(b) The following exchange rates and interest rates are observed for two countries - Country C and Country D - at the beginning (January 1st) of Year 2016, 2017, 2018, 2019, 2020, and 2021. Both the spot and one-year forward exchange rates are expressed with Country C's currency as the unit of denomination. That is, they are values of one unit of Country D's currency in terms of Country C's currency. All the interest rates are one-year interest rates observed at the beginning of the respective year. In answering this question, you assume the realized spot exchange rates are indeed the respective expected spot exchange rates. (i) Do the observed exchange rates and interest rates satisfy IFE, IRP, and UFR? Explain how you arrive at your conclusions by conducting analysis using the information provided. (ii) Based on your conclusion regarding the UFR condition in (1), comment on the perceived riskiness of investing in Country C vs. Country D. Specifically, how does the relative degree of riskiness change over time? Explain how you arrive at the conclusion. Observation date January 1, 2016 January 1, 2017 January 1, 2018 January 1, 2019 January 1, 2020 January 1, 2021 Spot exchange rate 0.8600 0.8302 0.8100 0.8141 0.8182 0.8220 One-year forward exchange rate 0.8452 0.8152 0.7946 0.7983 0.8016 0.8046 One-year interest rate Country C Country D 2.50% 4.30% 2.90% 4.80% 3.20% 5.20% 3.50% 5.55% 3.65% 5.80% 3.80% 6.05% (b) The following exchange rates and interest rates are observed for two countries - Country C and Country D - at the beginning (January 1st) of Year 2016, 2017, 2018, 2019, 2020, and 2021. Both the spot and one-year forward exchange rates are expressed with Country C's currency as the unit of denomination. That is, they are values of one unit of Country D's currency in terms of Country C's currency. All the interest rates are one-year interest rates observed at the beginning of the respective year. In answering this question, you assume the realized spot exchange rates are indeed the respective expected spot exchange rates. (i) Do the observed exchange rates and interest rates satisfy IFE, IRP, and UFR? Explain how you arrive at your conclusions by conducting analysis using the information provided. (ii) Based on your conclusion regarding the UFR condition in (1), comment on the perceived riskiness of investing in Country C vs. Country D. Specifically, how does the relative degree of riskiness change over time? Explain how you arrive at the conclusion. Observation date January 1, 2016 January 1, 2017 January 1, 2018 January 1, 2019 January 1, 2020 January 1, 2021 Spot exchange rate 0.8600 0.8302 0.8100 0.8141 0.8182 0.8220 One-year forward exchange rate 0.8452 0.8152 0.7946 0.7983 0.8016 0.8046 One-year interest rate Country C Country D 2.50% 4.30% 2.90% 4.80% 3.20% 5.20% 3.50% 5.55% 3.65% 5.80% 3.80% 6.05%
