Instructions for the project

**(FOREIGN COUNTRY ASSIGNED CHILE 1997-2006)**

The following pages contain annual data on interest rates, inflation rates, and percentage change in exchange rates (based on indirect quotes) for foreign countries, including the US, for the period 1995 - 2007.

Each one of you is assigned to a foreign country and a six-year time period (1995-2000 or 1997-2006). Please consult the attached list to determine your assigned country and time period.

Please use the attached sheets to answer the questions listed based on calculations using the data for the assigned country and the US during the assigned time period.

Use geometric instead of arithmetic averages. Use exact instead of the approximate method.

There is only one correct answer to these questions.You will be graded on whether or not your answers are correct.

The necessary information and concepts are all from Chapter 4. I will discuss the solution techniques to these problems only during class.I will not discuss them with anyone on an individual basisoutside the class.

Please answer the following ve questions: 01. During the assigned time period: US dollar appreciated / depreciated (choose one) in real terms against the currency of foreign country. 02. During the assigned period, what was the average uncovered rate of return from the US Viewpoint for the foreign country? 03. 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 lborrowed (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 prot in dollars using uncovered interest arbitrage during the assigned time period if you followed the strategy chosen in Q4. Work Sheet: Statistical Report Country CANADA Four-year time period 1998 1999 2000 2001 Geom Avg Ination Rate: US 1.5 2.2 3.4 2.8 Ination Rate: Foreign Country 1.0 1.7 2.7 2.5 Interest Rate: US 5.5 5.3 6.5 3.7 Interest Rate: Foreign Country 5.0 5.2 5.8 2.1 % Change in CD SR (Indirect quote) 7.10 0.10 0.00 4.3 % Change in CD SR (Direct quote) = [1/(1 + % change in IQ)] - 1 PPP Implications: Annual Uncovered Rate (for US) Annual Uncovered Rate (for Canada) Suggest investment strategy based on IFE: International Economic Trends Reference Tables Consumer Price Index 2007 2001 2003 2004 2006 Percent change from year ago 2000 2002 2005 2.3 1995 1996 1997 1998 1999 2.8 2.3 2.7 3.5 3.0 0.9 1.7 2.2 Australia 1.6 2.6 0.2 1.2 0.8 0.5 2.2 2.0 2.1 1.6 1.8 Austria 1.6 1.0 3.0 3.4 4.4 Canada 2.1 1.6 3.3 1.5 4.8 3.2 7.4 6.1 5.1 Chile -0.8 1.8 8.3 2.8 -0.9 -1.4 1.9 China 17.1 2.1 2.1 2.2 1.8 Geometric and Arithmetic Means of Rates and Percentages Denmark 1.2 Euro Area 2.6 2.1 1.7 If the rates for years 1, 2, 3, ... N are R1, R2, R3, .... RN , then you can calculate the arithmetic and geometric mean or averages 1.1 1.2 1.3 Finland 1.3 0.7 2 .3 18 2.1 of these rates over the N