class example_sols.docx

# class example_sols.docx - An investor is considering...

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An investor is considering investments in the UK & US. The investor sees that: Today’s spot \$/GBP = \$1.3918/GBP 1-year forward \$/GBP = \$1.4200/GBP US inflation expected to be: 2.5% UK inflation expected to be: 2.0% Current 1-year US interest rate = 1.98% Current 1-year UK interest rate = 0.58% Given this data, the investor wonders: 1) What does Relative PPP predict will be the 1-year change in the \$/GBP exchange rate? The exchange rate in 1 year? [S(\$/GBP) t+1 – S(\$/GBP) t ]/S(\$/GBP) t = (.025 - .02)/1.02 = .0049 or 0.49% (exact) = .025 - .02 = .005 or .5% (inexact) S(\$/GBP) t+1 = S(\$/GBP) t ] + (S(\$/GBP) t )* [ (.025 - .02)/1.02 ] = 1.3910 + 1.3910*[ (.025 - .02)/1.02 ] = \$1.3978/GBP 2) What does the IFE predict will be the 1-year change in the \$/GBP exchange rate? = (.0198 - .0058)/(1.0058) = 0.0139, or 1.39% 3) When could the investor expect to profit from a carry trade between the US & the UK (i.e. what must be the % change in the GBP/\$ or \$/GBP for a profit to arise)? A carry trade would involve borrowing from the UK and investing in the US

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• Fall '08
• STAFF
• Finance, Money Market Hedge, UK investment worth

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