Question

True or false questions and explain with 50 words

1)In general, firms are attracted to list their shares in a country's stock exchange with a large investor base.

2)Currency swaps can be used to help firms borrow cheaply.

3) Assume that inflation in the United States is expected to be 2.5 percent, while inflation in the eurozone is expected to be 1.2 percent over the next year. Today you receive an offer to purchase a one-year call option for US$.02 per unit on euros at a strike price of US$1.90. The current spot rate is US$1.18 per euro. If you believe that purchasing power parity holds, you should accept the offer.

Answer 1

1. True. Liquidity offered by a large investor base is higher which will benefit the companies.

2. True. They can borrow by using currency swaps with the help of other companies which might require some other currency and hence the overall cost of borrowing by both comes down.

3. Since inflation in US is high, USD is going to depreciate with respect to the Euro. The rate after one year by purchasing power parity should be = 1.18 x 1.025/1.012 = 1.195. Hence, this is less than the strike. So, we will have a loss if we buy the call. We should not accept the offer. False.