years, as follows: France 1.5 0.6 0.6 1.2 = (R, + R2 + R, + .. + RN ) /N Germany 4.5 13.1 Arithmetic Mean 7.9 5.4 Greece [(1+R, )* (1+ R2)* (1+ R; ) * **(1+ RN ) ]UN- 1 8.0 58.4 20.5 4 6.2 Geometric Mean = Indonesia 2.2 N Note, that in the geometric mean formula, the percentages are written in decimals. For example, we use 0.10 instead of 10% Ireland 5.5 and -0.02 instead of -2%. Also in the end we take the Nth root of the product, where N is the number of years in the averaging 10.0 11.3 Israel 1.9 2.0 Italy 5.4 4.0 - 0.8 0.1 1.8 0.7 -0.3 - 0.7 period. -0.1 It is important to know that the geometric mean is a more accurate measure than the arithmetic mean. Always try to Japan 4.4 7.5 0.8 4.9 use the geometric mean method when calculating averages of rate of returns or percentages. Korea 4.5 3.5 5 .3 2.7 Malaysia 3.4 2.7 34.4 20.6 15.9 16.6 Let us assume the following rates of return for the five year period (2000-2004) : Mexico $5.0 1.9 1.8 2.0 2005 Netherlands 1.4 1.5 2.6 2.7 2003 1.2 1.3 -0.1 2000 2001 2002 .8 2.3 7% New Zealand 3.1 3.0 4.75% -8 % 0.5% 23% 1.2 2.6 2.3 4 Rates of return Norway 9.0 5.9 9.7 -0.2 1.0 Philippines 3.0 Our estimate of the average rate of return over the 2000-04 period based on: 1.4 -0.3 0.0 Singapore 17 2.0 7.4 8.6 6.9 5.2 5.3 3 .6 2.8 Arithmetic Mean = (0.0475 - 0.08 + 0.005 + 0.23 + 0.07) / 5 = 0.0545 =5.45% South Africa 3.7 3 . 6 1.8 2.2 3.5 0.5 1.4 2.2 4.6 3.6 1.9 Geometric Mean = [(1+ 0.0475)*(1 - 0.08)*(1 + 0.005)*(1 + 0.23)*(1 + 0.07) ]'s - 1 Spain 0.5 0.7 -0.3 0.5 0.9 1.2 1.1 0 .7 2.5 0 .6 = (1.02746672) 3 - 1 Sweden 0 .8 4.6 2.2 1.8 0.8 0.5 0.0 = 0.04973 = 4.973% Switzerland 4.973 % is a more accurate measure of the average return over the 2000-04 period than 5.45% 5.8 5 .6 8.1 0.3 9.6 8.8 Thailand 5.8 54.4 45.0 21.6 84.6 64.9 54.9 2.3 2.3 80.4 85.7 urkey 9.1 2.9 2.5 1.8 1.6 1.3 0.8 3.2 United Kingdom 2.7 2.3 1.5 2.2 136 187 2.9 2.3 31.1 21.7 160 United States 2.8 162 12.5 22.4 09 8 50 0 35.8 23.6 50 0 Venezuela Research Division Federal Reserve Bank of St. LouisReference Tables International Economic Trends International Economic Trends Reference Tables Short-Term Interest Rates 2006 2007 Annual percent 1998 1999 2000 2001 2002 2003 2004 2005 1995 1996 1997 5.5 5.6 6.0 6.7 Exchange Rates 2007 5.4 5.0 4.8 Percent appreciation (+) or depreciation (-) of the U.S. dollar against the local currency 7.2 5.0 6.2 2002 2003 2004 2005 2006 7.7 3.5 4.3 1998 1999 2000 2001 Australia 1997 1.2 -10.1 5.2 5.8 1995 1996 -4.9 -16.7 -11.5 - 3.4 5.9 3.1 4.6 5.0 3.9 5.1 5 .6 2.4 12. Canada 9.2 -1.3 -5.3 5.3 18 1 11.0 -7.1 -6.9 -6,4 -5.3 12.0 8.6 13.5 14.9 3.3 3.3 3.3 Australia 1.4 -10.8 13.7 -0.7 L.F 7.1 0. -0.0 4.3 Chile -5.3 -1.5 3.2 05 -11.8 -8.2 10.4 9.0 8.6 4.6 3.2 Canada 8.5 6.1 17.7 0.4 3 .1 1.7 9.8 10.5 -2.7 -4.6 China 3.7 4.1 3.3 4.9 1.0 Chile -5.6 3.9 0.0 0.0 .0.0 Denmark 6.1 3.9 3.1 4.3 -0.3 0.0 -0.0 -3.1 -0.4 -0.2 BENN -0.2 16.6 -9.0 0.1 -0.9 -8.4 5.1 4.4 4.0 3.0 4.4 11.4 8.0 China 2.9 -5.3 5.8 15.9 Euro Area 15.5 10.6 -11.8 3.5 13.9 1.4 4.2 -0.9 -8.4 39.1 25.7 12.5 15.5 Denmark 15.5 3.1 -5.3 -16.5 -9.0 -0.1 20.0 5.5 16 4.4 Indonesia 6.7 17.3 6.5 7.4 7.0 Euro Area 8.7 2.3 13.9 -7.9 4.2 8.6 - 5.6 -0.2 11.3 11. 