1. Assume the Hong Kong dollar (HK$) value is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, an Australian dollar (A$) is worth $.50 and HK$3.9. The one-year interest rate on the Australian dollar is 11%, while the one-year interest rate on the U.S. dollar is 7%. You believe in the international Fisher effect.You will receive A$1 million in one year from selling products to Australia, and will convert these proceeds into Hong Kong dollars in the spot market at that time to purchase imports from Hong Kong. Forecast the amount of Hong Kong dollars that you will be able to purchase in the spot market one year from now with A$1 million. Show your work.
2. You believe that the Singapore dollar's exchange rate movements are mostly attributed to purchasing power parity. Today, the nominal annual interest rate in Singapore is 18%. The nominal annual interest rate in the U.S. is 3%. You expect that annual inflation will be about 4% in Singapore and 1% in the U.S. Assume that interest rate parity holds. Today the spot rate of the Singapore dollar is $.63. Do you think the one-year forward rate would underestimate, overestimate, or be an unbiased estimate of the future spot rate in one year? Explain.
3. Given S = £0.6361 and the 180-day Forward rate is £0.6352/$, what is the dollar forward premium? Based on the unbiased forward expectations hypothesis, by how much is the dollar expected to appreciate or depreciate over the next 180 days? Provide a forecast of the spot rate of exchange in 180 days.
4. Suppose $1.25/£ and the 1-year forward rate is $1.20/£. The real interest rate on a risk-free government security is 2 percent in both the United Kingdom and the United States. The US inflation rate is 5 percent.
a. What is the UK's inflation rate if the equilibrium relationships hold?
b. What is the UK's nominal required return on risk-free government securities?
5. Quotes for the US dollar and Thai Baht (Bt) are as follows:
Spot contract midpoint = Bt24.96/$
1-year forward contract midpoint = Bt25.64/$
1-year Eurodollar interest rate = 6.125% annually
a. Your newspaper does not quote 1-year Eurocurrency interest rates on Thai baht. Make your own estimate.
b. Suppose that you can either borrow or lend at a Thai Eurocurrency interest rate of 10% per year. Based on a $1 million initial amount, how much profit can you generate through covered interest arbitrage?