Exam 6: International Parity Conditions

Assume a nominal interest rate on one-year U.S. Treasury Bills of 4.60% and a real rate of interest of 2.50%. Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the U.S. over the next year?

Assume the current U.S. dollar-yen spot rate is 125¥/$. Further, the current nominal 180-day rate of return in Japan is 3% and 4% in the United States. What is the approximate forward exchange rate for 180 days?

In its approximate form the Fisher effect may be written as ________. Where: i = the nominal rate of interest, r = the real rate of return and π = the expected rate of inflation.

The theory of ________ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs.

The premium or discount on forward currency exchange rates between any two countries is visually obvious when you plot the interest rates of each country on the same yield curve. The currency of the country with the higher yield curve should be selling at a forward discount.

________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.

The Economist publishes annually the "Big Mac Index" by which they compare the prices of the McDonald's Corporation's Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger index?

The government just released international exchange rate statistics and reported that the real effective exchange rate index for the U.S. dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year. Other things equal U.S. ________ to/from Japan think this is good news and U.S. ________ to/from Japan think this is bad news.

The mean real exchange rate change against the U.S. dollar was ________ and the standard deviation of such changes was ________ for MOST countries as reported in the research by Dimson et. al. (2002).

The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales revenues of Sony DVDs would ________.

________ states that the spot exchange rate is determined by the relative prices of similar baskets of goods.

Two general conclusions can be made from the empirical tests of purchasing power parity (PPP):

According to the seminal work Triumph of the Optimists: 101 Years of Global Investment Returns by Dimson, Marsh, and Staunton, relative purchasing power parity does not hold.

The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as ________.

The Fisher Effect is a familiar economic theory in the domestic market. In words, define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

With covered interest arbitrage,

Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate?

If the forward rate is an unbiased predictor of the expected spot rate, which of the following is NOT true?

If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates will always be equal to current forward rates.

Consider the price elasticity of demand. If a product has price elasticity less than one it is considered to have relatively elastic demand.