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Suppose that the world consists of three countries, A, B, and C. Nominal interest rates, spot rates, and forward rates are (iA, 1B, ic,

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Suppose that the world consists of three countries, A, B, and C. Nominal interest rates, spot rates, and forward rates are (iA, 1B, ic, EA/B, EA/C, FA/B, FA/C) = (0.02, 0.05, 0.01, 0.70, 1.21, 0.67, 1.30). Since we are working with small numbers, keep things to 4 decimal points (e.g., 1.00005 rounds to 1.0001). Recall that Ex/y tells you how many X$ you get for Y$1, and FX/Y tells you the guaranteed rate at which you can exchange currencies in the future. 1. Given A$1, which scenario provides the highest number of A dollars in the future? A Buying A bonds B Converting A dollars to B dollars and buying B bonds with a forward contract C Converting A dollars to C dollars and buying C bonds with a forward contract D Indifferent between options A and B E Indifferent between options A and C F Indifferent between options B and C G Indifferent between all three options. 2. Calculate E[EA/B,t+1] if uncovered interest rate parity were to hold. 3. Calculate E[EA/C,t+1] if uncovered interest rate parity were to hold. Suppose covered interest rate parity holds. All of the values given in the question are unchanged except i and EA/C which are unknown and must be solved for. 4. Calculate EA/C. 5. Calculate E[EA/C,t+1] if uncovered interest rate parity were to hold as well.

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