Currency derivatives:

Which of the following are possible contract periods for forward contracts? a. 30 days b. 65 days c. 97 days d. 1 year, 2 months e. all of the above 2. Assume that as of May 15, a futures contract on 125,000 euros () with a June settlement date is priced at $1.00 per euro. The ______ of this currency futures contract will ________ for the euros on the settlement date. a. seller; pay $125,000 b. buyer; pay $125,000 c. seller; receive $125,000 d. buyer; receive $125,000 e. answers b and c are correct 3. The Swiss franc spot rate is $.90 and the Swiss franc 90-day forward rate is $.88. At what discount or premium is the Swiss franc selling? a. 2.22%, premium b. -2.22%, discount c. -9.09%, discount d. 8.89%, premium e. -8.89%, discount 4. What is the typical initial margin requirement for a currency futures contract? a. $500 b. $1,000-$2,000 c. 5%-10% of the contract d. none of the above 5. Which of the following is a similarity between the currency futures market and the forward market? a. both are self-regulating b. both use standardized contract sizes c. both use standardized delivery dates d. all of the above are similarities e. none of the above are similarities 6. Which of the following factors does not affect the premium of a currency call option? a. level of existing spot price relative to strike price b. length of time before the expiration date c. the currency of the call option d. potential variability of currency e. all of the above are factors 7. Suppose Darlene is a speculator who buys five British pound call options with a strike price of $1.50 and a March expiration date. The current spot price is $1.45. Darlene pays a premium of $0.01 per unit for the call option. Just before expiration, the spot price reaches $1.53, and Darlene exercises the option. Assume one option contract specifies 31,250 units. What is the profit or loss for Darlene?

a. $625 b. $3,125 c. $1,250 d. $6,250 e. none of the above 8. Suppose Darlene is a speculator who buys ten British pound put options with a strike price of $1.50 and a March expiration date. The current spot price is $1.55. Darlene pays a premium of $0.02 per unit for the call option. Just before expiration, the spot price reaches $1.48 and Darlene exercises the option. Assume one option contract specifies 31,250 units. What is the profit or loss for Darlene? a. $0 b. $6,250 c. $3,125 d. $625 e. none of the above 9. Peter has purchased a call option on euros () with a strike price of $1.06 and a premium of $0.01. The current spot price of the euro is $1.04. Just before expiration, the euro's spot price is $1.09.What is the per unit profit or loss to the writer of this option? a. $.02 loss b. $.02 profit c. $.03 loss d. $.03 profit 10. The forward rate will usually contain a premium (or discount) that reflects the difference between the home inflation rate and the foreign inflation rate. a. True b. False 11. A non-deliverable forward contract (NDF) is like a regular forward contract because it is for a specified amount and a specified exchange rate. However, it differs from a regular forward contract because it does not have a specified future settlement date. a. True b. False 12. Forward contracts are used primarily by small firms and individuals because they can be tailored to the needs of those clients. a. True b. False 13. A company expects to receive a foreign currency from the sale of merchandise. Because it is nervous about possible exchange rate movements in this currency, it wants to hedge its position with an option in the currency. The appropriate action for them to hedge is to buy a call option. a. True b. False 14. A European-style currency option may only be exercised on the expiration date. a. True b. False 15. If the spot rate of a currency increased substantially over a period, the futures price would likely increase by about the same amount.

a. True

Exchange rate systems:

Some countries use a _________ exchange rate arrangement, in which their home currency's value is pegged to a foreign currency or to some unit of account. a. fixed b. freely floating c. managed float d. pegged e. none of the above 2. Currently, the U.S. dollar is under which type of exchange rate system? a. fixed b. freely floating c. managed float d. pegged e. none of the above 3. The U.S. dollar was under which type of exchange rate system from 1944 to 1971? a. fixed b. freely floating c. managed float d. pegged e. none of the above 4. Which of the following countries suspended participation in the exchange rate mechanism (ERM) of the European Economic Community during the 1992 crisis? a. Britain b. France c. Italy d. Switzerland e. both a and c 6. Assume the Fed wants to boost exports for the United States. Which of the following strategies would help boost exports? a. raise interest rates b. increase the money supply by selling government bonds c. lower interest rates d. decrease the money supply by selling government bonds e. none of the above 7. Assume the Fed wants to decrease inflation in the United States. Which of the following strategies would help reduce inflation? a. raise interest rates b. increase the money supply by buying government bonds c. lower interest rates

