1. (2.5 Points) Assume the Hong Kong dollar (HK$) value is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, a euro () is worth $1.18 and HK$9.21. The one-year interest rate on euro is 8%, while the one-year interest rate on the U.S. dollar is 3%. You believe in the International Fisher effect.

Boston company will receive 2 million in one year from selling products to Europe, and will convert these proceeds into Hong Kong dollars in the spot market at that time to purchase imports from Hong Kong.

Estimate the amount of U.S. dollars that Boston will receive in one year when converting its receivables into U.S. dollars. (1.25 Points)

Forecast the amount of Hong Kong dollars that Boston will be able to purchase in the spot market one year from now with 2 million. (1.25 Points)(Hint: Since HK$ is pegged to USD, the value change between and HK$ one year later is going to be exactly the same as that between USD and )

ANS: Please label a/b in your response to the two sub-questions respectively.

2. (1.25 Points) The spot rate of the New Zealand dollar is $0.68. The spot rate of the Argentine Peso is 0.084 New Zealand dollars. You expect that the one-year inflation rate is 8 percent in the New Zealand, 10 percent in Argentine, and 3 percent in the U.S. The one-year interest rate is 9% in New Zealand, 8% in Argentine, and 2% in the U.S.

Assume that locational arbitrage and triangular arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in the International Fisher Effect. What is your expected spot rate of the Argentine Peso in one year with respect to the U.S. dollar?

ANS:

3. (1.25 Points) The spot rate of the Australian dollar is $0.76, and the spot rate of the British pound is $1.32. You expect that the one-year inflation rate is 8 percent in the U.K., 5 percent in Australia, and 3 percent in the U.S. The one-year interest rate is 8% in the U.K., 6% in Australia, and 5% in the U.S.

Assume that locational arbitrage and triangular arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in the International Fisher Effect. What is your expected spot rate of the British pound in one year with respect to the Australian dollar?

ANS: