ADDITIONAL CHAPTER 4 SOLUTIONS

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  1. 1.   In February 1985, Bolivian inflation reached a monthly peak of 182%. What was the annualized rate of inflation in Bolivia for that month?
  1. 2.   The inflation rate in Great Britain is expected to be 4% per year, and the inflation rate in France is expected to be 6% per year. If the current spot rate is £1 = FF 12.50, what is the expected spot rate in two years?
  1. If the $:¥ spot rate is $1 = ¥218 and interest rates in Tokyo and New York are 6% and 12%, respectively, what is the expected $:¥ exchange rate one year hence?
  1. Suppose that on January 1, the cost of borrowing French francs for the year is 18%. During the year, U.S. inflation is 5%, and French inflation is 9%. At the same time, the exchange rate changes from FF 1 = $0.15 on January 1 to FF 1 = $0.10 on December 31. What was the real U.S. dollar cost of borrowing francs for the year?
  1. 5.   In late 1990, following Britain’s entry into the exchange-rate mechanism of the European Monetary System, 10-year British Treasury bonds yielded 11.5%, and the German equivalent offered a yield of just 9%. Under terms of its entry, Britain established a central rate against the DM of DM 2.95 and pledged to maintain this rate within a band of plus and minus 6%.
  1. By how much would sterling have to fall against the DM over a 10-year period for the German bond to offer a higher overall return than the British one? Assume the Treasuries are zero-coupon bonds with no interest paid until maturity.
  1. How does the exchange rate established in Part a compare to the lower limit that the British government is pledged to maintain for sterling against the DM?
  1. What accounts for the difference between the two rates? Does this difference violate the international Fisher effect?
  1. Assume the interest rate is 11% on pounds sterling and 8% on euros. If the euro is selling at a one-year forward premium of 4% against the pound, is there an arbitrage opportunity? Explain.
  1. If the Swiss franc is $0.68 on the spot market and the 180-day forward rate is $0.70, what is the annualized interest rate in the United States over the next six months? The annualized interest rate in Switzerland is 2%.
  1. 8.   The interest rate in the United States is 8%; in Japan the comparable rate is 2%. The spot rate for the yen is $0.007692. If interest rate parity holds, what is the 90-day forward rate on the Japanese yen?
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