Question

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 |
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Borrowed Brazilian reals and invested in Brazilian reals |
||

Borrowed U.S. dollars and invested in Brazilian reals |
||

Borrowed Brazilian reals and invested in U.S. dollars |

2. __________ refers to the arbitrage strategy wherein an investor uses a forward contract to lock in future exchange rates and take advantage of interest rate differentials between two countries.

Triangular arbitrage |
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Uncovered interest arbitrage |
||

Locational arbitrage |
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Covered interest arbitrage |

3. __________ posits that changes in relative expected inflation rates between two countries will be reflected by changes in the spot exchange rate of the two countries.

Absolute purchasing power parity |
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International Fisher effect |
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Domestic Fisher effect |
||

Relative purchasing power parity |

4. The International Fisher Effect suggests that

an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country. |
||

the nominal interest rate differential reflects the expected change in the exchange rate. |
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any forward premium or discount is equal to the actual change in the exchange rate. |
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any forward premium or discount is equal to the expected change in the exchange rate. |

5. Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, and that the spot exchange rate is $1.60/€ and the forward exchange rate, with one-year maturity, is $1.58/€. Assume that an arbitrager can borrow up to $1,000,000 or €625,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?

$238.65 |
||

$14,000 |
||

$46,207 |
||

$7,000 |

6. You observe that the expected rate of inflation over the next year is 3.53% and current one year Treasury bills are yielding 5.82%. Based on the domestic Fisher effect, what is the approximate one year real rate of interest? Submit your answer as a percentage to two decimal places (Ex. 0.00%).

7. Suppose you observe a spot exchange rate of $1.20/€. If interest rates are 9% APR in the U.S. and 3% APR in the euro zone, what is the no-arbitrage 1-year forward rate?

€1.34/$ |
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$1.27/€ |
||

€1.20/$ |
||

$1.13/€ |

8. As of today, the spot exchange rate between China and the U.K. is 1 GBP = 9.5 CHY. Rates of inflation expected to prevail for the next year in China and the U.K. are 2% and 4%, respectively. What is the one-year forward rate that should prevail?

1 GBP = 9.69 CHY |
||

1 GBP = 9.55 CHY |
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1 GBP = 9.32 CHY |
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1 GBP = 9.18 CHY |

Answer #1

**(1)** Current Exchange Rate = 3.6 Real/$,
Brazilian Interest Rate = 4 % and US Interest Rate = 7 %

Expected Exchange Rate as per IRP = [(1.04) / (1.07)] x 3.6 = 3.499065 Real/$

Actual Exchange Rate = 3.2 Real / $

As is observable, the Brazilian Real is over valued with respect to the US $.

Hence, an arbitrage can be executed by the following the steps given below:

- Borrow 1 $ and convert the same into Reals at the current exchange rate to get (1x3.6) = 3.6 Reals

- Invest Reals at the Brazilian Interest Rate to yield = 1.04 x 3.6 = 3.744 Reals after one year.

- Convert Reals into $ at the actual exchange rate of 3.2 Reals/$ to yield = 3.744 / 3.2 = $ 1.17

- Dollar Borrowing Liability = 1.07 x 1 = $ 1.07

- Arbitrage Profit = 1.17 - 1.07 = $ 0.1

Hence, the correct option is **(c).**

**NOTE: Please raise separate queries for solutions to the
remaining unrelated questions.**

At the beginning of the year the exchange rate between the
Brazilian real and the U.S. dollar was 2.2 reals per dollar. Over
the year, Brazilian inflation was 12 percent and U.S. inflation was
4 percent. If purchasing power parity holds, at year-end the
exchange rate should be approximately ________________
dollars per real.
2.3913
0.4895
2.8498
0.4182
0.3440

1. 27
The 1-year interest rates on Canadian dollar and U.K. pound are
2 % and 5 % respectively. If the current spot rate is 2 Canadian
dollar per pound, then the 1-year forward rate (F Canadian
$/£ ) implied by the covered interest rate parity
approximation would be______.
Select one:
a. 2.15
b. 2.06
c. 1.94
d. 0.97
1.29
If the spot exchange rate between dollars and pounds is equal to
1.8 dollars for one U.K. pound and the...

