FNCE 423 – International Finance
Problem Set 2
1. Recall the example of calculating the magnitude of exchange rate depreciation or
appreciation in class.
(a) Suppose Eyen|$ = 10 at time t and 12.5 at time t+1. Calculate the rate of depreciation
of the yen against the dollar. Calculate the rate of appreciation of the dollar against
the yen.
(b) What is the expected dollar rate of return on dollar deposits if today's exchange rate is
$1.10 per euro, next year's expected exchange rate is $1.165 per euro, the dollar
interest rate is 10%, and the euro interest rate is 5%?
2.
The annualized interest rate on deposits in Canada is 10%. In yen deposits in Japan, it is
7.5%. The spot rate of the Yen is 130 Yen/$.
a.
Which currency is expected to depreciate in six months and by how much?
b.
If the covered interest parity condition holds, what is the six-month forward
Yen/$ exchange rate?
c.
A Canadian importer plans to pay 1 million yen six months from now. He buys
a forward contract and places $x in a Canadian bank deposit so that the
proceeds will be used to pay for the forward yen later. Calculate x
3. Go to the Financial Times website (www.ft.com). Hover over the tab “Markets” then
click on “Markets Data” in the drop down menu. Once there, hover over the
“Markets Data” tab then click on “Currencies” in the drop down menu. Finally, click
on “Currencies macromap” (next to “Highlights” near the top left corner of the
webpage). Using the options “Global currencies” and Currency Performance in the
last 1 month,
figure out how you can use this tool to assess the relative strength of each of the
currencies listed in the drop down menu on the right bottom corner. Which currency
or currencies appear to be the strongest in the last month? Which currency or
currencies appear to be the weakest in the last month? Explain how you arrived at
your answer in detail.
True, False, Uncertain. Explain. 2 lines maximum
1. Spot exchange rates are always lower than forward exchange rates because of the risk
premium
2. If the dollar interest rate is 10 percent, the euro interest rate is 12 percent, then an
investor should invest only in euros.
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Short Answers: 5 lines maximum
1. Discuss the effects of a rise in the dollar interest rate on the exchange rate.
2. Why might you prefer an option over a futures or forward contract?
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