ADDITIONAL CHAPTER 4 SOLUTIONS
- 1. In February 1985, Bolivian inflation reached a monthly peak of 182%. What was the annualized rate of inflation in Bolivia for that month?
- 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?
- 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?
- 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?
- 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%.
- 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.
- 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?
- What accounts for the difference between the two rates? Does this difference violate the international Fisher effect?
- 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.
- 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%.
- 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?