In early 2012, the spot exchange rate between Canadian dollar and U.S. dollar was 0.8200 (USD per CAD). Interest rates in the U.S. and Canada were 1.25% and 1.75% per annum, respectively, with continuous compounding. The six-month forward exchange rate was 0.8300 (USD per CAD). What arbitrage strategy was possible? How does your answer change if the forward exchange rate is 0.7900 (USD per CAD).

In early 2012, the spot exchange rate between Canadian dollar and U.S. dollar was 0.8200 (USD per CAD). Interest rates in the U.S. and Canada were 1.25% and 1.75% per annum, respectively, with continuous compounding. The six-month forward exchange rate was 0.8300 (USD per CAD). What arbitrage strategy was possible? How does your answer change if the forward exchange rate is 0.7900 (USD per CAD).

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Suppose the annual rate of inflation in Taiwan is 6.66%, and the annual rate of inflation in Mexico is 5.99%. If the Mexican peso depreciates relative to the Taiwan dollar by 4% in real terms, then which of the following would be correct? a, Nominal exchange rate appreciation by 4.825%. b. Nominal exchange rate depreciation by 3.393%. c. Nominal exchange rate appreciation by 3.512%. d. Nominal exchange rate depreciation by 4.603%. e. There is no change in the nominal exchange rate.
In June 2010, an investor is considering investing in bank deposits in Korea and Japan. Theannual interest rate on Korean deposits is 6.25%, versus 3.75% on deposits in Japan. Supposethat the forward rate (for June 2011) in June 2010 is equal to F(won/yen) = 8.2. In June 2010, theexpected exchange rate is 8.2 won/¥. For the remainder of this question, use the linearapproximations for uncovered and covered interest rate parity. The spot exchange rate in June2010 is E(won/yen) = 8 a. Does covered interest parity hold in this example?b. Does uncovered interest parity hold in this example?c. Suppose the exchange rate in June 2011 is equal to 7.472 won per yen. Calculate theinvestor’s actual return, assuming that he invests in Japanese deposits in June 2010.How do these answers compare with those from (b)?d. Consider two investors: one uses speculation and the other uses hedging. Based on yourprevious answers, which one earned a higher return (or smaller loss) on Japanese assetsbetween June…
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