Exam 6: International Parity Conditions

Both covered and uncovered interest arbitrage are risky operations in the sense that even without default in the securities, the returns are unknown until all transactions are complete.

Some forecasters believe that foreign exchange markets for the major floating currencies are "efficient" and forward exchange rates are unbiased predictors of future spot exchange rates. What are the three conditions of market efficiency as defined by the authors? What is implied by the term unbiased predictors? What does the empirical evidence have to say about the forward rate as an unbiased predictor of future spot rates?

Empirical tests have yielded ________ evidence about market efficiency with a general consensus that developing foreign markets are ________.

________ 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.

Phillips NV produces DVD players and exports them to the United States. Last year the exchange rate was $1.25/euro and Phillips charged 120 euro per player in Euroland and $150 per DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD players?

One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately

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 $44,600 which is the UK price multiplied by the current exchange rate of $1.63/£. Jaguar has committed to keeping the US price at $44,600 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $1.75/£, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate?

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.

Assume the current U.S. dollar-British spot rate is 0.6134£/$. If the current nominal one-year interest rate in the U.S. is 2.5% and the comparable rate in Britain is 3.5%, what is the approximate forward exchange rate for 360 days?

The price of a Big Mac in the U.S. is $3.73 and the price in Mexico is Peso 32.0. What is the implied PPP of the peso per dollar?

When the spot and forward exchange markets are not in equilibrium as described by interest rate parity, the potential for "riskless" arbitrage profit exists. This is called

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.

________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.

Empirical studies show that the Fisher Effect works best for short-term securities.

The current U.S. dollar-yen spot rate is 85¥/$. If the 90-day forward exchange rate is 88 ¥/$ then the yen is selling at a per annum ________ of ________.

Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year?

If the efficient market hypothesis is correct than the current quotations on the forward market are reflecting all available information about likely future rates and providing unbiased estimate of the future spot rate.

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

The authors state that empirical tests of purchasing power parity "have, for the most part, not proved PPP to be accurate in predicting future exchange rates." The authors then state that PPP does hold up reasonably well in two situations. What are some reasons why PPP does not accurately predict future exchange rates, and under what conditions might we reasonably expect PPP to hold?

One-year interest rates are currently 3.30% in the United States and 2.60% in "Euroland". The current spot rate between the euro and dollar is $1.3225/euro. What is the expected spot rate in one year if the international Fisher effect holds?