Question: IFE Shouldn’t the IFE discourage investors

> The director of currency forecasting at Champaign-Urbana Corp. says, “The most critical task of forecasting exchange rates is not to derive a point estimate of a future exchange rate, but rather to assess how wrong our estimate might be.” What does this

> Assume that foreign exchange markets were found to be weak-form efficient. What does this suggest about utilizing technical analysis to speculate in euros? If MNCs believe that foreign exchange markets are semi strong-form efficient, why would they devel

> Assume that the four-year annualized interest rate in the United States is 9 percent and the four-year annualized interest rate in Singapore is 6 percent. Assume interest rate parity holds for a four-year horizon. Assume that the spot rate of the Singapo

> Explain corporate motives for forecasting exchange rates.

> One assumption made in developing the IFE is that all investors in all countries have the same real interest rate. What does this mean?

> The Sports Exports Company has been successful in producing footballs in the United States and exporting them to the United Kingdom. Recently, Jim Logan, the owner of the Sports Exports Company, has considered restructuring his company by expanding throu

> During the Asian crisis, direct intervention did not prevent depreciation of currencies. Offer your explanation for why the interventions did not work.

> Compare and contrast interest rate parity (discussed in Chapter 7), PPP, and the IFE.

> Assume U.S. interest rates are generally higher than foreign interest rates. What does this suggest about the future strength or weakness of the dollar based on the IFE? Should U.S. investors invest in foreign securities if they believe in the IFE? Shoul

> Explain the international Fisher effect (IFE). What is the rationale for the existence of the IFE? What are the implications of the IFE for firms with excess cash that consistently invest in foreign Treasury bills? Explain why the IFE may not hold.

> Explain why PPP does not hold.

> The United States has expected inflation of 2 percent, whereas Country A, Country B, and Country C have expected inflation of 7 percent. Country A engages in much international trade with the United States. The products that are traded between Country A

> Investors based in the United States can earn 11 percent interest on a oneyear bank deposit in Argentina (with no default risk) or 2 percent on a one-year bank deposit in the United States (with no default risk). Assess the following statement: “Accordin

> You believe that the future value of the Australian dollar will be determined by purchasing power parity. You expect that inflation in Australia will be 6 percent next year, whereas inflation in the United States will be 2 percent next year. Today the sp

> The one-year Treasury (risk-free) interest rate in the United States is presently 6 percent, whereas the one-year Treasury interest rate in Switzerland is 13 percent. The spot rate of the Swiss franc is $0.80. Assume that you believe in the international

> Assume that you believe exchange rate movements are mostly driven by purchasing power parity. The United States and Canada presently have the same nominal (quoted) interest rate. The central bank of Canada just made an announcement that causes you to rev

> Assume that you believe purchasing power parity exists. You expect that inflation in Canada during the next year will be 3 percent and inflation in the United States will be 8 percent. Today the spot rate of the Canadian dollar is $0.90 and the one-year

> Recall that Ben Holt, Blades’ chief financial officer (CFO), has suggested to the board of directors that Blades proceed with the establishment of a subsidiary in Thailand. Due to the high growth potential of the roller blades market in Thailand, his ana

> 1 million euros in one year from selling exports. It did not hedge this future transaction. Boston believes that the future value of the euro will be determined by purchasing power parity (PPP). It expects that inflation in countries using the euro will

> Assume the value of the Hong Kong dollar (HK$) is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, an Australian dollar (A$) is worth $0.50 and HK$3.9. The one-year interest rate on the Aust

> Inflation differentials between the United States and other industrialized countries have typically been a few percentage points in any given year. Yet, in many years annual exchange rates between the corresponding currencies have changed by 10 percent o

> The nominal (quoted) U.S. one-year interest rate is 6 percent, whereas the nominal one-year interest rate in Canada is 5 percent. Assume you believe in purchasing power parity. You believe that the real one-year interest rate is 2 percent in the United S

> The United States and the country of Rueland have the same real interest rate of 3 percent. The expected inflation over the next year is 6 percent in the United States versus 21 percent in Rueland. Interest rate parity exists. The one-year currency futur

> Today, a U.S. dollar can be exchanged for three New Zealand dollars. The one-year CD (deposit) rate in New Zealand is 7 percent, and the one-year CD rate in the United States is 6 percent. Interest rate parity exists between the United States and New Zea

> The Argentine one-year CD (deposit) rate is 13 percent, while the Mexican one-year CD rate is 11 percent and the U.S. one-year CD rate is 6 percent. All CDs have zero default risk. Interest rate parity holds, and you believe that the international Fisher

> Today’s spot rate of the Mexican peso is $0.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7 percent, whereas Mexican inflation over this year is expected to be 3 percent. Wake Forest Co. plans to

