PROBLEM SET 04

PARITY CONDITIONS AND CURRENCY FORECASTING

1. Assume: (1) the U.S. annual interest rate = 10%; (2) the Swiss annual interest rate = 4%; and (3) the 90-day

forward rate for the SF = $.3864. At what current spot rate will interest rate parity (IRP) hold?

2. Assume the following: you have $10,000 to invest; the current spot rate of British pounds is $1.800; the 90-

day forward rate of the pound is $1.780; the annual interest rate in the U.S. is 4%; the annual interest rate in

the U.K. is 6%.

a.) Where would you invest your $10,000 to maximize your yield with no foreign exchange risk?

b.) Given the spot rate, the forward rate, and the U.S. interest rate, what is the equilibrium U.K. interest rate?

3. Assume you are a US investor with $1,000,000.

Spot rate of Canadian dollar = US$0.80/C$

90-day forward rate of Canadian dollar = US$0.79/C$

90-day Canadian interest rate = 4%

90-day US interest rate = 2.5%

a) What will you get if you invest in the US? What would be the yield to the investor?

b) What will you get if you invest in the Canada? What would be the yield to the investor?

c) Where will you invest?

4. The spot rate is BP0.60 per Swiss franc. The four-year annualized inflation rate is 9% in the UK and 6% in Switzerland.

a) What is the forecast for the franc's spot rate in four years?

b) What is the expected percentage appreciation or depreciation of the franc over the four-year period?

5. The spot rate is AUS$0.5800 per Singapore dollar. The forward premium for Singapore dollars is 13.79%.

What is the expected spot rate in 90 days?

6. The spot rate is BP0.08 per HK$. The annual interest rates are 4% for the UK and 9% for Hong Kong. What

is the market's forecast of the spot rate in two years?

7. The forecasted value for the Mexican peso is Euro0.1200 and its realized value is Euro0.1000. What is the

forecast error (root square error) for the peso?