Finance
1. You can trade at the following prices:
o Spot rate MXN10/$
o 6-month forward rate MXN11/$
o 6-month Mexican interest rate 18%
o 6-month US interest rate 6%
• Is covered interest arbitrage worthwhile? If so, explain the steps and compute the profit based on an initial (time t=0) transaction of $1 million. Calculate your profit in dollars in one period.
2. Currency exchange rates and Eurocurrency interest rates are as follows:
o Current Singapore dollar (S$) spot rate $0.50/S$
o 1-year Singapore dollar (S$) forward rate $0.51/S$
o 1-year Singapore dollar (S$) interest rate 4.0%
o 1-year US interest rate 6.0%
• In what direction will covered interest arbitrage force the quoted rates to change? Explain the steps and compute the profit based on a $1 million initial position.
3. Suppose P(D) = 100, P(F) = 1 and S = D100/F. Inflation in countries D and F are expected to be P(D) = 10% and P(F) = 21% over the foreseeable future.
o What are the expected price levels and expected nominal exchange rate in one period?
o Looking two years into the future, what are the expected price levels in each country and the expected real exchange rate?
4. One year ago, the spot exchange rate between Japanese yen and Swiss franc was Y160/SFr. Today, the spot rate is Y155/SFr. Inflation during the year was p(y) = 2% and p(SFr) = 3% in Japan and Switzerland, respectively.
a. What was the percentage change in the nominal value of the Swiss Franc?
b. One year ago, what nominal exchange rate would you have predicted for today based on the difference in inflation rates?
c. What was the percentage change in the real exchange rate during the year?
d. What was the percentage change in the relative purchasing power of the franc?
e. What was the percentage change in the relative purchasing power of the yen?
5. Purdue Co. (based in the U.S.) exports cable wire to Australian manufacturers. It invoices its product in U.S. dollars, and will not change its price over the next year. There is intense competition between Purdue and the local cable wire producers that are based there. Purdue's competitors invoice their products in Australian dollars and will not be changing their prices over the next year. The annualized risk-free interest rate is presently 8% in the U.S., versus 3% in Australia. Today the spot rate of the Australian dollar is $.55. Purdue Co. uses this spot rate as a forecast of future exchange rate of the Australian dollar. Purdue expects that revenue from its cable wire exports to Australia will be about $2 million over the next year.
• If Purdue decides to use the international Fisher effect rather than the spot rate to forecast the exchange rate of the Australian dollar over the next year, will its expected revenue from its exports be higher, lower, or unaffected? Explain.