QUESTION TWOa. Briefly evaluate the factors that may prevent the purchasing power parity from holding inreal economies.b. Assume the following information:£ Spot rate = C5.20/€12-month forward rate = C6.00/£C Interest rate = 26% per annumU.K. interest rate = 2% per annumi. Given the information above, does interest rate parity hold? What should be the 12-month forward rate, if interest rate parity holds?ii. How can an investor profit from this anomaly if she can easily borrow the equivalentof £1 million in either pounds or cedis to invest? How much profit can she make?

Part (b)Let's solve each part of this question.Given Information:Spot rate: ₵5.20/£12-month forward…

Answered: QUESTION TWO a. Briefly evaluate the…

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter7: International Arbitrage And Interest Rate Parity

Section: Chapter Questions

Problem 37QA

See similar textbooks

Similar questions

Suppose the dollar interest rate and the pound sterling interest rate are the same, 6 percent per year. What is the relation between the current equilibrium dollar/pound exchange rate and its expected future level? O A. Expected dollar/pound exchange rate is higher than the current one. O B. Expected dollar/pound exchange rate is lower than the current one. C. Expected dollar/pound exchange rate is equal to the current one. O D. One cannot tell given the information above. Suppose the expected future exchange rate, $1.44 per pound, and the US interest rate remain constant, while Britain's interest rate rises to 8 percent per year. What is the new equilibrium dollar/pound exchange rate? New equilibrium exchange rate is $ per pound. (Enter your response to the nearest penny.)
Market observes the “exchange rates” as of today:($1/$0)=0.95 , ($2/$0)=0.87 1. What is the implied interest rate between time t=0 and t=2 ? 2. Now there is a project with three certain cashflows:CF0=−$10MMCF1=$5MMCF2=$7MMWhat is NPV0? 3. How much is CF1 worth at t=2?
Assume that interest rate parity holds and that 90-day risk-freesecurities yield a nominal annual rate of 3% in the United States and a nominal annual rateof 3.5% in the United Kingdom. In the spot market, 1 pound = $1.29.a. What is the 90-day forward rate?b. Is the 90-day forward rate trading at a premium or a discount relative to the spot rate?
You took a long position on EUR when the prevailing market rate was EUR/USD: 1.3223-1.3227. After six months, you want to square your net FX position to take profits. Which of the following scenarios will yield you maximum profits? Scenario A: at EUR/USD 1.3245 – 1.3253 Scenario B: at EUR/USD 1.3230 – 1.3255 Scenario C: at EUR/USD 1.3231 – 1.3235 Scenario D: at EUR/USD 1.3247 – 1.3252 You took a short position on GBP when the prevailing market rate was GBP/USD: 1.3223-1.3227. After six months, you want to square your net FX position when the prevailing market rate is GBP/USD 1.3218-1.3221. How may pips did you earn? 5 pips 9 pips 2 pips .0009 pips If you want to square your long GBP position, at what rate are you going to sell GBP to maximize profits given GBP/USD quotes from three counterparties? BDO: 1.35-45 BPI: 1.40-55 SECB: 1.50-1.65 1.35 1.50 1.65 1.45 Given “RTB 5-12”, which of the following statements is correct? This is a 5-yr RTB issued in 2012 This…
A. Suppose the dollar interest rate and the euro interest rate are the same and equal 2 percent per year. Suppose the expected future $/€ exchange rate is $1.20 per 1 €. Suppose now Euro interest rate decreases to 1 percent per year. Determine how the new equilibrium $/€ exchange rate will change if the US interest rate remains constant. B. Indicate how the change in the Euro interest rate will affect the equilibrium $/€ exchange rate and the expected return on euro assets. Explain the changes on the graph.
Suppose a European call option to buy 1 euro for 1.40 CAD costs 0.08 CAD. The option maturity is in two months and the forward exchange rate for the same maturity is 1.50 CAD per euro. What arbitrage opportunity exists? Explain how you can exploit this opportunity and how much the profit is. (Ignore the time value of money)
Question Il: Suppose that the exchange rate is $0.92/e. Let rs= 4%, and re= 3%, u = 1.2, d = 0.9, T = 0.75, number of binomial periods = 3, and K = $1.00 Use Binomial Option pricing to answer the following two questions. (a) What is the price of a 9-month European call? (b) What is the price of a 9-month American call?
Suppose that investors are risk-neutral and the linear UIP equation holds. You are given the following information: UK interest rate: i = 0.07 US interest rate: i* = 0.02 Expected future spot rate e^e = 8. What is the current spot rate, e? (State your answer as a number to 2 decimal places. Exchange rates are Pounds per Dollar, in natural logs)
5. If the 60-day interest rates (simple, p.a.) are 3% at home (usd) and 4% abroad (eur) and thespot rate moves from 1.000 to 1.001:(a) What is the return differential, and what is the corresponding prediction of the change in the forward rate? (b) What is the actual change in the forward rate?(c) What is the predicted change in the swap rate computed from the return differential?(d) What is the actual change in the swap rate?
8. Consider countries X and Y with risk-free rates of 8 and 10 percent, respectively. The future price (Currency X/ Currency Y) for a contract deliverable in 3 months is the same as the current exchange rate. Is there any arbitrage opportunity? If there is, design a strategy to exploit the arbitrage
3
Let a flexible exchange rate system. Assume a current account deficit of $100 billion. Then the capital account balance must be a . a surplus of something more than $100 million. b . a deficit of $100 billion. c . a surplus of $100 billion. d . None of the answers is correct

SEE MORE QUESTIONS

Recommended textbooks for you

International Financial Management

Finance

ISBN:

9780357130698

Author:

Madura

Publisher:

Cengage

International Financial Management

Finance

ISBN:

9780357130698

Author:

Madura

Publisher:

Cengage

SEE MORE TEXTBOOKS