CHAPTER 17
2.
The exchange rate between US dollars and British pounds is 0.6 pounds per dollar. The
exchange rate between US dollars and Japanese yen is 100 yen to the dollar. Determine
the exchange rate of yen per pound and pounds per yen.
£0.6 = $1
3.
¥100 = $1
¥100 $1

= ¥100 per £0.6
$1 £0.6
£1 = [100/.6] ¥ = 166.67 ¥
£0.6
$1

= £0.6 per ¥100
$1 ¥100
¥1=£0.006
The US/Canadian exchange rate is $0.90 Canadian equals US $1. The US/UK exchange
rate is $2 US equals £1. How many Canadian dollars are there in £1?
$0.90C = $1 US
$2US = £1
$0.90C $1 US
x
= $0.90C per £0.5
$1 US
£0.5
£1=$1.80C
4.
The exchange rate between US dollars and British pounds is 0.6 pounds per dollar. You
can invest in the US for one year at the spot interest rate of 8 percent. Alternatively, you
can exchange dollars for pounds and invest in Britain at 12 percent. After one year, you
exchange the pounds for dollars at the prevailing exchange rate.
(a) At what exchange rate would your total return on the British investment be 15
percent?
(b) At what exchange rate would the returns on the US and British investments be equal?
(c) What should the forward exchange rate be?
a. 0.6(1.12) = £0.672
0.672/x = 1.15
x = £0.5843 per $1US
b. 0.672/x = 1.08
x = 0.6222
c. The forward exchange rate should be 0.6222. Then the US investor can lock in 8
percent with certainty by investing in the US or by investing in the UK using a
forward contract.
5.
Bobby Boyd is considering investing in US 1-year bonds at 8 percent or Canadian bonds
at 12 percent. The current exchange rate is Can$0.80 equals US $1. If the Canadian
bonds are chosen, Bobby intends to exchange US dollars for Canadian today in the spot
market; then in 1 year, Bobby would exchange the Canadian dollars for US dollars at the
spot exchange rate. A t what spot exchange rate in one year would the two investments
earn the same US dollar returns?
Assume an investment of $1. Investment in the US results in $1.08 in one year. Suppose
the US dollar is exchanged for $.80C. Investing at 12 percent results in $.896C in one
year.
$0.896C
= $1.08US
x
x  0.8296 Canadian dollars per US dollar.
6.
The spot exchange rate is Can $0.85 equals US$1. The forward exchange rate for
delivery in 1 year is Can$0.90 equals US$1. The 1-year spot interest rate in the US is 6
percent. What is the 1-year spot interest rate in Canada?
$ (1 + R C)
$1(1 + R US) = xS
x f1
$1(1 + R US)( x f1 )
= (1 + R C)
$ xS
$1(1.06)( 0.90)
= (1 + R C)
0.85
R C  0.1224
7.
Assume the US interest rate is 6 percent, the US inflation rate is 4 percent, the British
inflation rate is 12 percent, and the current exchange rate is £0.60 to US$1. If relative
purchasing power parity holds, what should happen to the exchange rate?
The British inflation rate is 8 percent higher than the US inflation rate. According to
relative purchasing power parity, the British currency should depreciate by 8 percent.
$1US should equal £0.60(1.08).
8.
Assume that relative purchasing power parity holds. The current exchange rate is US$1
equals 300 Mexican pesos. The inflation rate in the US over the next year will be 5
percent and the inflation rate in Mexico will be 55 percent. If so, what should the
exchange rate become in 1 year, other things held constant? US$1 equals how many
Mexican pesos?
$1US = 300 pesos
PUS = 5%
PM = 55%
Rate of depreciati on
 PUS  PFOR
of US dollars
 5%  55%  50%
50% appreciation of the US dollar.
$1US = 450 peso
9.
Suppose Robert Connors is a Canadian investor. The one-year spot interest rate in
Canada is 10 percent and the 1-year spot interest rate in the US is 8 percent. The spot
exchange rate between Canadian dollars and US dollars is US$1 equals Can$1.25.
Suppose Mr. Connors exchanges Canadian dollars for US dollars, invests at the one-year
spot interest rate in the US, and then exchanges the US dollars for Canadian currency. At
what future exchange rate will the return on the US investment strategy equal the return
from investing in Canada at the 1-year spot interest rate? Please state the exchange rate
two ways—Canadian dollars per US dollar and US dollars per Canadian dollar.
Canada
US
R0,can = 10%
R0,US = 8%
$1.00US = $1.25C
$0.80US = $1.00C
0
|
$1.00C
1
|
1.10
$0.80
(0.8)(1.08)
x1
x1 =
(0.8)(1.08)
= 0.7855
1.10
$1.00C = $0.7855 US
$1.27C = $1.00 US
= 1.10
10.
Suppose that interest rates in Japan are 1 percent for all maturities and interest rates in the
US are 5 percent for all maturities. A US investor borrows money in Japan for one year,
exchanges for US dollars at an exchange rate of 130 yen to one US dollar, and buys 30year US bonds. After 1 year the US bonds are sold, the money exchanged for yen at the
exchange of 110 yen to US$1, and the loan repaid. Compute the rate of return on this
strategy. Decompose this return into two parts, the exchange rate effect and the
difference in interest rates.
Japan
US
ROR =
0
|
¥1
1
|
¥1.01
1
130
 1  (1.05 )
= ¥0.88846


 130  (1/110)
0.88846
 1  0.1203
1.01
 0.00769   1.05   0.00769 
1 +
 1
ROR = 
 0.00909   1.01   0.00909 
ROR = [-0.1540] + [ 0.0337 ] = - 0.1203
-0.1540 = the exchange rate effect
0.0337 = the difference in interest rates