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International Financial Managmenet N1548 Seminar 4 Questions and answers 1. If we assume that foreign exchange markets for major world currencies are “efficient” and forward exchange rates are unbiased predictors of future spot exchange rates then using the assumptions of relative purchasing power parity and the below table of inflation rates and initial spot exchange rates in United States and UK, estimate the spot exchange rate for each period. Current spot exchange rate: $1.5723/ £ every 1£= $1.5723 Year 1 2 3 4 5 6 USA inflation 2.4% 2.8% 3.5% 3.2% 1.8% 2.2% UK inflation 3.2% 3.6% 4.2% 2.5% 2.4% 3.1% Expected exchange rate X1 X2 X3 X4 X5 X6 Answer: Using RPPP theory S 1 = S 0 1 + π 1 US 1 + π 1 UK = USD 1.5601 / GBP S 2 = S 1 1 + π 2 US 1 + π 2 UK = USD 1.5481 / GBP S 3 = S 2 1 + π 3 US 1 + π 3 UK = USD 1.5377 / GBP S 4 = S 3 1 + π 4 US 1 + π 4 UK = USD 1.5482 / GBP S 5 = S 4 1 + π 5 US 1 + π 5 UK = USD 1.5391 / GBP
S 6 = S 5 1 + π 6 US 1 + π 6 UK = USD 1.5257 / GBP 2. If the current spot exchange rate is CNY 9.8483/GBP, the 90-day Chinese Yuan deposit rate is 6.5% per annum and the yield on 90-day UK GBP denominated deposit is 9.6% per annum From the above scenario what is the forward exchange rate in 3 months’ time? i of pricecurrency ( CNY ) adjusted iof unit currency ( GBP ) adjusted F 90 = S [ 1 + ( ¿ maturity ) ] [ 1 + ( ¿ maturity ) ] F 90 = 9.8483 CNY / GBP [ 1 + ( 0.065 90 360 ) ] [ 1 + ( 0.096 90 360 ) ] = 9.7737 CNY / GBP 3.

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