> The U.S. three month interest rate (unannualized) is 1 percent. The Canadian three-month interest rate (unannualized) is 4 percent. Interest rate parity exists. The expected inflation over this period is 5 percent in the United States and 2 percent in Ca

> You believe that interest rate parity and the international Fisher effect hold. Assume that the U.S. interest rate is presently much higher than the New Zealand interest rate. You have receivables of 1 million New Zealand dollars that you will receive in

> Jim Logan, owner of the Sports Exports Company, has been pleased with his success in the United Kingdom. He began his business by producing footballs and exporting them to the United Kingdom. Although American-style football is still not nearly as popula

> Assume that locational arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in purchasing power parity. The spot rate of the British pound is $1.80. The spot rate of the Swiss franc is £0.3. You expect the one-yea

> Assume that Mexico has a one-year interest rate that is higher than the U.S. one-year interest rate. Assume that you believe in the international Fisher effect and interest rate parity. Assume zero transaction costs. Ed is based in the United States and

> Assume that the inflation rates of the countries that use the euro are very low, whereas other European countries that have their own currencies experience high inflation. Explain how and why the euro’s value could be expected to change against these cur

> Explain how you could determine whether PPP exists. Describe a limitation in testing whether PPP holds.

> Would PPP be more likely to hold between the United States and Hungary if trade barriers were completely removed and if Hungary’s currency were allowed to float without any government intervention? Would the IFE be more likely to hold between the United

> Describe a statistical test for the IFE.

> How could you use regression analysis to determine whether the relationship specified by PPP exists, on average? Specify the model, and describe how you would assess the regression results to determine if there is a significant difference from the relati

> The one-year risk-free interest rate in Mexico is 10 percent. The one-year risk-free rate in the United States is 2 percent. Assume that interest rate parity exists. The spot rate of the Mexican peso is $0.14. a. What is the forward rate premium? b. Wh

> Assume the following information is available for the United States and the eurozone: a. Does IRP hold? b. According to PPP, what is the expected spot rate of the euro in one year? c. According to the IFE, what is the expected spot rate of the euro in

> Beth Miller does not believe that the IFE holds. Current one-year interest rates in Europe are 5 percent, whereas one-year interest rates in the United States are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she

> Because Ben Holt, Blades’ chief financial officer, believes the growth potential for the roller blades market in Thailand is very high, he has decided to invest in Thailand. This investment would involve establishing a subsidiary in Bangkok consisting of

> Given the conversion of several European currencies to the euro, explain what would cause the euro’s value to change against the dollar according to the IFE.

> Brazil commonly has a much higher nominal interest rate than the United States. Yet, some large institutional investors do not invest in Brazilian money market securities, even when they believe the securities have no credit (default) risk. Use the IFE t

> Russia commonly experiences a high rate of inflation. a. Explain why the high Russian inflation typically places severe downward pressure on the value of the Russian ruble. b. In some periods, the Russian government intervenes in the foreign exchange m

> As of today, assume the following information is available: a. Use the forward rate to forecast the percentage change in the Mexican peso over the next year. b. Use the differential in expected inflation to forecast the percentage change in the Mexican

> Explain the rationale underlying PPP theory.

> Assume that the spot exchange rate of the Singapore dollar is $0.70. The one-year interest rate is 11 percent in the United States and 7 percent in Singapore. What will the spot rate be in one year according to the IFE? Which force causes the spot rate t

> Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 2 percent?

> How is it possible for PPP to hold if the IFE does not?

> Assume that the inflation rate in Brazil is expected to increase substantially. How will this affect Brazil’s nominal interest rates and the value of its currency (the real)? If the IFE holds, how will the nominal return to U.S. investors who invest in B

> Jim Logan’s business, the Sports Exports Company, continues to grow. His primary product is the footballs he produces and exports to a distributor in the United Kingdom. However, his recent joint venture with a British firm has also been successful. Unde

> Assume that the nominal interest rate in Mexico is 48 percent and the interest rate in the United States is 8 percent for one-year securities that are free from default risk. What does the IFE suggest about the differential in expected inflation in these

> Japan has typically had lower inflation than the United States has. How would one expect this to affect the Japanese yen’s value? Why does this expected relationship not always occur?

> The currencies of some Latin American countries, such as Brazil and Venezuela, frequently weaken against most other currencies. What concept in this chapter explains this occurrence? Why don’t all U.S.-based MNCs use forward contracts to hedge their futu

> Assume that several European countries that use the euro as their currency experience higher inflation than the United States does, while two other European countries that use the euro as their currency experience lower inflation than the United States d

> investors in the United States and Canada require the same real interest rate, and the nominal rate of interest is 2 percent higher in Canada, what does this imply about expectations of U.S. inflation and Canadian inflation? What do these inflationary ex

> Explain the theory of purchasing power parity (PPP). Based on this theory, what is a general forecast of the values of currencies in countries with high inflation?

