ER Ch. 6

ER Ch. 6 - Based on the exchange rate quotations below from...

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Based on the exchange rate quotations below from The Wall Street Journal, which area has the highest nominal interest rates? Answer Selected Answer: Britain. Suppose you observe an exchange rate of S(\$/SFr) = 0.85 (i.e., SFr 1 = \$.85). The one-year forward rate is F1(\$/SFr) = 0.935 (i.e., SFr 1 = \$.935). The risk-free interest rate is 5% in the U.S and 2% in Switzerland. How can a dollar-based investor make money? Answer Selected Answer: Borrow dollars in the U.S., exchange for Swiss francs, invest in Switzerland, and enter into a one-year forward contract to sell francs for dollars. In one year, translate the Swiss francs back into dollars at the forward rate. Purchasing power parity (PPP) theory provides that Answer Selected Answer: None of the above. Due to the integrated nature of their capital markets, investors in both the United States and United Kingdom require the same expected real interest rate of 3%. Expected annual inflation is 2% in the U.S. and 5% in the U.K. The spot exchange rate is currently £1.00 = \$1.80. What are the nominal interest rates in the U.K. and the U.S., assuming the Fisher effect holds?

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