1.A call option on Australian dollars has a strike (exercise) price of $.56. The
ID: 2741673 • Letter: 1
Question
1.A call option on Australian dollars has a strike (exercise) price of $.56. The present exchange rate is $.54. This call option can be referred to as:
A. in the money.
B.at a discount.
C.at the money.
D. out of the money.
2.According to the international Fisher effect, if Venezuela has a much lower nominal rate than other countries, its inflation rate will likely be ____ than other countries, and its currency will ____.
A. lower; strengthen
B. higher; strengthen
C. higher; weaken
D. lower; weaken
3.Assume that interest rate parity holds. The Mexican interest rate is 15%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso’s forward ____ will ____.
A.discount; decrease
B.premium; decrease
C.discount; increase
D.premium; increase
4.Which of the following is not an example of direct intervention in foreign exchange markets?
A. b and c above.
B. increasing the inflation rate.
C. exchanging dollars for foreign currency.
D. lowering interest rates.
A. in the money.
B.at a discount.
C.at the money.
D. out of the money.
Explanation / Answer
1. - D: Out of Money: Since the underlying price (present exchange rate = $0.54) is less than strike price = $0.56 the holder of call option can buy at cheaper price of $0.54 rather than exercising the option.
2. A: Lower, Strenghthen: International Fisher Effect states that the country whose interest rate is lower would experience a sthrenghtening of its currency vis-a-vis other currency (approximately equal to to the interest rate differential between the two countries). This happens becuase the country whose interest rate is low will also have lower inflation.
3. C: discount, increase: Since interest rate in Mexico is higher than interest rate in US so there is discount on Peso. Further, Forward Rate = Spot Rate x (1+ int. rate of foreign currency)/(1 + int. rate of domestic currency), since id decreases from 8% to 7% the denominator will decrease leading to increase in discount on Peso.
4. B: Increasing the inflation rate: Inflation rate is not a policy decision. It is an effect of various macro factors both domestic and international. The central bank just tries to control inflation using policy tools available at its disposal.
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