25. At the beginning of 2002 the AUD/USD exchange rate was 3.30% for Australia a

Question

25. At the beginning of 2002 the AUD/USD exchange rate was 3.30% for Australia and 2.33% for the US, what should the AUDUSD echange end of 2002, according to the approximate calculation of Relative PPp theory 1.9585 and the 2002 inflation rates were rate have been at the A USD/AUD 0.5068 B: C AUD/USD 1.9775 D: USD/AUD 1.8769 E: USD/AUD 0.8467 AUD/USD 1.9736 26, The maximum gain for the purchaser of a call option contract while the maximum loss is is A) unlimited; the premium paid. B) the premium paid; unlimited. C) unlimited; unlimited. D) unlimited; the value of the underlying asset. 27) Assume a nominal interest rate on one-year US Treasury Bills of 4.60% and a real rate of interest of 2.50% Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the US. over the next year? A) 2.10% B) 2.05% C) 2.00% D) 1.90% in 28) Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that exposure deals with cash flows for, whileexposure deals with future cash flows that might change because of changes in exchange rates. A) transaction; operating ransaction; operatichange rates, exposure deals with , xposure dead B) operating; transaction C) operating: accounting D) none of the above 29) A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/E, the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.05/E the U.S. firm will realize a A) loss; $2000 B) gain; $2000 C) loss; £2000 D) gain; £2000 30) Translation exposure measures A) changes in the value of outstanding financial obligations incurred prior to a change in exchange rates. B) the potential for an increase or decrease in the parent company's net worth and reported net income caused by a change in exchange rates since the last consolidation of international operations. C) an unexpected change in exchange rates impact on short run expected cash flows. D) none of the above of

Explanation / Answer

25. Spot Rate of (AUD/ USD) in the beginning of 2002 was 1.9585

Inflation rates for Australia will be 3.30%, while the rates for US will be 2.33%. It can be clearly seen that the inflation rates of Australia is more than US which gives less purchasing power parity to Australia in terms of US. So to equate the scenario, AUD will be depreciated at the end of the year.

So, Depreciation will be; (1+Inflation rate of Australia) – (1+Inflation rate of US)

(1.033-1.0233) = 0.0097 = 0.97%

Again at end of 2002 the (AUD/ USD) will be; Beginning Year Rate * (1+depreciation rate)

Or, (AUD/USD); 1.9585*1.0097= 1.9775

So option (c) is Correct.

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