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Unformatted text preview: hese models argue that growing budget deficits,
fast money growth, and rising wages and prices usually precede devaluations. Increases in
nominal interest rates typically reflect a combination of the probability and magnitude of a
possible devaluation. P ROBLEMS
1. Suppose the 1-year nominal interest rate in Zooropa is 9%, and Zooropa’s expected
inflation rate is 4%. What is the real interest rate in Zooropa?
Answer: The expected real interest rate is approximately 9% - 4% = 5%. The correct
computation is: (1 + 0.09) / (1 + 0.04) – 1 = 0.0481 or 4.81%.
2. You were recently hired by the Doolittle Corporation corporate treasury to help
oversee its expansion into Europe. Blake Francis, the CFO, wants to hire a foreign
exchange forecasting company. Blake has asked you to evaluate three different
companies, and he has obtained information on their past performanc...
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