Problem set for Exchange Rate Movement

CFA Level II
#1

Hello All

I have answered those three below questions. But I am not sure if am correct. Would you be able to comment my answer. My answers are all Flase.

Thank you very much.

Are following statements true or flase? Explain why?

(a) If the general price index in UK rises faster than that in the USA, we would expect the pound to appreciate relative to the dollar------------False

(b) Suppose you are a German machine tool exporter, and you invoice all your sales in foreign currency. Further suppose that European Central Bank begins to undertake an expansionary monetary policy. If it is certain that the easy money policy will result in higher inflation rates in Germany relative to those in other countries, then you should use the forward markets to protect yourself against future losses resulting from the deterioration in the value of the euro.--------False.

I THINK I DO NOT HAVE TO USE FORWARD MARKET BECAUSE ALL INVOICE AMOUNTS ARE WRITTEN IN FOREIGN CURRENCY, NOT EURO. THEREFORE IN THIS CASE I CAN ACHIEVE PROFIT, AS MY CLIENTS PAYS NON EURO WHICH IS STRONGER THAN EURO.

© If you could accurately estimate differences in the relative inflation rates of two countries over a long period while other market participants were unable to do so, you could successfully speculate in spot currency markets.----False

I CAN SUCCESSFULLY SPECULATE IN FORWARD CURRENCY MARKETS NOT spot currency markets.

#2

I think c is True, because if you are certain about inflation differentials, you would know the future spot price today, there would be no need to enter into fwds or futures (when you enter a fwd or future, you pay a premium in exchange for certainty).

Please correct me guys if I’m wrong.

#3

C is true! The question sounds a bit vague, but since they specifically mention relative inflation “over a long period”, it seems like they are trying to make a point about purchasing power parity. If a Big Mac costs twice as much Currency X as Currency Y in the distant future, Currency X will be worth about half of Currency Y.

Theoretically, you could use forwards, but spot trading would also work in this case.