ECON 460 – Homework 8 (Final HW)
Due in class on April 20, 2011
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%
(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%
(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%
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.
(10 points)
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)
b.
€ 1 = $1.35 in Paris
£ 1 = $1.60 in New York
€ 1.10 = £ 1.00 in London
How will arbitrageurs behave? (10 points)
3.
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 Fall '08
 Staff
 Economics, Inflation, Spot rate

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