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##### ECO three Questions Set

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Question;QUESTION 1;Suppose that one-year interest rates in the US are 0% and;that one-year interest rates in Europe are 4%. The current $/? exchange rate is;1.2. Suppose that you have $100 toINVEST.;(10 points) Use the uncovered interest rate parity (UIP);condition (the approximation) and solve for the expected exchange rate, one;year hence, that is consistent with UIP. Show that with this particular;exchange rate, the returns in 'like' CURRENCIES are approximately the same.;b. (10 points) Explain the intuition underlying your;results.;QUESTION 2;Suppose you have $1000 that serves as margin for a $9000 one;year loan where the interest rate is 1%. You INVEST the total = $10,000 in;Europe where the exchange rate is $1.25 $/?. The one-year interest rate in;Europe is 4%.;a. (10 points) According to UIP, what is the expected;exchange rate one year from now?;Consider the following two scenarios;Scenario #1: The $/? exchange rate remains constant over the;holding period = 1 year;Scenario #2: The exchange rate after one year is 1.3 $/?;b. (10 points) Assuming scenario #1, what is your profit /;loss and your rate of return in $ when you close your position?;c. (10 points) Assuming scenario #2, what is your profit /;loss and your rate of return in $ when you close your position?;QUESTION 3;Suppose that you have the following information;The inflation rate in the US is 2% and -2% in Japan;(deflation in Japan) The real exchange rate ($/yen) is appreciating by 2%.;d. (10 points) What is the implied change in the nominal;exchange rate ($/yen)? Please show work. Explain the intuition of your result.;e. (10 points) Suppose that Bank of Japan (BOJ) successfully;rids the economy of deflation so that the new rate of inflation is 2%, same as;the US. Assuming all else constant, what is the implication on the nominal;exchange rate? Explain the intuition of your result.

Paper#56500 | Written in 18-Jul-2015

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