1) You believe that IRP presently exists, whereas the nominal annual interest rate in Mexico is 14%. The nominal annual interest rate in the U.S. is 3%. You expect that annual inflation will be about 4% in Mexico and 5% in the U.S. The spot rate of the Mexican peso is $.10. Put options on pesos are available with a one-year expiration date, an exercise price of $.1008, and a premium of $0.014 per unit.

You will receive 1 million pesos in one year.

Determine the amount of dollars that you will receive if you use a forward hedge. 3 Marks

Determine the expected amount of dollars that you will receive if you do not hedge and believe in purchasing power parity (PPP). 3 Marks

Determine the amount of dollars that you will expect to receive if you use a currency put option hedge. Account for the premium you would pay on the put option. 4 Marks

2) Beth Miller does not believe that the International Fisher Effect (IFE) holds. Current one-year interest rates in Europe are 5 percent, whereas one-year interest rates in the U.S. are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.10.

a. According to the IFE, what should the spot rate of the euro in one year be 3 Marks

b. If the spot rate of the euro in one year is $1.00, what is Beths percentage return from her strategy? 3 Marks

c. If the spot rate of the euro in one year is $1.08, what is Beths percentage return from her strategy? 3 Marks

d. What must the spot rate of the euro be in one year for Beths strategy to be successful? 1 Mark

3)PPP and Real Interest Rates. The nominal (quoted) U.S. one-year interest rate is 6%, whereas the nominal one-year interest rate in Canada is 5%. Assume you believe in purchasing power parity. You believe the real one-year interest rate is 2% in the U.S, and that the real one-year interest rate is 3% in Canada. Today the Canadian dollar spot rate at $.90. What do you think the spot rate of the Canadian dollar will be in one year? 5 Marks

4)IFE, Cross Exchange Rates, and Cash Flows. Assume the value of the Hong Kong dollar (HK$) value is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, an Australian dollar (A$) is worth $.50 and HK$3.9. The one-year interest rate on the Australian dollar is 11%, whereas the one-year interest rate on the U.S. dollar is 7%. You believe in the international Fisher effect.

You will receive A$1 million in one year from selling products to Australia and will convert these proceeds into Hong Kong dollars in the spot market at that time to purchase imports from Hong Kong. Forecast the amount of Hong Kong dollars that you will be able to purchase in the spot market one year from now with A$1 million. Show your work. 5 Marks