Question

Chapter 6
1. An arbitrage is best defined as:
a. A legal condition imposed by the Commodity Futures Trading Commission.
b. The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making reasonable profits.
c. The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making guaranteed profits.
d. None of the above.

2. If a foreign country experiences a hyperinflation:
a. Its currency will depreciate against stable currencies.
b. Its currency may appreciate against stable currencies.
c. Its currency may be unaffected—it's difficult to say.
d. None of the above.

3. In view of the fact that PPP is the manifestation of the law of one price applied to a standard commodity basket:
a. It will hold only if the prices of the constituent commodities are equalized across countries in a given currency.
b. It will hold only if the composition of the consumption basket is the same across countries.
c. Both a. and b.
d. None of the above.

4. Generally unfavourable evidence on PPP suggests that:
a. Substantial barriers to international commodity arbitrage exist.
b. Tariffs and quotas imposed on international trade can explain at least some of the evidence.
c. Shipping costs can make it difficult to directly compare commodity prices.
d. All of the above.

5. A higher U.S. interest rate (i$ ↑) will result in:
a. A stronger dollar.
b. A lower spot exchange rate (expressed as foreign currency per U.S. dollar).
c. Both a and b.
d. None of the above.

Answer 1

(1): The answer is option “c” - The act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making guaranteed profits.

Explanation – The profit is guaranteed as there are price inequalities that can be exploited.

(2): The answer is option “a” - Its currency will depreciate against stable currencies.

Explanation – The buying power of the currency experiencing hyper-inflation will fall and this will lead to its depreciation.

(3): The answer is option “c” – both a and b.

Explanation – This is because PPP states that the exchange rate between currencies of two countries should be equal to the ratio of the countries' price levels and as the purchasing power of a currency sharply declines (due to hyperinflation) that currency will depreciate against stable currencies.

(4): The answer is option “d’ – all of the above.

This is self-explanatory.

(5): The answer is option “a” – a stronger dollar.

Explanation: This as per the uncovered interest parity condition.