International Finance: SOLUTIONS TO CHAPTER 4 PROBLEMS
- From base price levels of 100 in 1987, West German and U.S. price levels in 1988 stood at 102 and 106, respectively. If the 1987 $/DM exchange rate was $0.54, what should the exchange rate be in 1988? In fact, the exchange rate in 1988 was DM 1 = $0.56. What might account for the discrepancy? (Price levels were measured using the consumer price index.)
- In early 1996, the short-term interest rate in France was 3.7%, and forecast French inflation was 1.8%. At the same time, the short-term German interest rate was 2.6% and forecast German inflation was 1.6%.
- Based on these figures, what were the real interest rates in France and Germany?
- To what would you attribute any discrepancy in real rates between France and Germany?
- In July, the one‑year interest rate is 12% on British pounds and 9% on U.S. dollars.
- If the current exchange rate is $1.63:1, what is the expected future exchange rate in one year?
b.Suppose a change in expectations regarding future U.S. inflation causes the expected future spot rate to decline to $1.52:£1. What should happen to the U.S. interest rate?
- If expected inflation is 100% and the real required return is 5%, what will the nominal interest rate be according to the Fisher effect?
- Suppose that in Japan the interest rate is 8% and inflation is expected to be 3%. Meanwhile, the expected inflation rate in France is 12%, and the English interest rate is 14%. To the nearest whole number, what is the best estimate of the one‑year forward exchange premium (discount) at which the pound will be selling relative to the French franc?
- The inflation rate in Great Britain is expected to be 4% per year, and the inflation rate in Switzerland is expected to be 6% per year. If the current spot rate is £1 = SF 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?
- Assume the interest rate is 16% on pounds sterling and 7% on the Euro. At the same time, inflation is running at an annual rate of 3% in Germany and 9% in England.
- If the Euro is selling at a one-year forward premium of 10% against the pound, is there an arbitrage opportunity? Explain.
- What is the real interest rate in Germany? in England?
- Suppose that during the year the exchange rate changes from Euro2.7/£1 to Euro2.65/£1. What are the real costs to a German company of borrowing pounds? Contrast this cost to its real cost of borrowing Euro
- What are the real costs to a British firm of borrowing Euro? Contrast this cost to its real cost of borrowing pounds.
- Suppose today’s exchange rate is $0.62/Euro. The 6-month interest rates on dollars and Euro are 6% and 3%, respectively. The 6-month forward rate is $0.6185. A foreign exchange advisory service has predicted that the Euro will appreciate to $0.64 within six months.
- How would you use forward contracts to profit in the above situation?
- How would you use money market instruments (borrowing and lending) to profit?
- Which alternatives (forward contracts or money market instruments) would you prefer? Why?