> Explain the concept of interest rate parity. Provide the rationale for its possible existence

> The terrorist attacks on the United States on September 11, 2001, led to expectations of a weaker U.S. economy. Explain how such expectations could have affected U.S. interest rates and, therefore, the forward rate premium (or discount) on various foreig

> Assume the following information Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer.

> Assume the following information: Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1 million.) What market forces would occur to eliminate any furth

> For the last year, Blades, Inc., has been exporting its products to Thailand to supplement its declining U.S. sales. Under the existing arrangement, Blades sells 180,000 pairs of roller blades annually to Entertainment Products, a Thai retailer, for a fi

> Assume that the one-year interest rate in Canada is 4 percent. The one-year U.S. interest rate is 8 percent. The spot rate of the Canadian dollar (C$) is $0.94. The forward rate of the Canadian dollar is $0.98. a. Is covered interest arbitrage feasible f

> Assume that interest rate parity holds and will continue to hold in the future. At the beginning of the month, the spot rate of the British pound is $1.60, while the one-year forward rate is $1.50. Assume that U.S. annual interest rate remains steady ove

> Today, the annualized interest rate in the United States is 4 percent for any debt maturity. The annualized interest rate in Australia is 4 percent for debt maturities of three months or less, 5 percent for debt maturities between three months and six mo

> Assume that the one-year interest rate in the United Kingdom is 9 percent, whereas the one-year interest in the United States is 4 percent. The spot rate of the pound is $1.50. Assume that interest rate parity exists. The quoted one-year interest in the

> As of now, the nominal interest rate is 6 percent in the United States and 6 percent in Australia. The spot rate of the Australian dollar is $0.58, whereas the oneyear forward rate of the Australian dollar exhibits a discount of 2 percent. Assume that as

> Interest rate parity exists between the United States and Poland (its currency is the zloty). The one-year risk-free CD (deposit) rate in the United States is 7 percent. The one-year risk-free CD rate in Poland is 5 percent; it is denominated in zloty. A

> You obtain the following quotes from different banks. One bank is willing to buy or sell Japanese yen at an exchange rate of 110 yen per dollar. A second bank is willing to buy or sell the Argentine peso at an exchange rate of $0.37 per peso. A third ban

> Assume that interest rate parity exists and will continue to exist. As of this morning, the one-month interest rate in the United States was higher than the one-month interest rate in the eurozone. Assume that as a result of the European Central Bank’s m

> Explain the concept of covered interest arbitrage and the scenario necessary for it to be plausible.

> Biscayne Co. will be receiving Mexican pesos today and will need to convert them into Australian dollars. Today, a U.S. dollar can be exchanged for 10 Mexican pesos. An Australian dollar is worth one-half of a U.S. dollar. a. What is the spot rate of a M

> Jim Logan, owner of the Sports Exports Company, remains concerned about his exposure to exchange rate risk. Even if he hedges his transactions from one month to another, he recognizes that a long-term trend of depreciation in the British pound could have

> Alabama Bank is willing to buy or sell British pounds for $1.98. The bank is willing to buy or sell Mexican pesos at an exchange rate of 10 pesos per dollar. It is willing to purchase British pounds at an exchange rate of 1 peso 0 5 .05 British pound. Sh

> A bank is willing to buy dollars for 0.9 euro per dollar. It is willing to sell dollars for 0.91 euro per dollar. Also consider the following information: You can sell Australian dollars (A$) to the bank for $0.72. You can buy Australian dollars from the

> Assume that the annual U.S. interest rate is currently 8 percent, whereas Japan’s annual interest rate is currently 7 percent. The spot rate of the Japanese yen is $0.01. The one-year forward rate of the Japanese yen is $0.01. Assume that as covered inte

> Assume that interest rate parity exists, along with the following information: Spot rate of Swiss franc 5 $0.80 6-month forward rate of Swiss franc $ 5 0.78 12-month forward rate of Swiss franc $ 5 0.81 Assume that the annualized U.S. interest rate is 7

> Earlier this morning, the annual U.S. interest rate was 6 percent, whereas Mexico’s annual interest rate was 8 percent. The spot rate of the Mexican peso was $0.16. The one-year forward rate of the peso was $0.15. Assume that as covered interest arbitrag

> Assume zero transaction costs. As of now, the Japanese oneyear interest rate is 3 percent, and the U.S. one-year interest rate is 9 percent. The spot rate of the Japanese yen is $0.0090 and the one-year forward rate of the Japanese yen is $0.0097. a. Det

