A British money financier is managing €10 million and wants to invest it in safe bonds either in France or United Kingdom for one year. The one-year interest rate on such assets is 0.63% in Britain and 0% in France. The one-year forward euro-pound exchange rate is 1.121 €/£ (euros per pound). Assume that the covered interest parity condition (CIP) always holds and to ensure consistency, treat the UK as home country. The current euro-pound spot exchange rate is calculated to be 1.1281... Suppose the financier believes that the uncovered interest parity (IP) condition also holds and the foreign exchange market participants are acting based on correct expectations about future spot euro-pound exchange rate in the sense that their expectations predict the future rate without bias. Given these assumptions, what is the one-year expected spot euro-pound exchange rate prevailing in the market? Now suppose that the financier believes that while the uncovered interest parity (IP) condition also holds, the foreign exchange market participants have incorrect expectations about future spot euro-pound exchange rate. She believes that she has a better understanding of the economy and expects the future spot rate to be 1.2 €/£, on average. Assume that she is risk neutral in the foreign exchange market. Where should she invest the $10 million?
A British money financier is managing €10 million and wants to invest it in safe bonds either in France or United Kingdom for one year. The one-year interest rate on such assets is 0.63% in Britain and 0% in France. The one-year forward euro-pound exchange rate is 1.121 €/£ (euros per pound). Assume that the covered interest parity condition (CIP) always holds and to ensure consistency, treat the UK as home country. The current euro-pound spot exchange rate is calculated to be 1.1281... Suppose the financier believes that the uncovered interest parity (IP) condition also holds and the foreign exchange market participants are acting based on correct expectations about future spot euro-pound exchange rate in the sense that their expectations predict the future rate without bias. Given these assumptions, what is the one-year expected spot euro-pound exchange rate prevailing in the market? Now suppose that the financier believes that while the uncovered interest parity (IP) condition also holds, the foreign exchange market participants have incorrect expectations about future spot euro-pound exchange rate. She believes that she has a better understanding of the economy and expects the future spot rate to be 1.2 €/£, on average. Assume that she is risk neutral in the foreign exchange market. Where should she invest the $10 million?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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- A British money
financier is managing €10 million and wants to invest it in safe bonds either in France or United Kingdom for one year. The one-year interest rate on such assets is 0.63% in Britain and 0% in France. The one-year forward euro-pound exchange rate is 1.121 €/£ (euros per pound). Assume that the covered interest parity condition (CIP) always holds and to ensure consistency, treat the UK as home country. The current euro-pound spot exchange rate is calculated to be 1.1281...
Suppose the financier believes that the uncovered interest parity (IP) condition also holds and the foreign exchange market participants are acting based on correct expectations about future spot euro-pound exchange rate in the sense that their expectations predict the future rate without bias. Given these assumptions, what is the one-year expected spot euro-pound exchange rate prevailing in the market?
Now suppose that the financier believes that while the uncovered interest parity (IP) condition also holds, the foreign exchange market participants have incorrect expectations about future spot euro-pound exchange rate. She believes that she has a better understanding of the economy and expects the future spot rate to be 1.2 €/£, on average. Assume that she is risk neutral in the foreign exchange market. Where should she invest the $10 million?
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