Tutorial 3 2019 revised.pdf - Tutorial 3 Finish the rest of the Launchpad Problem on p.61 of the textbook Q1 The yen is now trading in the spot market

Tutorial 3 2019 revised.pdf - Tutorial 3 Finish the rest of...

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Tutorial 3 Finish the rest of the Launchpad Problem on p.61 of the textbook. Q1. The yen is now trading in the spot market at 106 per USD and its one year forward rate is 100 per USD. Concerns about the stability Trump’s presidency have made USD a riskier currency to hold and investors demand a FX risk premium of 0.7% from the USD. Given this info, do we know the market’s expectation of this exchange rate one year from now? If the interest rate in Japan is 2%, what would US interest rate be? Q2. Suppose domestic country is Japan and foreign country is Australia. Hence E = Yen per AUD. E e is assumed to be fixed by some long run factors. (i) If UIP holds. Is it possible for a high yield currency to be expected to appreciate, for example, i = 5%, i* = 3%, 𝐸 𝑒 −𝐸 𝐸 = −2% ? If not, what should the equilibrium situation like? Can carry trader then make positive expected profit? (ii) Suppose the yen is perceived to have more foreign exchange risk and investors
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