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# Fx Currency Essay

792 words - 4 pages

INTERNATIONAL FINANCE ASSIGNMENT 2 _ Answer Key PROBLEM I (30 points) Suppose the quarterly (90-day) interest rate in the US is 2.5% and it is 4% in Canada. If the \$/CD spot exchange rate is \$0.80/CD and the 90-day forward exchange rate between US and Canadian dollars is \$0.79/CD , does the interest rate parity (IRP) hold? Why or why not? If it does not hold, what is the direction of the capital flow?

1.025 0.79  1.04 0.80 0.9856 ≠ 0.9875 IRP does not hold. 2.5< (4-1.25=2.75) Therefore, funds flow from US to Canada.

If an arbitrageur can borrow up to \$1,000,000 (or CD1,250,000), formulate a covered interest arbitrage. Make sure to explain your steps in detail (just writing out three ...view middle of the document...

Value of a dollar in Japan Value of a dollar in Sweden Value of a Krona in Japan

¥129.87 SKr 2.00 ¥65.00

Sell ¥1,000,000 for dollars, get 1,000,000/129.87 = \$7,700 Sell \$7,700 for Kronas, get 7700*2.00 = SKr15,400 Sell SKr 15,400 for Yen, get 15400*65 = ¥1,001,001 Arbitrage profit = ¥1,001,001 - ¥1,000,000 = ¥1001

PROBLEM III: (10 points) The \$/CD spot exchange rate is \$0.85/CD and it is expected to decrease to \$0.80/CD in a year. If the expected inflation rate in Canada is 4% , what should the expected inflation rate be in the US? __________________________

1   \$ 0.80 (0.80)(1.04)   1 \$   0.9788 1.04 0.85 0.85  \$  0.021 = 2.1% deflation

PROBLEM IV: (10 points) The Australian dollar spot exchange rate is \$0.90/AUD. If the semi-annual interest rates in Australia and the U.S. are 5% and 3%, respectively, what should the \$/AUD exchange rate be in six months? ___________________________

S 1.03 (1.03)(0.90)  1  S1   \$0.8829 / AUD 1.05 0.90 1.05

PROBLEM V: (15 points)
If the annual inflation rate is 3.5 percent in the...

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