International Fisher Effect Assignment -
Q1. You are given the following information:
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U.S.
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France
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Japan
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Nominal one year interest rate
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5%
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9%
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8%
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Spot rate
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---
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$1.17
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$0.010
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Interest rate parity exists between the U.S. and France as well as the U.S. and Japan. The international Fisher effect exists between the U.S. and France as well as the U.S. and Japan.
Bill (based in the U.S.) invests in a one-year CD (certificate of deposit) in Japan and sells Japaness Yen one year forward to cover his position.
Erica (based in Japan) invests in a one-year CD in France and does not cover her position.
What are the returns on funds invested for Bill and Erica respectively? Please justify your explanation both in terms of theory and calculations.
Q2. The U.S. three-month interest rate (unannualized) is 3%. The Canadian three-month interest rate (unannualized) is 7%. A put option with a three-month expiration date on Canadian dollars is available for a premium of $0.04 and a strike price of $0.60. The spot rate of the Canadian dollar is $0.64. Assume that you believe in International Fisher Effect (IFE).
a. Forecast the dollar amount of your profit or loss from buying a put option contract specifying C$100,000.
b. Forecasr the USD received by A&M company which uses the put option to hedge against its 3 month receivables of C$ 100,000.
Please label a/b in your response to the two sub-questions respectively.
Q3. Compare and contrast the international Fisher effect (IFE), interest rate parity (IRP), and forward expectations parity (FEP). Hint- you can find the discussion of FEP from Ch8 PPT slides.
Q4. The Financial Times reports that the interest rate per annum is 0.05% in the United States and 10.0% in Turkey. Why do you think the interest rate is so high in Turkey? Based on the reported interest rates, how would you predict the change of the exchange rate between the U.S. dollar and the Turkish lira?
Q5. James Smith, an international fund manager, uses the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. James gathers the financial information as follows:
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Current rand spot exchange rate
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$0.188
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Expected annual U.S. inflation
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8%
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Expected annual South African inflation
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6%
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Expected U.S. one-year interest rate
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1%
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Expected South African one-year interest rate
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0.08%
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Calculate the following exchange rates (ZAR and USD refer to the South African rand and U.S. dollar, respectively).
a. Using the IFE, the expected ZAR spot rate in USD one year from now.
b. Using PPP, the expected ZAR spot rate in USD one year from now.
c. Using IRP (interest rate parity), the one year ZAR forward rate in USD.
Please label a/b/c in your response to the three sub-questions respectively.
Q6. Assume the Hong Kong dollar (HK$) value is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, a euro (€) is worth $1.12 and HK$9.10. The one-year interest rate on euro is 6%, while the one-year interest rate on the U.S. dollar is 2%. You believe in the International Fisher effect.
Boston Company will receive €4 million in one year from selling products to Europe, and will convert these proceeds into Hong Kong dollars in the spot market at that time to purchase imports from Hong Kong.
a. Estimate the amount of U.S. dollars that Boston will receive in one year when converting its € receivables into U.S. dollars.
b. Forecast the amount of Hong Kong dollars that Boston will be able to purchase in the spot market one year from now with €4 million.
Please label a/b in your response to the two sub-questions respectively.
Q7. The spot rate of the New Zealand dollar is $0.69. The spot rate of the Argentine Peso is 0.082 New Zealand dollars. You expect that the one-year inflation rate is 9 percent in the New Zealand, 11 percent in Argentine, and 3 percent in the U.S. The one-year interest rate is 8% in New Zealand, 6% in Argentine, and 1% in the U.S.
Assume that locational arbitrage and triangular arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in the International Fisher Effect. What is your expected spot rate of the Argentine Peso in one year with respect to the U.S. dollar?
Q8. The spot rate of the Australian dollar is $0.75, and the spot rate of the British pound is $1.28. You expect that the one-year inflation rate is 8 percent in the U.K., 5 percent in Australia, and 3 percent in the U.S. The one-year interest rate is 7% in the U.K., 9% in Australia, and 4% in the U.S.
Assume that locational arbitrage and triangular arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in the International Fisher Effect. What is your expected spot rate of the British pound in one year with respect to the Australian dollar?