1. You are given the following information:

U.S. Philippine

Nominal one year interest rate 5% 9% Spot rate ----- $0.018

Thailand

7% $0.028

Interest rate parity exists between the U.S. and Philippine as well as the U.S. and Thailand. The international Fisher effect exists between the U.S. and Philippine as well as the U.S. and Thailand.

Noah (based in the U.S.) invests in a one-year CD (certificate of deposit) in Philippine and sells Philippine peso one year forward to cover his position.

Mia (based in Thailand) invests in a one-year CD in Philippine and does not cover her position.

What are the returns on funds invested for Noah and Mia respectively? What conclusions/comments related to IRP and/or IFE can you make from Noahs return and Mias return respectively? (Hint: You can get the exchange rate between Philippine peso and Thai baht from their respective rate to USD.)

ANS: Please clearly label your return calculations, i.e., the investment return for Noah and Mia respectively.

2. The U.S. six-month interest rate (unannualized) is 2.85%. The Denmark six-month interest rate (unannualized) is 1.20%. There are six-month European call options and put options available for Danish krone (DKK). Both options have the same premium of $0.0003/DKK and a strike price of $0.1425/DKK. The spot rate of the Danish krone (DKK) is $0.1400/DKK. Assume that you believe in International Fisher Effect (IFE).

Forecast the dollar amount of your profit or loss from buying a 6-month European put option contract specifying DKK1,000,000. Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. (2 points)

Forecast the USD paid by A&M company which uses the call option to hedge against its 6 month payables of DKK1,000,000. Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. (2 points)

ANS: Please label a/b in your response to the two sub-questions respectively.

3. James Cook, an international fund manager, uses the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. James Cook gathers the financial information as follows:

Current rand spot exchange rate Expected annual U.S. inflation Expected annual South African inflation Expected U.S. one-year interest rate Expected South African one-year interest rate

$0.053 4% 6%

5.50%

8.25%

3

Both interest rates given above are nominal interest rates. Calculate the following exchange rates (ZAR and USD refer to the South African rand and U.S. dollar, respectively). The interest rate given is the nominal interest rate. a. Using the IFE, the expected ZAR spot rate in USD one year from now. (1 point) b. Using PPP, the expected ZAR spot rate in USD one year from now. (1 point) c. Using IRP (interest rate parity), the one year ZAR forward rate in USD. (1 point)

ANS: Please label a/b/c in your response to the three sub-questions respectively.