a) inflation rates are unrelated
b) exchange rate differential reflects the inflation rate differential
c) inflation rate is smaller in weaker currencies
d) the interest rate is greater than the inflation rate during depreciations
Ans: b
Section: Purchasing power parity
Level: Easy
4.3 The Fisher effect states that the _________ rate is made up of a real required rate of return
and an inflation premium.
a) nominal exchange
b) real exchange
c) nominal interest
d) adjusted dividend
Ans: c
Section: The fisher effect
Level: Easy
4.4 A rise in the inflation rate in one nation relative to others will be associated with a fall in
the first nation’s exchange rate and with a rise of its interest rate relative to foreign interest
rates. The two conditions combined result in the _________ Effect.
a) Fisher
b) Herstatt
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c) Unbiased forward rate
d) International Fisher
Ans: d
Section: The fisher effect
Level: Easy
MEDIUM (applied)
4.5 Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%,
respectively, over the next several years. If the current spot rate for the Mexican peso is $.005,
then the best estimate of the peso's spot value in 3 years is
a) $.00276
b) $.01190
c) $.00321
d) $.00102
Ans: d
Section: Purchasing power parity
Level: Medium
4.6 If the expected inflation rate is 5% and the real required return is 6%, then the Fisher effect
says that the nominal interest rate should be
a) 1%
b) 11.3%
c) 11%
d) 6%
Ans: b
Section: The fisher effect
Level: Medium
4.7 The inflation rates in the U.S. and France in January 1991 were expected to be 4% per annum
and 7% per annum, respectively. If the current spot rate that day was $.1050, then the expected
spot rate in three years was
a) $.1150
b) $.1112
c) $.0964
d) $.0992
Ans: c
Section: Purchasing power parity
Shapiro’s Multinational Financial Management, Test Bank
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Level: Medium
4.8 Suppose the expected inflation in the U.S. on January 1, 1988 was projected at 5% annually
for the next 5 years and at 12% annually in Italy for the same time period, and the lira/$ spot rate
that day was currently at L2400 = $1, then the PPP estimate of the spot rate five years from now
was
a) 1738
b) 3314
c) 2560
d) 2250
Ans: b
Section: Purchasing power parity
Level: Medium
4.9 If expected inflation is 20% and the real required return is 10%, then the Fisher effect says
that the nominal interest rate should be exactly
a) 30%
b) 32%
c) 22%
d) 12%
Ans: b
Section: The fisher effect
Level: Medium
4.10 On January 1, 1990, the annual inflation rates in the U.S. and Greece were expected to be
3% and 8%, respectively. If the current spot rate that day for the drachma was $.007, then the
expected spot rate in three years was
a) $.00607
b) $.00823
c) $.00751
d) $.00694
Ans: a
Section: Purchasing power parity
Level: Medium
4.11 If a country's freely floating currency is undervalued in terms of purchasing power parity,
its capital account is likely to be
a) in deficit or tending toward a deficit
b) in surplus or tending toward a surplus
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c) Subsidized by the International Monetary Fund
d) a candidate for loans from the World Bank
Ans: a
Section: Purchasing power parity
Level: Medium
4.12 If the rate of inflation in all of the world’s currency markets rises from 5% to 7%, this will
tend to make forward exchange rates move toward
a) smaller premiums or larger discounts in relation to the dollar
b) larger premiums or smaller discounts in relation to the dollar
c) no change on average
d) parity
Ans: c
Section: Purchasing power parity
Level: Medium
4.13 A 150% real return in Brazil is higher than a 15% dollar return in the U.S.
a) because arbitrage opportunities exist
b) when the inflation controls are suspended in Brazil
c) it depends on whether these are nominal or real returns
d) regardless of nominal or real returns
Ans: c
Section: Purchasing power parity
Level: Medium
4.14 On January 1, 1994, the annual inflation rates in the U.S. and Italy were expected to be 4%
and 7%, respectively. If the current spot rate on that day was $1 = L2,000, then the expected spot
rate for the lira in three years was
a) $.0004591
b) $.0011590
c) $.0009892
d) $.0005471
Ans: a
Section: Purchasing power parity
Level: Medium
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4.15 On January 1, 1985, the annual inflation rates in the U.S. and France were expected to be
4% and 6%, respectively. If the current spot rate that day was $.1250, then the expected spot rate
in two years was
a) $.1299
b) $.1150
c) $.1203
d) $.1335
Ans: c
Section: Purchasing power parity
Level: Medium
4.16 Suppose five-year deposit rates on Eurodollars and Euro marks are 12% and 8%,
respectively. If the current spot rate for the mark is $0.50, then the spot rate for the mark five
years from now implied by these interest rates is
a) .5997
b) .4169
c) .5185
d) .4821
Ans: a
Section: The international fisher effect
Level: Medium
4.17 The direct spot quote for the Canadian dollar is $.76 and the 180-day forward rate is $.74.
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 Canada
b) interest rates are rising faster in Canada than in the U.S.
