Question

9) Suppose that the price level in Canada is CAD17,800, the price level in Italy is
EUR13,000, and the spot exchange rate is CAD1.30/EUR. Which of the following
statement is MOST likely to be true?
A. The internal purchasing power of the Canadian Dollar is greater than its external
purchasing power.
B. Absolute purchasing power parity suggests that the Canadian Dollar is overvalued
(relative to the Euro).
C. Absolute purchasing power parity holds.
D. Relative purchasing power parity suggests that the Euro is overvalued (relative to the
Canadian Dollar).
E. The implied exchange rate of CAD/EUR that satisfies absolute PPP is about 0.6742.
10) If both uncovered interest parity (UIP) and real interest parity (RIP) were to hold, then
which of the following is LEAST likely to be true:
A. Real interest rates are the same across different countries.
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B. Expected change in future spot exchange rate is equal to nominal interest rate
differential.
C. Inflation differential is equal to nominal interest rate differential.
D. Unbiasedness hypothesis does not necessarily hold.
E. Current spot exchange rate is equal to the ratio of two price levels.
11) Which of the following statements regarding foreign currency futures and forward
contracts is LEAST likely to be true?
A. Futures contracts are standardised while forward contracts are customised.
B. Comparing with forward contracts, futures contracts carry no or low default risk
C. Investors taking a long position in futures contracts have to make a premium payment
to the counterparty because they receive a privilege in the long position.
D. Forward contracts require no explicit collateral while futures contracts require
margins.
E. Futures contracts are traded in exchange while forward contracts are traded over-thecounter.

Answer 1

Question 9 - The answer is (a) The internal purchasing power of the Canadian Dollar is greater than its external
purchasing power. This is because canadian dollar is cheap in terms of euros hence a consumer can buy a good for less amount than for EUROs in italy some the identical product.

(b) is incorrect because absolute purchasing power parity is CAD1.30/EUR and suggests that the Canadian Dollar is undervalued relative to EURO

(c) is incorrect because Absolute purchasing power parity does not holds

(d) Absolute purchasing power parity suggests that the Euro is overvalued (relative to theCanadian Dollar) and not relative PPP

(e) is incorrect because absolute ppp is 1.3692

Question 10 the answer is B. Expected change in future spot exchange rate is equal to nominal interest rate
differential.

(a) is incorrect beacuse the statement "eal interest rates are the same across different countries."is true

(c) is incorrect beacuse the statement " Inflation differential is equal to nominal interest rate differential."is true

(d) is incorrect beacuse the statement "Unbiasedness hypothesis does not necessarily hold."is true

(e) is incorrect because the statement "Current spot exchange rate is equal to the ratio of two price levels." is true

Question 11 The answer is (C )Investors taking a long position in futures contracts have to make a premium payment to the counterparty because they receive a privilege in the long position. This is because there is no premium paid on entering n the contracts whether forward or futures.

(A.)is incorrct because the statement "futures contracts are standardised while forward contracts are customised" is true as the futures contracts are traded on exchange and forward contacts are customised contracts traded on Over the counter markets

(b) is incorrect because the statement "Comparing with forward contracts, futures contracts carry no or low default risk" is true as the presence of clearing houses reduces the risk associated with futures contracts

(D) is incorrect because the statement "Forward contracts require no explicit collateral while futures contracts require margins" is true as there is daily settlement of gains or losses in the futures contracts so margin is required to cover the losses if any.

(e) is incorrect because "Futures contracts are traded in exchange while forward contracts are traded over thecounter." is true