Question

1. Portfolio diversification hypothesis relaxes the risk neutrality assumption under differential rate of return hypothesis.
   1. True
   2. False

2. Portfolio diversification hypothesis relaxes the risk neutrality assumption under differential rate of return hypothesis.
   1. True
   2. False

3. Suppose the spot exchange rate E€/$ = 1.25. However, the expected exchange rate in a year’s time is Ee  €/$    = 1.7. This implies that investors expect the dollar to appreciate.
4. 1. False
   2. True

4. Suppose Frank invests $7,000 in a domestic asset for a year. The amount returned to him after a year is 9 percent higher than what he had invested. This 9 percent is                                     .
   1. the foreign interest rate
   2. the domestic inflation rate
   3. the interest rate that banks charge on their loans
   4. the rate of return on his investment

5. A decrease in the expected exchange rate E$/£e causes:

1. 1. an increase in the rate of return on pound in the short run.
   2. an increase in the rate of return on dollar in the short run.
   3. a pound depreciation and a dollar appreciation.
   4. a decrease in the rate of return on pound in the long run.

Answer 1

Q1&2 (same).

The given statement is TRUE.

Q3.

The current rate of 1.25 implies that one dollar can fetch 1.25 Euros. If in future it is expected to fetch 1.7 Euros, it means that the worth of a dollar is expected to increase. So this statement is TRUE.

Q4.

d. This is the rate of return on his investment.

Q5.

A decrease in the expected exchange rate of $/Pound will mean that the number of dollars a pound can buy will decrease or we can say the value of the dollar will increase with respect to the pound. So the correct answer is option c (pound depreciation & dollar appreciation)