1) Which of the following statements regarding foreign exchange market is LEAST likely to be true?

A. Netting arrangements are used to reduce the cross-currency settlement risk (Herstatt risk)

B. Inter-bank trades account for the majority of foreign exchange transactions

C. Foreign exchange dealers take positions in foreign exchange arbitrage and speculation.

D. The foreign exchange market is a geographically centralized market.

E. Companies and individuals buy/sell foreign currencies at exchange rates determined by the foreign exchange market makers.

2) Suppose that the spot exchange rate S(/) between the yen and the euro is currently 110/, the 1-year euro interest rate is 6% p.a., and the 1-year yen interest rate is 3% p.a. Which of the following statements is MOST likely to be true?

A. The high interest rate currency must sell at a forward premium when priced in the low interest rate currency to prevent covered interest arbitrage Page 3 of 13

B. Real interest parity does not hold

C. Uncovered interest parity requires equality of the return to investing in yen for 1-year versus converting the yen principal into euros, investing the euros for 1-year, and then selling the euro principal plus interest at the forward rate for yen

D. Covered interest parity between a 1-year yen-denominated asset and a eurodenominated asset of matching maturity holds if the forward exchange rate F(/) < S(/)

E. The expected future spot rate, SE (/), should be higher than the current spot rate to ensure uncovered interest parity