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#### SP21 MGMT 144 Multinational Finance Homework for Parity Conditions 1

SP21 MGMT 144 Multinational Finance Homework for Parity Conditions 1. Suppose the interest rate in the U.S. is 5%, and interest rate in U.K. is 10%. The spot exchange rate is S(\$/£)=1.2. What if the one-year forward exchange rate was a tiny bit too high at \$1.146/£? Please construct a CIA transaction 2. Currently, the spot exchange rate is \$1.50/£ and the three-month forward exchange rate is \$1.52/£. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as \$1,500,000 or £1,000,000. a. Determine whether the interest rate parity is currently holding. b. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. c. Explain how the IRP will be restored as a result of covered arbitrage activities. 3. Suppose that the current spot exchange rate is €0.80/\$ and the three-month forward exchange rate is €0.7813/\$. The three-month interest rate is 5.60 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to \$1,000,000 or €800,000. a. Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit. b. Assume that you want to realize profit in terms of euros. Show the covered arbitrage process and determine the arbitrage profit in euros. 4. As of November 1, 1999, the exchange rate between the Brazilian real and U.S. dollar is R\$1.95/\$. The consensus forecast for the U.S. and Brazil inflation rates for the next 1-year period is 2.6% and 20.0%, respectively. What would you forecast the exchange rate to be at around November 1, 2000? 5. In the October 23, 1999 issue, the Economist reports that the interest rate per annum is 5.93% in the United States and 70.0% in Turkey. Why do you think the interest rate is so high in Turkey? Based on the reported interest rates, how would you predict the change of the exchange rate between the U.S. dollar and the Turkish lira? 6. In 2008, the exchange rate between the US dollar and New Zealand dollar was NZ\$1.71/\$; in 2009, the exchange rate between the US dollar and New Zealand dollar was NZ\$1.37/\$. Suppose the one year interest rate in New Zealand was 9.1%, and the rate in US was 4.2%. Can you conduct a currency carry trade with positive profit? How?

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