Sem 6.docx - BF2207 International Finance International...

BF2207 International Finance
International Arbitrage and Interest Rate Parity
Problem Set 4
Question 1. Forward Rate
a. Assume that Mexico’s economy has expanded significantly, causing a high demand for
loanable funds there by local firms. How might these conditions affect the forward
discount of the Mexican peso?
.
b. Assume that the 30-day forward premium of the euro is –1 percent, while the 90-day
forward premium of the euro is 2 percent. Explain the likely interest rate conditions that
would cause these premiums. Does this ensure that covered interest arbitrage is
worthwhile?
c. If the U.S. interest rate is close to zero, while the interest rate of Russia was very high,
what would interest rate parity suggest about the forward rate of the Russian ruble?
Question 2. Forward Premium and Discount
a. Assume that interest rate parity holds. At the beginning of the month, the spot rate of the
Canadian dollar is $0.70, while the one-year forward rate is $0.68. Assume that U.S.
interest rates increase steadily over the month. At the end of the month , the one-year
forward rate is higher than it was at the beginning of the month . Yet, the one-year
forward discount is larger (the one-year premium is more negative) at the end of the
month than it was at the beginning of the month . Explain how the relationship
between the U.S. interest rate and the Canadian interest rate changed from the beginning
of the month until the end of the month.
.

b. The interest rate in Indonesia is commonly higher than the interest rate in the U.S., which
reflects a higher expected rate of inflation there. Why should Nike consider hedging its