Question

Suppose you are a currency speculator trying to forecast what will happen to the value of the dollar over the next year. Suppose all of our usual theories hold (uncovered, covered and real interest rate parities, absolute and relative purchasing power parities, as well as the Fisher effect for nominal interest rates). For each of the separate cases below, use the information in that case to compute the expected depreciation of the dollar, or state if there is not enough information. State the name of the parity condition(s) you use and show your work.

a. Expected inflation over the next year is expected to be 1% in the U.S. and -1% in Europe.

b. The nominal interest rate in the U.S. for a 1-year dollar deposit is 3%, and that for a euro deposit is 2%.

c. The current spot exchange rate is 1 dollar per euro, and the forward rate for a year from now is 1.1 dollars per euro.

Answer #1

Suppose that you are told that the interest rate on a US
government bond is 3 percent compared to a 2 percent interest rate
on a comparable German bond (i.e. equal risk and maturity). a)
Assuming that uncovered interest parity holds (so that investors
are currently indifferent between the two assets), what would this
imply about the market's expectation of the future value of the
dollar in the exchange market? Explain. (10 points) b) Suppose that
the current spot rate...

2. Suppose that you are told that the interest rate on a US
government bond is 3 percent compared to a 2 percent interest rate
on a comparable German bond (i.e. equal risk and maturity).
a) Assuming that uncovered interest parity holds (so that
investors are currently indifferent between the two assets), what
would this imply about the market's expectation of the future value
of the dollar in the exchange market? Explain. (10 points)
b) Suppose that the current spot...

How much arbitrage profit can you obtain with the following
information?
Hint. Covered interest arbitrage
Spot exchange rate: 1.1 Euro / dollar
Forward exchange rate: 1 Euro / dollar
Risk free rate in U.S: 3%
Risk free rate in Europe: 2%

22. Assume the following information:
You have $2,000,000 (US dollars) to invest:
Current spot rate of euro = $1.30
1-year forward rate of euro = $1.25
1-year deposit rate in U.S. = 11%
1-year deposit rate in Europe = 14%
If you use covered interest arbitrage for a 1-year investment, what
will be the amount of U.S. dollars you will have after one year?
(Points : 3.5)
-$2,192,307.69.
-$2,371,200.00.
-$3,672,500.00.
-$1,403,076.92.
Question 23. 23. Continued from...

6) Assume that U.S. and British investors require a real return
of 3%. If the nominal U.S.
interest rate is 16%, and the nominal British interest rate is 13%,
then according to the
Real Interest Parity (RIP) as well as the Uncovered Interest Parity
(UIP), the British
inflation rate is expected to be about _________ the U.S. inflation
rate, and the British
pound is expected to _________.
A. 3 percentage points above; appreciate by about 3%
B. 3 percentage points...

1. You observe that one U.S. dollar is currently equal to 3.6
Brazilian reals in the spot market. The one year US
interest rate is 7% and the one year Brazilian interest rate is 4%.
One year later, you observe that one U.S. dollar is now equal to
3.2 Brazilian reals in the spot market. You would have made a
profit if you had:
Borrowed U.S. dollars and invested in U.S. dollars
Borrowed Brazilian reals and invested in Brazilian reals
Borrowed...

3) 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...

Question 1
(a) Assume the following information:
Spot rate of £ = $1.60
180-day forward rate of £ = $1.59
180-day British interest rate = 4%
180-day U.S. interest rate = 3%
Based on this information, is covered interest arbitrage by U.S.
investors feasible (assuming that U.S. investors use their own
funds ($1 million))? Explain.
(b) Covered Interest Arbitrage in Both Directions. The one-year
interest rate in New Zealand is 6 percent. The one-year U.S.
interest rate is 10 percent....

The exchange rate today $1.00 = €0.85. You are a currency
speculator. Suppose you have $1,000,000 in dollars and 1,000,000 in
euros in your portfolio and you believe the dollar will depreciate
in value versus the euro (€). Suppose you know in one
week the exchange rate will be$1.00 = €0.76. Your intent is to
profit from currency speculation. Using the money in your portfolio
to make currency trades, calculate how much profit you could make
in dollars. Provide your answer...

Suppose that the expected real interest rate in the United
States is 9 percent per year while that in Europe is 3 percent per
year. What do you expect to happen to the real dollar/euro exchange
rate over the next year?

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