> Today, the one-year U.S. interest rate is 4 percent, while the corresponding rate in Argentina is 17 percent. The spot rate of the Argentine peso (AP) is $0.44. The one-year forward rate of the AP exhibits a 14 percent discount. Determine the yield (perc

> Assume that interest rate parity exists. The spot rate of the Argentine peso is $0.40. The one-year interest rate in the United States is 7 percent; the comparable rate is 12 percent in Argentina. Assume the futures price is equal to the forward rate. An

> Assume that interest rate parity exists. The 6-month forward rate of the Swiss franc has a premium, whereas the 12-month forward rate of the Swiss franc has a discount. What does this tell you about the relative level of Swiss interest rates versus U.S.

> Assume the following information: Given this information, is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy if you had $1 million to use. What market forces woul

> Blades, Inc., has been exporting to Thailand since it made the decision to supplement its declining U.S. sales by exporting its roller blades to that country. Furthermore, Blades has recently begun exporting its products to a retailer in the United Kingd

> Assume that interest rate parity exists, along with the following information: Spot rate of British pound 5 $1.80 6-month forward rate of pound 5 $1.82 12-month forward rate of pound 5 $1.78 a. Is the annualized 6-month U.S. risk-free interest rate grea

> Assume that interest rate parity exists and will continue to exist. As of today, the one-year interest rate in Singapore is 4 percent; the corresponding rate is 7 percent in the United States. The Singapore central bank is expected to decrease interest r

> Assume that the spot rate of the Brazilian real is $0.30 today. Also assume that interest rate parity exists. Obtain the interest rate data you need from Bloomberg.com to derive the one-year forward rate premium (or discount), and then determine the one-

> Assume that interest rate parity exists. As of this morning, the one-month interest rate in Canada was lower than the one-month interest rate in the United States. Assume that as a result of the Fed’s monetary policy this afternoon, the one-month interes

> Assume that the annual U.S. interest rate is currently 6 percent, whereas Germany’s annual interest rate is currently 8 percent. The spot rate of the euro is $1.10 and the one-year forward rate of the euro is $1.10. Assume that as covered interest arbitr

> Assume that cross exchange rates are always properly aligned, such that triangular arbitrage is not feasible. While at the Miami airport today, you notice that a U.S. dollar can be exchanged for 125 Japanese yen or 4 Argentine pesos at the foreign exchan

> You are given these quotes by the bank: You can sell Canadian dollars (C$) to the bank for $0.70. You can buy Canadian dollars from the bank for $0.73. The bank is willing to buy dollars for 0.9 euro per dollar. The bank is willing to sell dollars for 0.

> You go to a bank and are given these quotes: You can buy a euro for 14 pesos. The bank will pay you 13 pesos for a euro. You can buy a U.S. dollar for 0.9 euro The bank will pay you 0.8 euro for a U.S. dollar. You can buy a U.S. dollar for 10 pesos. The

> Assume that interest rate parity exists. The one-year nominal interest rate in the United States is 7 percent, while the one-year nominal interest rate in Australia is 11 percent. The spot rate of the Australian dollar is $0.60. You will need 10 million

> The one-year interest rate in Singapore is 11 percent. The one-year interest rate in the United States is 6 percent. The spot rate of the Singapore dollar (S$) is $0.50 and the forward rate of the S$ is $0.46. Assume zero transaction costs. a. Does inter

> Jim Logan, owner of the Sports Exports Company, will be receiving about 10,000 British pounds about one month from now as payment for exports produced and sent by his firm. Logan is concerned about his exposure Jim Logan, owner of the Sports Exports Comp

> Explain the concept of triangular arbitrage and the scenario necessary for it to be plausible.

> At the end of this month, you (the owner of a U.S. firm) are meeting with a Japanese firm to which you will try to sell supplies. If you receive an order from that firm, you will obtain a forward contract to hedge the future receivables in yen. As of thi

> The interest rate in Indonesia is commonly higher than the interest rate in the United States, which reflects a high expected rate of inflation there. Why should Nike’s Indonesia-based division consider hedging its future remittances from that country to

> Assume that interest rate parity holds. At the beginning of the month, the spot rate of the Canadian dollar is $0.70, whereas the one-year forward rate is $0.68. Assume that U.S. interest rates increase steadily over the month. At the end of the month, t

> If the U.S. interest rate is close to zero, while the interest rate of Russia is very high, what would interest rate parity suggest about the forward rate of the Russian ruble? Explain.

> Describe a method for testing whether interest rate parity exists. Why are transaction costs, currency restrictions, and differential tax laws important when evaluating whether covered interest arbitrage can be beneficial?