Chapter 6 International Parity Relationships Essay examples

1653 Words Jan 27th, 2013 7 Pages
CHAPTER 6 INTERNATIONAL PARITY RELATIONSHIPS AND FORECASTING FOREIGN EXCHANGE RATES
ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS

PROBLEMS

1. Suppose that the treasurer of IBM has an extra cash reserve of $100,000,000 to invest for six months. The six-month interest rate is 8 percent per annum in the United States and 7 percent per annum in Germany. Currently, the spot exchange rate is €1.01 per dollar and the six-month forward exchange rate is €0.99 per dollar. The treasurer of IBM does not wish to bear any exchange risk. Where should he/she invest to maximize the return?

If $100,000,000 is invested in the U.S., the maturity value in six months will be $104,000,000.
Alternatively, $100,000,000 can be converted
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Although Davies would be investing in a peso-denominated bond, the investment goal is to achieve the highest holding period return, measured in U.S. dollars, on the investment. Davies finds the higher yield on the Mexican one-year bond, which is considered to be free of credit risk, to be attractive but he is concerned that depreciation of the peso will reduce the holding period return, measured in U.S. dollars. Hamson has prepared selected economic and financial data, given in Exhibit 3-1, to help Davies make the decision.

Selected Economic and Financial Data for U.S. and Mexico Expected U.S. Inflation Rate 2.0% per year Expected Mexican Inflation Rate 6.0% per year U.S. One-year Treasury Bond Yield 2.5% Mexican One-year Bond Yield 6.5%

Nominal Exchange Rates Spot 9.5000 Pesos = U.S. $ 1.00 One-year Forward 9.8707 Pesos = U.S. $ 1.00

Hamson recommends buying the Mexican one-year bond and hedging the foreign currency exposure using the one-year forward exchange rate. She concludes: “This transaction will result in a U.S. dollar holding period return that is equal to the holding period return of the U.S. one-year bond.”

a. Calculate the U.S. dollar holding period return that would result from the transaction recommended by Hamson. Show your calculations. State whether Hamson’s conclusion

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