Question: You observe the following spot exchange rate and interest rate quotations for New Zealand, Japan, and the United States. In addition, your firm has prepared forecasts for the spot exchange rate in one year, also listed below.
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Spot Exchange Rate |
Expected Spot Exchange Rate |
One year Interest Rate |
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| New Zeland |
0.67 USD per NZD |
0.71 USD per NZD |
2.5% |
|
| Japan |
102 JPY per USD |
106 JPY per USD |
0.25% |
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| United States |
|
|
1% |
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a. Comparing rates of return. Please calculate the expected rate of return for each currency from the standpoint of a US dollar investor. (Please include four decimal places.) Does uncovered interest rate parity hold?
b. Suppose the spot exchange rate for the NZD depreciates to 0.65. Holding the other variables equal, does the expected return on NZD deposits increase or decrease? Explain in words why this is so.
c. Please calculate the expected return on NZD deposits from the standpoint of a Japanese investor.
d. Calculate the spot exchange rate for the NZD and JPY that is consistent with uncovered interest rate parity.
e. Using the spot exchange rates you have calculated in part (d), is the NZD expected to appreciate ordepreciate against the US dollar? Is the JPY expected to appreciate or depreciate against the US dollar? Please explain in words the relationship between the change in value of a currency and the interest rate inthat currency, assuming that uncovered interest rate parity holds.