Consider a financial institution which would like to invest 100 AUD today and receive USD in one year from now. The real rate is 5% in Australia and the inflation rate in Australia is 5%. The inflation rate in the US is 7.5%.
a) Assume that the real rate equivalence holds. Calculate the nominal interest rate in the US and Australia.
b) Assume the spot exchange rate is 0.80 USD per 1 AUD. Calculate the forward rate for one year from now.
c) Consider the following two strategies:
1. The financial institution invests 100 AUD in Australia for one year and transfers the repayment at the forward rate.
2. The financial institution transfers 100 AUD to USD at the spot exchange rate and invests in the US.
Calculate the investment result and Interpret your finding.