b. False

d. decrease the money supply by buying government bonds e. none of the above 8. Which of the following statements is not true with respect to the euro since its introduction in 1999? a. its value declined substantially against the British pound, the dollar, and many other currencies from 1999 to 2000 b. there was more money flowing out of Europe and into U.S. and other financial markets than money flowing from these countries to Europe, causing a depreciation of the euro after it was introduced c. investors preferred to hold assets denominated in dollars, pounds, or yen rather than in euros, contributing to the depreciation of the euro d. all of the above are true with respect to the euro 9. In December 1971, the Bretton Woods Agreement called for a devaluation of the U.S. dollar by about 8 percent against other currencies. a. True b. False 10. A currency board is a system for maintaining the value of the local currency with respect to some other specified currency. To do this, the currency board must have credibility in its promise to maintain the exchange rate. a. True b. False 11. Three members of the European Union initially decided not to participate in the single European currency (euro). These countries are the United Kingdom, Denmark, and Sweden. a. True b. False 12. The European Central Bank is based in Frankfurt and is responsible for setting monetary policy for all participating European countries. Its objective is to control inflation in the participating countries and to stabilize the value of the euro with respect to other major currencies. a. True b. False 13. One method of direct intervention by the U.S. Federal Reserve System in currency markets is to sell dollars and buy foreign currencies to make the U.S. dollar depreciate. a. True b. False 14. Dollarization represents the replacement of a foreign currency with U.S. dollars. This process is a little less drastic than a currency board. a. True b. False

Arbitrage & IRP:

Bank A quotes a bid price of $1.52 and an ask price of $1.54 for the British pound. Bank B quotes a bid price of $1.51 and an ask price of $1.53 for the British pound. If a trader has $100,000 to invest, what should the trader do to take advantage of locational arbitrage and how much profit would the trader make? a. buy pounds at Bank A, sell pounds at Bank B, make $1,000 b. buy pounds at Bank A, sell pounds at Bank B, make $657.89 c. buy pounds at Bank B, sell pounds at Bank A, make $1,000

d. buy pounds at Bank B, sell pounds at Bank A, make $657.89 e. none of the above, locational arbitrage is not possible 2. National Bank quotes a bid price of $1.15 and an ask price of $1.17 for the euro. City Bank quotes a bid price of $1.10 and an ask price of $1.14 for the euro. If you have $1,000,000 to invest, what would your profit be from conducting locational arbitrage? a. locational arbitrage is not possible in this situation b. $30,000 c. $10,000 d. $50,000 e. none of the above 3. A bank quotes a bid price of $1.50 for the British pound (), a rate of $0.75 for the Swiss franc (Sf), and a rate of Sf2.02 for the British pound. If I have $100,000 to invest, what should I do to take advantage of triangular arbitrage and how much profit would I make (assume the bid and ask prices are the same)? a. buy pounds with dollars, sell pounds for francs, buy dollars with francs, make $101,000 profit. b. buy pounds with dollars, sell pounds for francs, buy dollars with francs, make $1,000 profit. c. buy francs with dollars, sell francs for pounds, buy dollars with pounds, make $101,000 profit. d. buy francs with dollars, sell francs for pounds, buy dollars with pounds, make $1,000 profit. e. none of the above, triangular arbitrage is not possible. 4. The spot rate is $0.75 for the Swiss franc (Sf), the 180 day forward rate for the Swiss franc is $0.80, the 180 day interest rate in the U.S. is 4%, and the 180 day interest rate in Switzerland is 3%. If I have $100,000 to invest, what would my approximate annual yield be from covered interest arbitrage? a. 9.87% b. 10.93 c. 21.87 d. 19.73% e. none of the above, a covered interest arbitrage profit cannot be made. 5. Assume the Swiss franc has a 90-day interest rate of 3% and the U.S. dollar has a 4% 90-day interest rate. What is the non-annualized discount or premium on the Swiss franc? a. 9.7% premium b. 9.7% discount c. 0.97% premium d. 0.97% discount e. none of the above 6. Assume interest rate parity does not hold, yet covered interest arbitrage is still not possible. Which of the following is not a reason for this anomaly? a. accounting differences b. transaction costs c. currency restrictions d. differential tax laws e. all of the above are reasons

7. Which of the following forms of arbitrage takes advantage of differentials in cross exchange rates? a. locational arbitrage b. covered interest arbitrage c. triangular arbitrage d. interest rate arbitrage e. none of the above 8. The British pound () is worth $1.60, while the euro () is worth $.95. What is the value of the British pound with respect to the euro? a. 0.59 b. 1.68 c. 1.68 d. 0.59 e. none of the above 9. Arbitrage can be loosely defined as capitalizing on a discrepancy in quoted prices. In many cases, there is no investment of funds tied up for any length of time and no risk involved in the strategy. a. True b. False 10. According to interest rate parity, if the interest rate in the U.S. is greater than the interest rate in Canada, then the Canadian dollar forward rate should be at a discount. a. True b. False 11. If the interest rate in the United Kingdom is 6% and the interest rate in the U.S. is 4%, the approximate premium on the British pound forward rate should be 2%. a. True b. False 12. If interest rate parity exists, then foreign investors will earn the same return as U.S. investors. a. True b. False

13. In triangular arbitrage, currency transactions are conducted in the spot market to capitalize on a discrepancy in the cross exchange rate between two currencies. a. True b. False