8.8 15.3 7.2 21.8 -9.3 Israel 4.4 13.4 0.2 4.1 4.2 24.2 44.2 21.6 0.2 6 8 Indonesia 12.7 -3.9 -1.6 0.1 -0.7 -7.8 0.6 Japan* 8.1 -1.5 3.1 5.0 Israel 0.0 6.0 10.2 8.9 5.6 1.2 12.4 13.3 15.0 -5.2 12.7 3.1 -7.5 -6.7 1.8 Korea 2.6 2.8 2.8 8.0 13. -3.9 -6.8 apan -7.9 15.6 1.3 -10.6 -2.6 6. 5.5 64 64 -15.3 -4.9 14.2 -3.2 -4.7 Malaysia 17.2 8.5 47.2 24.6 13.4 Korea -4.2 4.2 18.5 -6.3 -0.0 0.0 -0.3 -3.2 48.2 32.9 22.3 27.1 7.5 3.2 0.0 0.0 0.0 Mexico 5.4 2.0 39.3 6.5 5.7 5.7 Malaysia 4.4 0.3 -3.4 0.0 0.3 7.3 48 9.3 7.7 5.0 4.6 1.1 -1.2 3.4 11.7 New Zealand 9.0 7.2 2.0 6.7 6.9 18.4 4.2 15.4 6.5 90.2 -20.2 -12.4 -5.7 8.4 -11.7 5.8 Mexico 8.7 -9.5 Norway 5.5 4.9 3.7 5.9 7.3 6 .1 5 .3 23.4 1.4 15.9 95 -4.6 -4.4 -8.7 9.7 5.5 3.8 -0.5 12.3 12.9 15.0 10.0 9.9 New Zealand -11.4 4.8 11.8 1.0 2.3 3.5 2.1 11.2 6.6 3.3 12.9 Philippines -10.1 2.0 2.6 2.0 1.0 0.7 Norway .10.2 1.9 9.6 3.4 -1.7 -6.8 2.9 4.4 5.0 7.3 9. 1 15.4 1.2 5.0 2.6 -4.4 13.1 Singapore -5.2 12.9 10.1 9.7 11.2 10.7 7.5 6.9 27 2.0 12.4 38.8 -3.0 -1.5 -4.6 15.0 15.3 16.5 2.1 1.7 2.3 3 .6 Philippines -27 South Africa 13.5 1.8 -0.1 12.5 1.4 3.9 3.0 5.4 6.4 4.2 4.2 3.1 4.0 4.0 4.1 -0.5 Singapore -7.2 21.9 28.2 -14.7 -1.4 3.7 5.8 4.1 03 05 0.8 1.6 2.6 10.6 13.6 24.2 Sweden 3.2 2.9 1.1 18.5 7.2 20.0 -1.3 -8.4 1.5 1.4 2.1 1.6 3.2 South Africa 11.0 12.7 6.0 16.9 -9.1 1.7 2.0 3.8 4.9 3.9 Switzerland 2.9 1.7 2.1 1.6 1.0 13.9 4.1 2.6 Sweden 7.5 -6.0 0.6 -4.3 21.7 1.2 18.2 -13.6 7.6 0.3 10.3 12.1 23.8 15.6 17.9 0.1 37 12.5 -0.1 7.8 Thailand 92.4 59.5 38.5 17.3 Switzerland -13.5 4.6 3.1 -0.1 -5.9 -15.0 74.6 38.9 76.2 70.3 73.5 4 7 4.8 6.0 6.2 10.7 3.3 .3.4 urkey 72.3 4.0 3.7 4.6 5 1.7 22.5 33.0 -8.3 54 6 1 Thailand 0.9 -0.4 -5.0 -5.7 6.3 -8.8 6.8 5 .3 49.3 96.0 23.0 United Kingdom 6.7 60 3.5 5.2 1.2 1.6 71.7 60.6 6.5 3.7 17 Turkey 54.8 77.6 86.6 .1.3 -7.9 5.5 5.3 5.4 5.6 28.5 5.3 -4.2 -8.1 -10.8 United States 40.0 28.5 28.5 28.5 28.5 1.1 -4.7 1.2 2.4 6.7 -5.6 37.0 -2.9 1.9 -1.5 45.0 45.0 60.0 38.0 38.0 United Kingdom 6.0 1.5 -12.3 -8.2 Venezuela 19.0 49 .56 7 4 8 17.7 105 2.7 0.0 United States 12.3 6 5 60.4 38.4 "The actual value for 2003 is 0.037; the actual value for 2004 is 0.029; the actual value for 2005 is 0.029. 17.1 12.0 10.6 Venezuela 19.0 136.1 Percent appreciation (+) or depreciation (-) of the U.S. dollar against a group of currencies Research Division Federal Reserve Bank of St. Louis 11 10 Research Division Federal Reserve Bank of St. Louis