Week03_Assignment_Angelini

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Economics

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Feb 20, 2024

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1. Suppose that the interest rates in the U.S. and Germany are equal to 5%, that the forward (one year) value of the € is F $/€ = 1$/€ and that the spot exchange rate is E $/€ = 0.75$/€. Please answer the following questions by explaining all steps of your analysis : a. Does the covered interest parity condition hold? Why or why not? Forward rate = spot rate x (1 + US interest rate)/(1 + German interest rate) Spot rate = 0.75/€ 0.75 x (1 + 0.05) / (1 + 0.05) = 0.75 x 1.05/1.05 = 0.75 Forward rate = $0.75/€ The covered interest parity condition does not hold because the actual forward rate is $1.00/€ but the forward as per interest rate parity is only $0.75/€. b. How could you make a riskless profit without any money tied up assuming that there are no transaction costs in buying and or selling foreign exchange? Assume $1 million Euro @ spot rate: $0.75/€ € = $1,000,000 / ($0.75/€) € = 1,333,333.333 Euro @ forward rate $ = € 1,333,333.333 * (%1.00/€) $ = 1,333,333.33

Riskless profit = 1,333,333.33 – 1,000,000 Riskless Profit = $333,333.333 Could make a riskless profit of $333,333.333 per $1,000,000 without any money tied up 2. Suppose that two countries, Britain and the U.S. produce just one good - beef. Suppose that the price of beef in the U.S. is $2.80 per pound, and in Britain it is £3.70 per pound. a. According to PPP theory, what should the $/£ spot exchange rate be? $2.80 / £3.70 = $0.757 / £1 (spot exchange rate) PPP suggests exchange rate should be adjusted so purchasing power is equal in both countries. To solve for this I just divided $ value by £ value to find the rate. b. Suppose the price of beef is expected to rise to $3.10 in the U.S. and to £4.65 in Britain. What should be the one year forward $/£ exchange rate? $3.10 / £4.65 = $0.667 / £1 (one year forward exchange rate) 3. How important is the creation of international banking facilities to the international competitiveness of the U.S. banking industry? The creation of international banking facilities is incredibly important to the international competitiveness of the US banking industry. International banking facilities allow for banking activities to occur between countries and currencies by accepting things like foreign deposits and making international loans. These provide the US banking industry with the means to access international

markets more easily and to be involved in global transactions. In addition, the US banking industry can have clientele that are located internationally, helping to expand their customer outreach and aid their competitive advantage.

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