In the bad scenario, the euro can appreciate against the dollar by -15%. The probability of that is 50%. In the good scenario, it will grow 5%. The interest rate is 10% in the EU. a) Find the dollar return of the euro deposit in the bad scenario. That is, if you invest one today dollar in Europe, how many future dollars will you get a year from now? Answer: 0.935 b) In the good scenario, an investment of one euro in Europe returns 1.155 future dollars. Find the expected return on a European deposit. Answer: 1.045 c) Profit is a convex function of the return. The profit of the bad case is -0.067, of the good case 0.077, and of the expected return 0.044. Graph th
In the bad scenario, the euro can appreciate against the dollar by -15%. The probability of that is 50%. In the good scenario, it will grow 5%. The interest rate is 10% in the EU.
a) Find the dollar return of the euro deposit in the bad scenario. That is, if you invest one today dollar in Europe, how many future dollars will you get a year from now?
Answer: 0.935
b) In the good scenario, an investment of one euro in Europe returns 1.155 future dollars. Find the expected return on a European deposit.
Answer: 1.045
c) Profit is a convex function of the return. The profit of the bad case is -0.067, of the good case 0.077, and of the expected return 0.044. Graph the profit function that would map all the three returns into profits.
Answer:
(d) Find the expected profit. Draw a graph of the profit function and show how the expected profit is found.
Answer:1.005 or .005
e) The certainty equivalent of your answer to (d) is 1.005. Find the forward premium. Show calculation.
Answer: -0.086
(f) Find the risk premium. Answer: 0.014
(g) Which assumption of the uncovered interest premium is not holding in this question? In other words, what is the reason UIP is not holding here?
(h) Is the CIP holding? Does it rely on your assumption from (g)? Explain.
I need assitance with questions E and F; how would you do the calculation to obtain those answers?
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