Homework 8 Answer

Homework 8 Answer - ECON 460 Homework 8 (Final HW) 1. a....

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
ECON 460 – Homework 8 (Final HW) 1. a. Draw a graph to show the CIP condition. In the graph, plot the following and indicate whether there will be capital inflow or outflow: (10 points) (i) I NY = 0.02; I Germany = 0.02; Spot rate: € 1 = $1.35; Forward rate: € 1 = $1.30. Assume transaction cost of 0.25 I NY D- I Germany = 0.02 – 0.02 = 0 p, forward premium = (1.30-1.35)/1.30 = 0.03/1.30 = -0.037 INFLOWS (ii) I NY = 0.02; I Germany = 0.03; Spot rate: € 1 = $1.35; Forward rate: € 1 = $1.33. Assume transaction cost of 0.25% I NY D- I Germany = 0.02 – 0.04 = -0.01 p, forward premium = (1.33-1.35)/1.35 = 0.02/1.35 = 0.-0148 INFLOWS (iii) I NY = 0.04; I Germany = 0.02; Spot rate: € 1 = $1.35; Forward rate: € 1 = $1.3635. Assume transaction cost of 0.25% I NY D- I Germany = 0.04 – 0.02 = 0.02 p, forward premium = (1.3635-1.35)/1.35 = 0.0135/1.35 = 0.01 INFLOWS NOTES ON GRAPH: i-i* is measured on vertical axis p, forward premium, is measured on x axis Draw a band for transaction cost. b. What is the effect of each of the above on domestic interest rate, foreign interest rate, spot rate and forward rate? Use the money market graph and foreign exchange graph to explain this. 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
(10 points) Capital Inflows: S 0 S 1 S 1 S 0 i NY i GER 0.02 0.02 D D Domestic money market Foreign money market S 0 S 1 S 0 e D €1 D D €0 Spot market Forward market 2. Given the following exchange rates, how will arbitrageurs behave? Calculate profit/loss. a. € 1 = $1.35 in New York € 1 = $1.36 in Paris What will happen to the Euro in the two markets? Depreciate or appreciate? (5 points) 2
Background image of page 2
Buy Euros in New York and sell Euros in Paris. The Euro will appreciate in New York and depreciate in Paris. Profit made is $0.01 per $1.35. b.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 5

Homework 8 Answer - ECON 460 Homework 8 (Final HW) 1. a....

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online