Question

**1. Suppose the expected annual rate of inflation for the
coming year is 8% for the US and 4% for Switzerland. The current
spot exchange rate is $:SFr=2. The one-year interest rate is 10% in
the US. Using the precise form of the international parity
relations, compute the one-year interest rate in Switzerland, the
expected Swiss franc to pound exchange rate in one year, and the
one-year forward exchange rate.**

**2. A US investor likes to invest in the foreign exchange
market. After an analysis of US dollar to British pound exchange
rate data over the past decade, he has come up with his own model
to forecast the £:$ exchange rate one year ahead. Based on this
model, the forecast for the one-year-ahead exchange rate is $1.5315
per £. The spot £:$ is equal to 1.5620. The annual one-year
interest rates 2% in dollars and 4.25% in pounds.**

**a) What is the one-year forward £:$ exchange
rate?**

**b) If the US investor invests based on his model, which
currency would he buy forward?**

Answer #1

1. From International parity,

Real rate of interest in USA = Real rate of Interest in Switzerland

=(1+nominal interest rate in USA)/(1+inflation rate in USA) -1 =(1+nominal interest rate in Switzerland)/(1+inflation rate in Switerland) -1

=> 1.10/1.08 -1 = (1+nominal interest rate in Switzerland)/1.04 -1

=> nominal interest rate in Switzerland = 1.1*1.04/1.08-1 =
0.059259 or **5.93% (One year interest rate in
Switzerland)**

From Interest rate parity theorem

Expected Spot rate after one year / Spot rate = (1+nominal interest rate in Switzerland)/(1+nominal interest rate in USA)

=>Expected Spot rate after one year = 2*1.059259/1.10 =
**1.9259 Swiss Fr/$**

**or $:SFr= 1.9259**

**The Expected one year forward rate and the expected spot
rate in one year are the same in this case**

**Hence, Expected One year forward rate = 1.9259
SFr/$**

One year ago, the spot exchange rate between Japanese yen and
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rate is S_0 ^¥/Sfr = ¥155/SFr. Inflation during the year was p^¥ =
2 percent and p^SFr= 3 percent in Japan and Switzerland,
respectively.
a.) What was the percentage change in the nominal value of the
Swiss franc?
b.) One year ago, what nominal exchange rate would you have
predicted for today based on the difference in inflation rates?
c.)...

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1. 27
The 1-year interest rates on Canadian dollar and U.K. pound are
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$/£ ) implied by the covered interest rate parity
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Select one:
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1.29
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Dollar annual interest rate 4.803 % Swiss franc annualinterest rate...

Casper
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$
1,050,000
Spot exchange rate (SFr/$)
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3-month forward rate (SFr/$)
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U.S. Dollar annual interest rate
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Swiss franc annual interest rate
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Multiple Choice
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