c) prices in Canada are expected to rise more rapidly than in the U.S.
d) the Canadian dollar's spot rate is expected to rise in terms of the U.S. dollar
Ans: c
Section: Interest rate parity theory
Level: Medium
4.18 Suppose that on January 1, 1987, the spot rate on the Dutch guilder was $0.39 and the
180-day forward rate was $0.40. The difference between the spot and forward rates suggested
that
a) interest rates were higher in the U.S. than in the Netherlands
b) the guilder had risen in relation to the dollar
c) the inflation rate in the Netherlands was declining
d) the guilder was expected to fall in value relative to the dollar
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Ans: a
Section: Interest rate parity theory
Level: Medium
4.19 Suppose the price indexes in Mexico and the U.S., which both began the year at 100, are at
160 and 103, respectively, by the end of the year. If the exchange rate began the year at Mex$4.5
= $1 and ended the year at Mex$5.9 = $1, then the change in the real value of the peso during the
year is (a "-" indicates a real devaluation)
a) 0.0%
b) -5.0%
c) 18.5%
d) -8.2%
Ans: c
Section: Purchasing power parity
Level: Medium
4.20 Suppose the spot rates for the pound, mark, and Swiss franc prior to 1999 were $1.20, $.32,
and $.40, respectively. At the same time, the associated 90-day interest rates (annualized) were
16%, 8%, and 4%, while the U.S. 90-day interest rate was 12%. What was the 90-day forward
rate (to the nearest cent) on a TCU (TCU 1 = £1 + DM1 + SFr1) if interest parity were to hold?
a) $1.92
b) $1.98
c) $1.94
d) $1.87
Ans: a
Section: Interest rate parity theory
Level: Medium
4.21 The current five-year Euro yen rate is 6% per annum (compounded annually). The five-year
Eurodollar rate is 8.5%. What is the implied forward premium or discount of the yen (over the
current spot rate) for a five-year forward contract?
a) 4.17% premium
b) 18.46% discount
c) 11.00% discount
d) 12.36% premium
Ans: d
Section: Interest rate parity theory
Level: Medium
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4.22 Suppose the spot rates on January 1, 1992 for the pound, mark, and Swiss franc were $1.50,
$.42, and $.48, respectively. At the time, the associated 90-day interest rates (annualized) were
12%, 6%, and 4%, while the U.S. 90-day interest rate (annualized) was 8%. What was the 90-day
forward rate on a DCU (DCU 1 = £1 + DM1 + SFr1) if interest parity were to hold?
a) $2.4027
b) $2.3923
c) $2.4196
d) $2.3738
Ans: b
Section: Interest rate parity theory
Level: Medium
4.23 Suppose it is January 1, 1998 and spot pounds are selling at $1.7342, while 90-day forward
pounds are selling at $1.7156. At the same time, DM spot and 90-day forward rates are $0.6138
and $0.6014, respectively. According to these quotes the
a) pound is selling at a 3.87% forward discount relative to the DM
b) pound is selling at a 2.37% forward premium relative to the DM
c) DM is selling at a 0.97% forward discount relative to the pound
d) DM is selling at a 1.54% forward premium relative to the pound
Ans: a
Section: Interest rate parity theory
Level: Medium
4.24 If annualized interest rates in the U.S. and France on January 1, 1991 are 9% and 13%,
respectively, and the spot value of the franc is $.1109, then at what 180-day forward rate will
interest rate parity hold?
a) $.1070
b) $.1150
c) $.1088
d) $.1130
Ans: c
Section: Interest rate parity theory
Level: Medium
4.25 If annualized interest rates in the U.S. and Switzerland are 10% and 4%, respectively, and
the 90-day forward rate for the Swiss franc is $.3864, at what current spot rate will interest rate
parity hold?
a) $.3902
b) $.3874
c) $.3807
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d) $.3792
Ans: c
Section: Interest rate parity theory
Level: Medium
4.26 The spot rate on the euro is $1.33 and the 180-day forward rate is $1.34. The difference
between the two rates means
a) interest rates are higher in the U.S. than in Germany
b) the euro has risen in relation to the dollar
c) the inflation rate in Germany is declining
d) the euro is expected to fall in value relative to the dollar
Ans: a
Section: Interest rate parity theory
Level: Medium
4.27 It is July 1, 1990. Suppose the spot rates for the pound, mark, and Swiss franc are $1.30,
$.35, and $.40, respectively. The associated 90-day interest rates (annualized) are 16%, 8%, and
4%, while the U.S. 90-day interest rate (annualized) is 12%. What is the 90-day forward rate on
an ACU (ACU 1 = £1 + DM1 + SFr1) if interest parity holds?
