Ch. 6 Problems - INTERNATIONAL PARITY & FORECASTING...

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INTERNATIONAL PARITY & FORECASTING EXCHANGE RATES Chapter 6 Questions
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Question 7 Researchers found that it is very difficult to forecast future exchange rates more accurately than the forward exchange rate or the current spot exchange rate. How would you interpret this finding?
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Answer Question 7 It is easy to forecast the forward rate and the spot exchange rate today because they are known and listed numbers in the newspapers and public knowledge. You can calculate the forward rate based on the two countries interest rates and the current spot rate. However, the future rate of exchange is more speculation than based on a formula so it makes sense that researchers and everyone else find the future exchange rate more difficult to forecast. While the countries interest rates and forward rates are considered and used to form the future rate, it is a pure guess as to the situation of the economy at that point in the future including the potential for inflation, trade deficits, political instability, and other detrimental economic events.
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Problem 1 Suppose that the treasurer of IBM has an extra cash reserve of $100,000,000 to invest for six months. The six-month interest rate is 8% per annum in the United States and 7% per annum in Germany. Currently, the spot exchange rate is €1.01 per dollar and the six- month forward exchange rate is €0.99 per dollar. The treasurer of IBM does not wish to bear any exchange risk. Where should he or she invest to maximize the return?
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Answer Problem 1 The treasurer of IBM should invest (hedge) in Germany in order to maximize the return. Option 1: Invest in the United States
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This note was uploaded on 06/06/2011 for the course FINA 4810 taught by Professor Hamilton during the Spring '08 term at University of Georgia Athens.

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Ch. 6 Problems - INTERNATIONAL PARITY & FORECASTING...

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