Problem Session #2

PROBLEM SESSION #2

True, False, Uncertain. Explain.

1. Spot exchange rates are always lower than forward exchange rates

2.  If the dollar interest rate is 10 percent, the euro interest rate is 12 percent, then an investor should invest only in euros.

3.  A rise in the interest rate offered by dollar deposits causes the dollar to appreciate.

Short Answers:

1.  Explain why (holding interest rates constant), a rise in the expected depreciation in a country's currency leads to depreciation of that currency today?

Calculations

Q.1

Suppose interest rates are given as 10% on US$ denominated assets and 8% on similar CND$ assets. If the current spot rate equals 2 Canadian dollars per U.S. dollar. Calculate the forward discount or forward premium on the US$.

Q.2

Recall the example of calculating the magnitude of exchange rate depreciation or appreciation in class.

(a)  Suppose Eyen|$ = 10 at time t and 12.5 at time t+1. Calculate the rate of depreciation of the yen against the dollar. Calculate the rate of appreciation of the dollar against the yen.

(b)  Under what circumstances would the rate of depreciation of the yen be equal to the rate of appreciation of the dollar

Q.3 (This question is the same as the last question given at the end of class)

Use the asset approach to exchange rate determination discussed in class to answer the following questions. The interest rate on US dollar denominated assets maturing in one year is 10% and the interest rate on comparable Canadian dollar denominated assets is 8%.

(a)  Consider two possible expectations for the direct spot exchange rate between the Canadian dollar and the U.S. dollar (ECDN$|US$) in one year: (1) the spot rate will fall by 5 Canadian cents or (2) the spot rate will rise by 3 Canadian cents.

(i)  Which scenario is likely using the interest parity theory?

(ii)  Determine the current equilibrium spot rate under the MOST likely scenario

Web Exercise

3. Go to the Financial Times website (www.ft.com). Hover over the tab “Markets” then click on “Markets Data” in the drop down menu. Once there, hover over the “Markets Data” tab then click on “Currencies” in the drop down menu. Finally, click on “Currencies macromap” (next to “Highlights” near the top left corner of the webpage). Using the options “Global currencies” and Currency Performance in the last 1 month,

Figure out how you can use this tool to assess the relative strength of each of the currencies listed in the drop down menu on the right bottom corner. Which currency or currencies appear to be the strongest in the last month? Which currency or currencies appear to be the weakest in the last month? Explain how you arrived at your answer in detail