Question
1.The price of a tall vanilla latte at Starbucks in New York is $3.25 while in Rome it is 3. The current spot exchange rate
| 1.The price of a tall vanilla latte at Starbucks in New York is $3.25 while in Rome it is 3. The current spot exchange rate is $1.1050/. Assuming the Law of One Price holds, what should be the USD price in Rome for the latte? Which currency is overvalued and by how much? |
| 2.Assume that the export price of a Toyota Corolla from Osaka, Japan is 1,950,000. The exchange rate is 110/$. The forecast rate of inflation in the United States is 2.0% per year and is 0.0% per year in Japan. Use this data to answer the following questions on exchange rate pass-through. |
| a. What was the export price for the Corolla at the beginning of the year expressed in U.S. dollars? |
| b. Assuming purchasing power parity holds, what should the exchange rate be at the end of the year? |
| c. Assuming 100% pass-through of exchange rate, what will be the dollar price of a Corolla at the end of the year? |
| d. Assuming 75% pass-through, what will be the dollar price of a Corolla at the end of the year? |
| 3.CIA Susan Prescott is a foreign exchange trader for a bank in New York. She has $1 million (or its Swiss franc equivalent) for a short term money market investment and wonders if she should invest in U.S. dollars for three months, or make a covered interest arbitrage (CIA) investment in the Swiss franc. She faces the following quotes: | ||||||||
|
| Assumptions |
| Value |
|
|
| SFr. Equivalent | |
|
| Arbitrage funds available |
| $1,000,000 |
|
|
| SFr. 994,000 | |
|
| Spot exchange rate (SFr./$) |
| .9940 |
|
|
|
| |
|
| 3-month forward rate (SFr./$) |
| .9910 |
|
|
|
| |
|
| U.S. dollar 3-month interest rate |
| 2.600% pa |
|
|
|
| |
|
| Swiss franc3-month interest rate |
1.600% pa |
|
|
|
|
What should Susan do?
| 4.UIA .Susan Prescott, using the same values and assumptions as in the previous question, now decides to seek the full 2.600% return available in US dollars by not covering her forward dollar receipts -- an uncovered interest arbitrage (UIA) transaction. Assess this decision. | |||||||
| Assumptions |
| Value |
|
|
| SFr. Equivalent | |
| Arbitrage funds available |
| $1,000,000 |
|
|
| SFr.994,000 | |
| Spot exchange rate (SFr./$) |
| .9940 |
|
|
|
| |
| 3-month forward rate (SFr./$) |
| .9910 |
|
|
|
| |
| Expected spot rate in 90 days (SFr./$) | .9940 |
|
|
|
| ||
| U.S. dollar 3-month interest rate |
| 2.600% pa |
|
|
|
| |
| Swiss franc3-month interest rate | 1.600% pa |
|
|
|
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Financial Accounting A User Perspective
Authors: Robert E Hoskin, Maureen R Fizzell, Donald C Cherry
6th Canadian Edition
470676604, 978-0470676608
