Question

**Show how differences in interest rates effect forward
rates?**

Answer #1

According to interest rate parity forward rates are dependent on
the interest rate of foreign and domestic countries. The forward
rates are given as follows:

**Forward Rate = Spot Rate X (1 + Interest Rate of Foreign
country)/(1 + Interest Rate of Domestic country)**

Here we have to keep in mind that the domestic country has to be
kept as base currency.

The basic premise is that higher the interest rates, higher the
loss of value of currency. For example let the rates in US be 2%
and rates in India are 7%.

Current spot rate = rupees 50 per 1 USD.

After a years 50 rupees shall be 50*1.07=53.50

After a year dollar shall be =1*1.02=1.02 Dollars

New rate = 53.50/1.02=52.45 rupees/dollar.

Hence we can see that if interest rates are higher there is a
depreciation in the currency value.

As per formula: Value = 50*1.07/1.02=52.45 rupees /dollar

How do interest rates enter in the determination of the forward
exchange rate?

What effect would government deficit spending have on interest
rates? Explain. This change in interest rates caused by the
government deficit spending would have a long run effect on
investment spending. What effect would that be and why?

How are the forward rates between two currencies derived?

Briefly discuss the following statement: “If interest rates
decline, the buyers of both a Forward Rate Agreement (FRA) and
interest rate futures contract will benefit”.

Consider the forward interest rates defined by the following
equation: fk = 0.09 + 0.002k − 0.002k^2 for k = 0, 1, 2, 3, 4.
1) Find the 4-year spot rate
2) ) Find the 2 year deferred 3-year forward rate.

Demonstrate graphically and explain the effect of the following
on bond prices and interest rates.
a. an increase in the personal savings rate. How would this change
affect capital spending? b. increased profitability of investments
and increased deficits

Which one of the following supports the idea that real interest
rates are equal across countries?
Multiple Choice
Unbiased forward rates condition
International Fisher effect
Interest rate parity
Purchasing power parity
Uncovered interest rate parity

How to prove the forward exchange rate is F =
[S(1+rd) / (1+ rf )] under THE PRINCIPLE OF
NO-ARBITRAGE? (S is the spot rate and F the forward rate, and
rf and rd are foreign currency interest rates
and domestic currency interest rates respectively) (Or you can show
that F < S(1+rd) / (1+ rf ) and
F > S(1+rd) / (1+
rf ) violates the principle of no-arbitrage)

1. Explain the factors that determine the risk structure of
interest rates. Explain how a change of each factor changes
interest rates. [5 marks]
2. Suppose the liquidity premium is 0.4%, and the one-year
Canada bond rate is 8% and two-year Canada bond rate is 10%. Please
calculate the forward rate iet+1. [5
marks] (Hint: Using the method showed in
Application-Forward Rate in the textbook)

The substitution effect causes a borrower to increase private
savings as interest rates rise, and it causes the same effect on a
lender. True/False.

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