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Name: Mona AlGannas Class: International Finance Date: 18 July 2012 ID: 200700691
Take Home Quiz #8
Multiple Choice
Identify the choice that best completes the statement or answers the question.
__A__ 1. Assume a two-country world: Country A and Country B. Which of the following is
correct about purchasing power parity (PPP) as related to these two countries?
a. If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will
weaken.
b. If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will
weaken.
c. If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will
strengthen.
d. If Country B's inflation rate exceeds Country A's inflation rate, Country A's currency will
weaken.
__A__ 2. The international Fisher effect (IFE) suggests that:
a. a home currency will depreciate if the current home interest rate exceeds the current foreign
interest rate.
b. a home currency will appreciate if the current home interest rate exceeds the current foreign
interest rate.
c. a home currency will appreciate if the current home inflation rate exceeds the current foreign
inflation rate.
d. a home currency will depreciate if the current home inflation rate exceeds the current foreign
inflation rate.
__B__ 3. According to the IFE, if British interest rates exceed U.S. interest rates:
a. the British pound's value will remain constant.
b. the British pound will depreciate against the dollar.
c. the British inflation rate will decrease.
d. the forward rate of the British pound will contain a premium.
e. today's forward rate of the British pound will equal today's spot rate.
__A__ 4. If interest rates on the euro are consistently below U.S. interest rates, then for the
international Fisher effect (IFE) to hold:
a. the value of the euro would often appreciate against the dollar.
b. the value of the euro would often depreciate against the dollar.
c. the value of the euro would remain constant most of the time.
d. the value of the euro would appreciate in some periods and depreciate in other periods, but
on average have a zero rate of appreciation.
__C__ 5. If the international Fisher effect (IFE) did not hold based on historical data, then this
suggests that:
a. some corporations with excess cash can lock in a guaranteed higher return on future foreign
short-term investments.
b. some corporations with excess cash could have generated profits on average from covered
interest arbitrage.
c. some corporations with excess cash could have generated higher profits on average from
foreign short-term investments than from domestic short-term investments.
d. most corporations that consistently invest in foreign short-term investments would have
generated the same profits (on average) as from domestic short-term investments.
__E__6. Assume that U.S. and British investors require a real return of 2%. If the nominal U.S.
interest rate is 15%, and the nominal British rate is 13%, then according to the IFE, the British
inflation rate is expected to be about _______ the U.S. inflation rate, and the British pound is
expected to _______.
a. 2 percentage points above; depreciate by about 2%
b. 3 percentage points above; depreciate by about 3%
c. 3 percentage points below; appreciate by about 3%
d. 3 percentage points below; depreciate by about 3%
e. 2 percentage points below; appreciate by about 2%
__B__ 7. Assume that the inflation rate in Barbados is 3.20%, while the inflation rate in the U.S.
is 3.00%. According to PPP, the Barbados dollar (BBD) should _______ by _______%.
a. appreciate; 0.1938%
b. depreciate; 0.1938%
c. appreciate; 0.1942%
d. depreciate; 0.1942%
__A__ 8. Nominal interest rates in Cyprus are 7%, while nominal interest rates in the U.S. are
5%. The spot rate for the Cyprus pound (CYP) is $1.50. According to the international Fisher
effect (IFE), the Cyprus pound should adjust to a new level of:
a. $1.47.
b. $1.53.
c. $1.43.
d. $1.57.
True/False
Indicate whether the statement is true or false.
__ True __ 9. The relative form of purchasing power parity (PPP) accounts for the possibility of
market imperfections such as transportation costs, tariffs, and quotas in establishing a
relationship between inflation rates and exchange rate changes.
__ False __ 10. According to the international Fisher effect (IFE), the exchange rate percentage
change should be approximately equal to the differential in income levels between two
countries.
__ True __ 11. Research indicates that deviations from purchasing power parity (PPP) are
reduced over the long run.
__ False __ 12. The IFE theory suggests that foreign currencies with relatively high interest
rates will appreciate because the high nominal interest rates reflect expected inflation.
__ False __ 13. If the IFE theory holds, that means that covered interest arbitrage is not
feasible.
__ True __ 14. If interest rate parity holds, and the international Fisher effect (IFE) holds,
foreign currencies with relatively high interest rates should have forward discounts and those
currencies would be expected to depreciate.
__ False __ 15. Interest rate parity can only hold if purchasing power parity holds.
__ False __ 16. If interest rate parity holds, then the international Fisher effect must hold.