Test bank chapter 1 Introduction

Solution: use Equation (5-6). Remember that the reciprocal of 3342.63 = 0.0002991.
new exchange rate = $0.0002991[(1 + .05)/(1 + .90)]
= $.0001652/KHR;
or KHR1/$.0001653 = KHR6053.27/$

23. If the expected inflation rate is 4% and the real required return is 5%, what is the nominal interest rate?

A. 1%
* B. 9%
C. 6%
D. 5%
E. 11%


Solution: Use Equation (5-7): nominal rate = real rate + inflation rate.
Nominal rate = 5% + 4% = 9%

Use the following information to answer the next three questions.

Assume the following: you have $10,000 to invest; the current spot rate of British pounds is $1.800; the 90-day forward rate of the pound is $1.780; the annual interest rate in the US is 4%; the annual interest rate in the UK is 6%.

24. Where would you invest your $10,000 to maximize your yield with no foreign exchange risk?

* A. in the United States
B. in the United Kingdom
C. cannot tell
D. does not make any difference
E. in Germany


Solution: invest in the US: $10,000 x 1.01 = $10,100


Invest in the UK and cover in the forward market.


Buy pounds at the present spot rate:
$10,000/1.8 = £5,555
invest in the UK:
£5,555 x 1.015 = £5,638
sell pounds forward: £5,638 x 1.78 = $10,036


The investor would earn $64 more by investing in the United States instead of the United Kingdom.

25. Given the US interest rate, the UK interest rate, and the spot rate, what would be an equilibrium forward exchange quotation?

A. 1.800
B. 1.780
* C. 1.809
D. 1.905
E. 2.000


Solution: use Equation (5-8) and solve for the forward rate:
[(F - 1.800)/1.800 x (360/90)] = 0.04 - 0.06
F = £1.809

26. Given the spot rate, the forward rate, and the US interest rate, what is the equilibrium UK interest rate?

A. 6.0%
B. 8.9%
C. 4.0%
D. 6.0%
* E. 8.4%