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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,
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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