a) $2.0512
b) $2.1134
c) $2.0397
d) $2.0489
Ans: d
Section: Interest rate parity theory
Level: Medium
4.28 The current five-year Euro yen and Eurodollar rates are 8% and 12.5% per annum,
respectively. What is the implied forward premium or discount of the yen (over the current spot
rate for a five-year forward contract)?
a) 4.17% premium
b) 18.46% discount
c) 17.74% discount
d) 22.64% premium
Ans: d
Section: Interest rate parity theory
Level: Medium
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4.29 The 90-day interest rates (annualized) in the U.S. and Japan are, respectively, 10% and 7%,
while the direct spot quote for the yen in New York is $.004300. At what 90-day forward rate
would interest rate parity hold?
a) .004430
b) .004271
c) .004332
d) .004176
Ans: c
Section: Interest rate parity theory
Level: Medium
4.30 If annualized interest rates on January 1, 1985 in the U.S. and France were 9% and 13%,
respectively, and the spot value of the franc was $.1109, then at what 180-day forward rate would
interest rate parity hold?
a) $.1070
b) $.1150
c) $.1088
d) $.1130
Ans: c
Section: Interest rate parity theory
Level: Medium
DIFFICULT (applied)
4.31 Suppose the pound devalues from $1.25 at the start of the year to $1.00 at the end of the
year. Inflation during the year is 15% in England and 5% in the U.S. What is the real
devaluation (-) or real revaluation (+) of the pound during the year?
a) - 12.38%
b) - 20.71%
c) + 2.39%
d) + 1.46%
Ans: a
Section: Purchasing power parity
Level: Difficult
4.32 Suppose it is May 1, 1981 and the price indexes in Spain and the U.S., which both began
the year at 100, are at 117 and 105, respectively, by the end of the year. If the beginning and
ending exchange rates, respectively, for the peseta are $.1320 and $.1125, then the change in the
real value of the peseta (a "-" indicates a real devaluation) during the year is
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a) 0%
b) -5.0%
c) 2.4%
d) -8.2%
Ans: b
Section: Purchasing power parity
Level: Difficult
4.33 Suppose the Swiss franc revalues from $0.40 at the beginning of the year to $0.44 at the
end of the year. U.S. inflation is 5% and Swiss inflation is 3% during the year. What is the real
devaluation (-) or real revaluation (+) of the Swiss franc during the year?
a) + 7.9%
b) - 5.3%
c) + 8.1%
d) - 1.6%
Ans: a
Section: Purchasing power parity
Level: Difficult
4.34 Suppose the value of the Polish zloty moves from Z 1000 = $1 at the start of the year to Z
1,800 at the end of the year. At the same time, the Polish price level changes from an index of
100 on January 1 to 134 on December 31. U.S. inflation during the year was 4.5%. If the one-
year interest rate on the zloty is 44%, what was the real dollar cost of borrowing the zloty
during the year?
a) 17.53%
b) 27.81%
c) -23.44%
d) -8.76%
Ans: c
Section: Purchasing power parity
Level: Difficult
4.35 Suppose it is October 1, 1990 and inflation rates in the U.S. and France are expected to be
4% and 9%, respectively, next year and 6% and 7%, respectively, in the following year. If the
current spot rate is $.1050, then the expected spot value of the franc in two years is
a) $.1111
b) $.1024
c) $.0992
d) $.1074
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Ans: c
Section: Purchasing power parity
Level: Difficult
4.36 Suppose it is January 1, 1994 and the Deutsche mark revalues from $.30 at the beginning
of the year to $.33 at the end of the year. Inflation during the year is 5% in the U.S. and 3% in
Germany. What is the real devaluation (-) or real revaluation (+) of the Deutsche mark during
the year?
a) + 7.9%
b) - 5.3%
c) + 8.1%
d) - 1.6%
Ans: a
Section: Purchasing power parity
Level: Difficult
4.37 If the U.S. trade balance with Japan is expected to go from a deficit this year to a surplus
next year, the forward rate on yen would
a) be less than the spot rate
b) be higher than the spot rate
c) equal the spot rate
d) could be either above or below the spot rate
Ans: d
Section: The relationship between the forward rate and the future spot rate
Level: Difficult
4.38 The following exchange and interest rate quotations in 1998 were observed:
Eurocurrency rates
Exchange rate per $
90-days (% annum)
(Discretely-compounded)
Spot
90-day
forward
Bid:
Ask:
$
15 5/8
16
DM
7 7/8
8 1/4
£
12 1/4
13
DM
1.881
1.843
£
.4961
.4902
DM
1.801
1.773
£
.4937
.4889
An arbitrage profit can be obtained by
a) borrowing pounds and lending dollars
b) borrowing dollars and lending DM
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c) borrowing DM and lending pounds
d) there are no arbitrage opportunities
Ans: a
Section: Interest rate and parity theory
Level: Difficult