China 2001-2006

Q1. During the assigned time period: US dollar appreciated / depreciated (choose one) in real terms against the currency of foreign country.

Q2. During the assigned period, what was the average uncovered rate of return from the US

viewpoint for the foreign country?

Q3. During the assigned period, what was the average uncovered rate of return from the foreign

country's viewpoint?

Q4. Based on your answers to questions 2 and 3, given perfect hindsight about interest rates and

exchange rate changes during the assigned time period you should have:

Invested/ borrowed (choose one) in the US and invested / borrowed (choose one) in foreign

country.

Q5. Assume that you could both borrow and invest at the average interest rates prevailing in

foreign country and in the US during the assigned time period. Also assume that you have a line

of credit for one million dollars in the US or an equivalent amount in foreign country. Given

perfect hindsight about interest rates and exchange rate changes, please calculate your total

profit in dollars using uncovered interest arbitrage during the assigned time period if you

followed the strategy chosen in Q4.

Work Sheet

Country China

Six-year time period 2001 2002 2003 2004 2005 2006 Geom. Avg

Inflation Rate: US 2.8 1.6 2.3 2.7 3.4 3.2 2.68%

Inflation Rate: China 0.5 -0.8 1.2 3.9 1.8 1.5 1.34%

Interest Rate: US 3.7 1.7 1.2 1.6 3.5 5.2 2.81%

Interest Rate: China 3.2 2.7 2.7 3.3 3.3 3.3 3.08%

% Change in CD SR (Indirect quote) -0.0 0.0 0.0 -0.0 -1.0 -2.7 -.46%

% Change in CD SR (Direct quote) = [1/(1 + % change in IQ)] 1

PPP Implications:

Annual Uncovered Rate (for US)

Annual Uncovered Rate (for China)

Suggest investment strategy based on IFE: