Part II Marks 60 1. Which of the following statements is correct regarding the c

Question

Part II Marks 60 1. Which of the following statements is correct regarding the covered interest par ity condition? A: Spot and forward exchange rates tend to diverge, in general, to be precisely in line with the interest differential. 5: The domestic interest rate must be higher or lower than the foreign interest rate by the extent the domestic currency is anticipated to depreciate or appreciate. The domestic interest rate must be lower (higher) than the foreign interest rate by the extent the domestic currency sells at a discount (premium). All of the above statements are correct A and C are correct. C: D: E: 2. According to the international Fisher Effect, if an investor purchases a five-year U.s. bond that has an annual interest rate of 5% rther than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the to at a rate of at least 1% per year over the next 5 years. A: British pound; appreciate B: British pound; revalue C: U.S. dollar; appreciate D: U.S. dollar; depreciate E: none 3. A decision to hedge receivables in the money market will be taken if A: B: C: D: E: the domestic interest rate is higher than the foreign interest rate. the domestic interest rate is lower than the foreign interest rate. the interest parity forward rate is higher than the expected spot rate. the interest parity forward rate is lower than the expected spot rate. the interest parity forward rate is equal to the expected spot rate. 4. At the beginning of 2002 the AUD/USD exchange rate was 1.9585 and the 2002 inflation rates were 3.30% for Australia and 2.33% for the US. What should the AUD/USD exchange rate have been at the end of 2002, according to the approximate calculation of Relative PPP theory? A USD/AUD 0.5068 B: AUD/USD 1.9736 C: AUD/USD 1.9775 D: USD/AUD 1.8769 E: USD/AUD 0.8467 Which of the following is NOT true for the writer of a put option? A: 5. The maximum loss is limited to the strike price of the underlying asset less the premium. B: The gain or loss is equal to but of the opposite sign of the buyer of a put option. C: The maximum gain is the amount of the premium D: All of the above are true.

Explanation / Answer

1. Under the Covered Interest Rate Parity “Spot and Forward Exchange Rates” tend to remain in equilibrium with the interest rates differential. Hence the first statement is correct.

If the domestic interest rate is higher than the foreign interest rate then foreign investments will be lucrative, thus it will make the domestic currency stronger (appreciate) in comparison with the foreign currency. But the statement suggest that, if the domestic interest rate is higher or lower than the foreign interest rates domestic currency will depreciate or appreciate in terms to foreign currency. Hence the statement is incorrect.

Again in the 3rd statement if the domestic interest rate is lower than foreign interest rate then domestic currency will depreciate as the demand will not be there and foreign investors will pull out their funds from the domestic rates. This will make the domestic currency to be sold at discount while higher rates will allow the domestic currency to be sold at premium making it stronger. So this statement is correct.

So of the option (a) & (c) are correct thus option (E) is correct.

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