Global Money Markets and Institutions Assignment #4 Spring 2019 Chapter 6 Problems.

Name: _____________________________________

1.) The current spot exchange rate is $1.53/ and the three-month forward rate is $1.50/. Based on your analysis of the exchange rate, you are confident that the spot exchange rate will be $1.55/ in three months. Assume that you would like to buy or sell $1,000,000.

a.) What actions do you need to take to speculate in the forward market? b.) Is the dollar at a forward premium or discount? Explain your answer.

2.) A currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate in the U.S. is i$ = 5% and in the euro zone the one-year interest rate is i = 4%. The spot exchange rate is $1.25/ and the one-year forward exchange rate is $1.40/.

a.) Show how to realize a certain profit via covered interest arbitrage. b.) How do interest rates, the spot currency market, and the forward currency market adjust to produce an equilibrium?

3.) Japan is expected to have inflation of 2% for the coming year, while the US is expected to have deflation of 3%. The spot exchange rate is yen 95/$. A Toyota made in Japan costs yen 4.75 million. Purchasing Power Parity holds.

a.) What is the best estimate of the spot rate 1-year from today? Explain your answer. b.) What will be the dollar cost of a car imported from Japan one year from today?

4.) The 1-year UK inflation rate is 4%, and the 1-year US inflation rate is 3%. The current spot exchange rate is $1.90/.

a.) Assuming Purchasing Power Parity holds, what is your estimate of the spot rate that is likely to prevail in one year?

5.) A currency dealer has good credit and can borrow either 1,000,000 or 750,000 for two years. The 2-year euro interest rate is 5%, and the 2-year pound interest rate is 6%. The spot exchange rate is 0.75/, and the 2-year forward exchange rate is 0.80/.

a.) Show how to realize a certain profit via covered interest arbitrage. b.) How do interest rates, the spot currency market, and the forward currency market adjust to produce an equilibrium? Provide some explanation of the adjustment process.

6.) The 5-year US dollar interest rate is 3% and the 5-year Russian ruble interest rate is 8%. The spot exchange rate is RUB25/$ and the 5-year forward exchange rate is RUB30/$.

a.) Is a covered interest arbitrage profitable? Show your work. ..continued on back. 7.) The spot exchange rate is 107/$. US inflation is 4% per year for the next two years and Japan has inflation of 6% per year for the next two years. Two years from today the spot exchange rate is 105/$.

a.) Which country gained competitiveness? b.) Compare the % change in the spot rate to what is required to maintain PPP. c.) What is the real exchange rate index for the $? d.) What is the real exchange rate index for the ?

8.) The spot exchange rate is $1.74/. US inflation is 3% per year for the next three years and the UK has deflation of 2% per year for the next three years. Three years from today the dollar has depreciated and spot exchange rate is $2.15/.

a.) Which country gained competitiveness? b.) Compare the % change in the spot rate to what is required to maintain PPP. c.) What is the real exchange rate index for the $? d.) What is the real exchange rate index for the ?

9.) The US inflation rate is expected to be 4.5% per year for the next five years, and the UK inflation rate is expected to be 2.50% per year. The spot exchange rate is $2.0/.

a.) Using Relative PPP find the expected $/ exchange rate five years from today.

Some problems from the text book:

10.) While you were visiting London, you purchased a Jaguar for 35,000, payable in three months. You have enough cash at your bank in New York City, which pays 0.35%, compounded monthly, to pay for the car. Currently, the spot exchange rate is $1.45/, and the 3-month forward exchange rate is $1.40/. In London, the annualized money market interest rate is 2.0% for a three-month investment. There are two ways to pay for the Jaguar.

a.) Keep the funds at your bank in the US and buy a 35,000 forward. b.) Buy the appropriate amount of pounds today in the spot market and invest this amount in the UK for three months so that the maturity value becomes 35,000.

Which method do you prefer? Why?

11.) The exchange rate between the Brazilian real and the US dollar is R$1.95/$. You forecast that inflation over the coming year will be 2% in the US and 20% in Brazil. What would you forecast the exchange rate to be one year from today?