# Ch 4 Basics 0 by YA411O6

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1. According to purchasing power parity, if a Big Mac costs £1.99 in the UK and \$3.41 in
the USA, what should be the exchange rate of dollars to pounds?

2. If a Big Mac costs £1.99 in the UK and \$3.41 in the USA, and the actual exchange rate is
£0.50 at that time, does PPP suggest the pound is overvalued or undervalued? By how
much (what %)?

3. If the USA has annual inflation of 5%, Switzerland has annual inflation of 3%, and the
spot rate is SFr 1 = \$0.75, what does PPP suggest the spot rate should be in three years?

4. Use the monetary approach to predict the U.S. inflation rate, given the following
forecasts: money-supply growth = 5%, real GNP growth = 2%, and the velocity of money
will fall 0.5%.

5. According to the Fisher Effect, if the UK has inflation of 7%, and the UK has a nominal
rate of return = 9%, what should the UK real rate be?

6. If the USA has inflation of 4% and the UK has inflation of 7%, what should the
approximate interest rate differential be?

7. According to the Fisher Effect, if the USA has inflation of 4%, the UK has inflation of
7%, and the UK has a nominal rate of return = 9%, what should the U.S. nominal rate be?

8. If the one-year interest rate is 2% on Swiss francs and 7% on U.S. dollars, and the
exchange rate is currently SFr 1 = \$0.91, what does the International Fisher Effect
suggest the spot rate will be in one year?

9. If the one-year interest rate is 2% on Swiss francs and 7% on U.S. dollars, the exchange
rate is currently SFr 1 = \$0.91, and the expected spot rate in one year is SFr 1 = \$1.00,
what does the International Fisher Effect suggest the U.S. interest rate will become?
10. If the spot rate is \$1.95/£ and the one-year forward rate is \$1.87/£, Does this imply a
forward premium or forward discount on pounds? What is the amount (%)?

11. In London, interest paid on pounds sterling is 12%. If the spot rate is \$1.95/£ and the one-
year forward rate is \$1.87/£, what is the covered yield on pounds?

12. Is there a covered interest differential?

13. An arbitrageur sees an opportunity for a covered interest arbitrage. In London, interest
paid on pounds sterling is 12%, while in New York, interest paid on dollars is 7%. If the
spot rate is \$1.95/£ and the one-year forward rate is \$1.87/£, how much profit will the
arbitrageur make if he can borrow \$1,000,000 to put into a covered interest arbitrage?
is zero).

14. What is the 90-day forward rate if U.S. interest is 10%, Japanese interest is 7%, and the
spot rate is \$0.003800/¥? Use a 360-day year and assume interest rate parity (i.e. there are
no arbitrage opportunities).

15. What is the annualized (%) premium?

16. If the interest rate on dollars is 6%, the interest rate on euros is 5%, and the spot rate is
\$0.90/ €, what is the implied value of the euro in five years?

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