Global Skills: Foreign Currency
Part A)
1. What is the spot rate for the British pound (GBP) on Wednesday in terms of the U.S. dollar (USD)? Or, from the U.S. perspective, what is the direct quote on pounds?)
2. What is the spot price for the USD on Wednesday in terms of the Swiss franc (CHF)? (Or, from the U.S. perspective, what is the indirect rate on Swiss francs?)
3. Using your answers from #1 and #2 above, calculate the cross rate of exchange between the British pound (GBP) and the Swiss franc (CHF) (need to see your math).
4. Calculate the annualized forward premium or discount on six-month forward yen (need to see your math).
5. Based on your answer to #4 above, if you are planning to go to Japan in 6 months, should you buy your yen today? Why or why not?
6. According to the international Fisher Effect, if the real interest rate is 4%, if the US inflation rate is 5% and the Japanese inflation rate is 7%, then what is the nominal interest rate in the US? What is the nominal interest rate in Japan? Need to see math.
7. What is the expected difference between interest rates in the United States and Japan (do not need to see math, this can be answered in words and not numbers)?
8. Did the value of the Canadian dollar (CAD) rise or fall between Tuesday and Wednesday (hint - do not always view currency from a US perspective)?
Part B) Suppose the spot pound and the 90-day forward pound are both selling for $1.65, while the U.S. interest rates are 10 percent and British interest rates are 6 percent. Using the covered interest arbitrage theory, describe what will happen to the spot price of the pound, the 90-day forward price of the pound, interest rates in the United States, and interest rates in the U.K. when arbitrageurs enter this market.