Study Guide - Chapter 8 - Money and Banking

Suppose the yen is expected to depreciate over the next year by 8%.
c. What would the one year forward rate be?
d. What would the 90 day forward rate be?

2. Suppose in 1970 the CPI in the U.S. was 150 when the CPI in Mexico was 78. The peso/$ exchange rate was 12. In 1980 the CPI in the U.S. was 250 when the CPI in Mexico was 425. If PPP holds what should the exchange have been in 1980? If the actual exchange rate was 60, was the peso undervalued or overvalued according to PPP.

3. The price of gold is $380 in the U.S. and Can$425 in Canada. If the Law of One Price holds, what is the exchange rate? If the actual exchange rate is $.85/Can$, how could you make money?

4. A one year government bond sells for $925.93 in France and $952.38 in Germany. If interest rate parity holds, which currency is expected to appreciate and which one is expected to depreciate? What is the difference in expected inflation rates between the two countries?

5. One year interest rates are 5% in the U.S. and 12% in the U.K. The current exchange rate is $1.48/pound. What would the 90 day forward rate be? The 180 day forward rate?

6. The 90 day forward rate for yen is 106 yen/$. If speculators are buying dollars forward (going long on dollars), are they anticipating the spot rate in July 1994 to be above or below 106?

7. A domestic electronics wholesale dealer has a contract to accept delivery of Japanese stereo equipment in October and pay 16,000 yen per unit. Would the importer want to go long (buy) or short (sell) on Yen? Why?

8. A U.S. cattle rancher has a contract to sell beef to the French government in August for a fixed amount of French francs per pound. Would the exporter want to go long (buy) French francs or go short (sell) French francs? Why?

9. Suppose that the effective one year return to a U.S. investor buying a U.K. bond was 12%. The spot rate is $2/pound and the one year forward rate is $2.12/pound. What is the interest rate on the U.K. bond?

10. In 1985, many economists argued that the U.S. dollar was too strong, in that foreign goods were too cheap and U.S. goods too expensive. How could speculators have used forward foreign exchange markets to bet this belief?

11. The German mark is trading at 1.55 DM/$ spot and 1.59 three months forward. Is the mark selling at a forward discount or premium? What is the forward premium (discount) at an annual rate?

12. Between 1976 and 1988, consumer prices increased at an average annual rate of 8.6% in the U.K. and 6.28% in the U.S. If PPP held in 1976, should the U.S. dollar have strengthened or weakened relative to the pound during the twelve year period? The exchange rate was virtually constant, at $1.80/pound in 1976 and $1.78/pound in 1988. According to PPP, is the U.S. dollar overvalued or undervalued relative to the pound in 1988?

13. Suppose we observe the following 1 year interest rates. Euro $ = 15% and Euro DM = 12%. The exchange rate is $.40/DM.
a) What should the 12 month forward rate be?
b) Suppose the actual 12 month forward rate is not what you found from (a), but is $.42/DM. What would profit seeking arbitragers do?

14. Assume that you are a Iowa corn farmer and you are shipping 100,000 bushels of corn to a buyer in France. Delivery will take place in six months at an agreed upon price of FF14/bushel. The cost of production is $2/bushel. What is the farmer's profit under the following situations?
a. the farmer hedges against exchange rate risk with a 180 day forward contract at FF5/$.
b. the farmer does not hedge and the spot rate is FF7/$ in 6 months.
c. the farmer does not hedge and the spot rate is FF3.5/$ in 6 months.

15. One year T-bills in the US are yielding 4%. One year T-bills in the UK are yielding 8%. The current exchange rate is $1.54/£. Assuming interest rate parity, forecast the following:
a. 90 day forward rate
b. 180 day forward rate
c. one year forward rate

16.  German Stock Index     DM/$            Italian Stock Market                 Lira/$
1994        4522                   1.50                           15,444                       1498
1995        4698                   1.40                           17988                        1576

Given the above information, which stock market would have provided an American investor with the greatest one year return, in dollars? In other words, calculate the effective return in each market for a U.S. investor and compare.