International Finance PDF

Final Examination
Semester 2 / Year 2012

COURSE
COURSE CODE
TIME
DEPARTMENT
LECTURER
: INTERNATIONAL FINANCE
: FINE3033
: 2 1/2 HOURS
: FINANCE
: KAN YOKE YUE
Students ID
Batch No
:
:
Notes to candidates:
1) The question paper consists of 2 sections and 4 pages.
2) Section A: Answer ALL questions.
Section B: Answer ALL questions.
3) Write all your answers in the answer booklet.
4) Return the question paper and answer booklet.
INTERNATIONAL FINANCE
Section A: Multiple-Choice Questions
Answer ALL the questions
(2 x 10 = 20 marks)
1. A bank's bid rate on Swiss francs is $0.43 and its ask rate is $0.45. Its bid-ask
percentage spread is:
A) about 2.00%.
B) about 0.02 %.
C) about 4.65%.
D) about 4.44%.
2. Assume a Japanese firm exports to the U.S. in U.S. dollars. Assume that the forward
rate and spot rate of the Japanese yen are equal. If the Japanese firm expects the U.S.
dollar to _______ against the yen, it would likely wish to hedge. It could hedge by
_______ dollars forward.
A) depreciate; buying
B) depreciate; selling
C) appreciate; selling
D) appreciate; buying
3. The international Fisher effect (IFE) suggests that:
A) the nominal interest rates of both countries are the same.
B) the inflation rates of both countries are the same.
C) the exchange rates of both countries will move due to change in trade deficits.
D) nominal interest rates contain a real rate of return and an anticipated inflation.
4. If the interest rate is higher in the U.S. than in the United Kingdom, and if the forward
rate of the British pound (in U.S. dollars) is the same as the pounds spot rate, then:
A) U.S. investors could possibly benefit from covered interest arbitrage.
B) British investors could possibly benefit from covered interest arbitrage.
C) neither U.S. nor British investors could benefit from covered interest arbitrage.
D) A and B
5. According to the international Fisher effect, if U.S. investors expect a 4% rate of
domestic inflation over one year, and a 3% rate of inflation in European countries that
use the euro, and require a 2% real return on investments over one year, the nominal
interest rate on one-year U.S. Treasury securities would be:
A) 2%.
B) 3%.
C) 6%.
D) 10%.
Page 1 of 4
6. RCB Corporation, a U.S. company has a branch in China. The branch has more
operating expenses than sales revenue in China, the US company will _______ if the
dollar _______.
A) benefit; weakens
B) be unaffected; weakens
C) be unaffected; strengthens
D) benefit; strengthens
7. If the Malaysian Ringgit appreciates against the U.S. dollar over this year, the
consolidated earnings of a U.S. company with a subsidiary in Malaysia will be ____ as a
result of the exchange rate movement.
A) negative
B) adversely affected
C) favorably affected
D) unaffected
8. When the real interest rate is relatively low in a given country, then the currency of
that country is typically expected to be:
A) weak, since the countrys quoted interest rate would be high relative to the
inflation rate.
B) strong, since the countrys quoted interest rate would be low relative to the
inflation rate.
C) strong, since the countrys quoted interest rate would be high relative to the
inflation rate.
D) weak, since the countrys quoted interest rate would be low relative to the inflation
rate.
9. Due to _______, market forces should realign the cross exchange rate between two
foreign currencies based on the spot exchange rates of the two currencies against the U.S.
dollar.
A) forward realignment arbitrage
B) triangular arbitrage
C) covered interest arbitrage
D) locational arbitrage
10. Which of the following is not true regarding IRP, PPP, and the IFE?
A) IRP suggests that a currencys spot rate will change according to interest rate
differentials.
B) PPP suggests that a currencys spot rate will change according to inflation
differentials.
C) The IFE suggests that a currencys spot rate will change according to interest rate
differentials.
D) All of the above are true.
Page 2 of 4
Section B
Answer ALL Questions.
Question 1
(Total 20 marks)
Mr. Lee is a currency speculator. He observes the following information:

US annual interest rate is 2.5%
UK annual interest rate is 2.8%
Spot rate is $2.10//.
One-year Forward rate of pound is $2.30/
(a)
Does interest rate parity exist? Draw a graphic analysis of the interest rate parity.
(5 marks)
(b)
Who can benefit from covered interest arbitrage? US investors or UK investors?

(3 marks)
(c)
Explain how covered interest arbitrage can be done to obtain profits. You can start
with either $1,000,000 or 1,000,000.
(12 marks)
Question 2
(Total 20 marks)
Next Edge Corporation, a US based company, imports raw material from Europe. Next
Edge needs 15,000,000 in 1 year period to pay its purchases.
The following interest rates are observed:
Annual Deposit Rate (%)
European Bank
2.8%
US Bank
2.6%
Annual Lending Rate (%)

5.4%
5.8%
The following exchange rates are observed:

Sport rate for Euro
$2.20/
12-month forward rate for Euro $2.30/
Which is the best hedging strategy for Next Edge Corporation? Money market hedge or
forward contract? Explain your analysis in detail.
(20 marks)
Page 3 of 4
Question 3
(Total 20 marks)
(a)
Explain the relationship between inflation rate and foreign exchange rate using the
concept of Purchasing Power Parity (PPP).
(5 marks)
(b) Why is Purchasing Power Parity not consistent in explaining foreign exchange
movement?
(6 marks)
(c)
Assume the inflation rate in UK is 2.5%, while inflation rate in the US is 2.0%.
According to purchasing power parity, how much is the percentage change in value
for pound?
(4 marks)
(d)
International Fisher Effect (IFE) uses interest rate differentials to explain why
exchange rates change over time. How is IFE related to PPP?
(5 marks)
Question 4
(a)
(Total 20 marks)
Briefly explain the three common forms of arbitrage.

(6 marks)
(b)
You observe the following exchange rates:
Bank A
Bank B
Bank C
Actual Exchange Rate

S$/RM
0.50
S$/pound
2.40
RM/pound
5.50
Explain how arbitrage can be performed using S$1,000,000. How much is the profit
from the arbitrage activity?
(14 marks)
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Page 4 of 4

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Final Examination

Semester 2 / Year 2012

Mr. Lee is a currency speculator. He observes the following information:

Who can benefit from covered interest arbitrage? US investors or UK investors?

Annual Lending Rate (%)

The following exchange rates are observed:

Briefly explain the three common forms of arbitrage.

You observe the following exchange rates:

Actual Exchange Rate

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