1. Suppose the initial Brazilian real to US dollar exchange rate
is 4 reals (or “reais”) to 1 US dollar. The cost to buy a specified
market basket of same quality products is $500,000 in the U.S. and
R$1,400,000 in Brazil. Valued in U.S. dollar terms, the market
basket in Brazil costs $350,000. (This market basket cost
represents the combined price of thousands of products, and so also
indicates an average price for those products.)
(a) Consider the incentives of...

Suppose you observe that 90–day interest rate across the
eurozone is 5%, while the interest rate in the U.S. over the same
time period is 3%. Further, the spot rate and the 90–day forward
rate on the euro are both $1.25.
You have $500,000 that you wish to use in order to engage in
covered interest arbitrage.
Which of the following best describes covered interest
arbitrage?
a)Using forward contracts to mitigate default risk, while
attempting to capitalize on equal interest...

For this question
you should assume that there are four economies – the U.S, the U.K,
Canada and Europe. The U.S is the home economy. You are given the
following information. The U.S interest rate is 0.08.
Interest
Rate
Spot Exchange rate Forward
rate
U.K
0.05
1.0
Canada
0.15
2.0
Europe
0.5
What is the spot exchange rate between the U.K and Canada where
the U.K is the home country?
b.
What is the expected return for a U.S...

The spot rate for the Omani Rial is $2.6008/Rial. The U.S.
inflation rate is anticipated to be 1.3%. The Oman inflation rate
is expected to be 7.5%. Both countries are expected to have a real
interest rate of 1.5%. Show calculations.
A.) Based on the Fisher effect, calculate the U.S. nominal
interest rate (x.xx%).
B.) Based on the Fisher effect, calculate the Uzbekistan nominal
interest rate (x.xx%).
C.) Using purchasing power parity, calculate the expected spot
rate in 1 year....

If the spot exchange rate is 0.62 euro per Canadian dollar and
the three-month forward rate is 0.60 euro per
Canadian dollar, then the ________ on the Canadian dollar in
percentage (at an annual rate) is roughly
________.
Select one:
a. forward premium, 3.226%
b. forward premium, 12.90%
c. forward discount, 12.90%
d. forward discount, 3.226%
The 1-year interest rates on Canadian dollar and U.K. pound are
2 % and 5 % respectively. If the current spot rate is 2...

The spot rate for the CRL is $0.0587/CRL. The U.S. inflation
rate is anticipated to be 2.8%. The Country L inflation rate is
expected to be 5.8%. Both countries are expected to have a real
interest rate of 1.2%. Show calculations.
a.)Based on the Fisher effect, calculate the U.S. nominal
interest rate.
b.) Based on the Fisher effect, calculate the Country L nominal
interest rate.
c.)Using the international Fisher effect, calculate the expected
spot rate in 3 years.

A U.S. investor can borrow 1,000,000 or 500,000 GBP. The spot rate
is $2.00/GBP, the one year forward rate is $2.02/GBP. The U.S. one
year interest rate is 14% and the one year British interest rate is
12%. Determine if there is a covered interest rate arbitrage
opportunity, and if so, clearly show each step involved in the
arbitrage opportunity. Show the total dollar profit. If you
determined that there is no arbitrage opportunity, describe why you
made that decision.

James Smith, an international fund
manager, uses the concepts of purchasing power parity (PPP) and the
International Fisher Effect (IFE) to forecast spot exchange rates.
James gathers the financial information as follows:
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Expected annual U.S. inflation 8%
Expected annual South African inflation 6%
Expected U.S. one-year interest rate 1%
Expected South African one-year interest rate 0.08%
Calculate the following exchange rates
(ZAR and USD refer to the South African rand and U.S. dollar,
respectively)....

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