Question 8

Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/ and the forward exchange rate, with one-year maturity, is $1.16/. Assume that an arbitrager can borrow up to $1,000,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?

9.If IRP fails to hold,

pressure from arbitrageurs should bring exchange rates and interest rates back into line.

it may fail to hold due to transactions costs.

it may be due to government-imposed capital controls.

all of the options

10.As of today, the spot exchange rate is 1.00 = $1.60 and the rates of inflation expected to prevail for the next year in the U.S. is 2% and 3% in the euro zone. What is the one-year forward rate that should prevail?

1.00 = $1.6157

1.6157 = $1.00

1.00 = $1.5845

$1.00 1.03 = 1.60 1.02

11.If the annual inflation rate is 5.5 percent in the United States and 4 percent in the U.K., and the dollar depreciated against the pound by 3 percent, then the real exchange rate, assuming that PPP initially held, is

0.07.

0.9849.

0.0198.

4.5.