Exam 6: International Parity Relationships and Forecasting Foreign Exchange Rates

Suppose that the one-year interest rate is 5.0 percent in the United States; the spot exchange rate is $1.20/€; and the one-year forward exchange rate is $1.16/€. What must one-year interest rate be in the euro zone to avoid arbitrage?

Suppose you observe a spot exchange rate of $1.50/€. If interest rates are 3% APR in the U.S. and 5% APR in the euro zone, what is the no-arbitrage 1-year forward rate?

The random walk hypothesis suggests that

According to the technical approach, what matters in exchange rate determination

A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i_$ = 2% and in the euro zone the one-year interest rate is i_€ = 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities?

According to the monetary approach, what matters in exchange rate determination are

The Fisher effect can be written for the United States as:

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

USING YOUR PREVIOUS ANSWERS and a bit more work, find the 1-year forward BID exchange rate in $ per € that that satisfies IRP from the perspective of a customer.

The Fisher effect states that

The main approaches to forecasting exchange rates are

Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (that's a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. The interest rate in Japan (on an investment of comparable risk) is 13 percent. What is your strategy?

If a foreign county experiences a hyperinflation,

Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (that's a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. What must the interest rate in Japan (on an investment of comparable risk) be before you are willing to consider investing there for six months?

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

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?

USING YOUR PREVIOUS ANSWERS and a bit more work, find the 1-year forward ASK exchange rate in $ per € that that satisfies IRP from the perspective of a customer.

A U.S.-based currency dealer has good credit and can borrow $1,000,000 for one year. The one-year interest rate in the U.S. is i_$ = 2% and in the euro zone the one-year interest rate is i_€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how to realize a certain dollar profit via covered interest arbitrage.

Generally unfavorable evidence on PPP suggests that

According to the monetary approach, the exchange rate can be expressed as