Answer the following questions after reading the chapter and working the recommended problems.
Assume the one-year interest rate is 10% on British pounds and 9% on U.S. dollars.
If the current exchange rate of the pound is $1.62, what is the expected future spot in one year?
Suppose a change in expectations causes the expected future spot rate to decline to $1.53. What should
happen to the U.S. interest rate?
Beth Miller does not believe that the International Fisher Effect holds. Current 1-year interest rates in Europe
are 4%, while 1-year interest rates in the U.S. are 3%. Beth converts $100,000 to euros at $1.10 and invests
them in Germany. One year later, she converts the euros back to dollars.
According to the IFE, what should the spot rate of the euro be in 1 year?
If the spot rate of the euro in 1 year is $1.00, what is Beth's percentage return from her strategy?
If the spot rate of the euro in 1 year is $1.08, what is Beth's percentage return from her strategy?
What must the spot rate of the euro be in 1 year for Beth's strategy to be successful?
A U.S. firm expects that the British pound will depreciate from $1.70 to $1.65 in one year. The firm has no
spare cash, but it could borrow either 1 million dollars at 6% or 1 million pounds at 5% for a year. Determine
the profit or loss for the firm if they pursue a strategy to capitalize on the expected depreciation of the pound.
Sample Solution