Annual data on interest rates, inflation rates, and percentage change

Annual data on interest rates, inflation rates, and percentage change
In exchange rates (based on indirect quotes) for foreign countries, including the US, for the
period 1995 – 2007.
Each one of you is assigned to a foreign country and a six-year time period (1995-2000
or 200
1

2006). Please consult the attached list to determine your assigned country and
time period.
Please use the attached sheets to answer the questions listed based on calculations using the data
for the assigned country and the US during the assigned time period.
Use geometric instead of arithmetic averages.
Use exact instead of the approximate method.
There is only one correct answer to these questions.
You will be graded on whether or not
your answers are correct.
The necessary information and concepts are all from Chapter 4. I will discuss the solution
techniques to these problems only during class.
Q1.
During the assigned time period:
US dollar
appreciated / depreciated
(choose one) in real terms against the currency of foreign
country.
Q2.
During the assigned period, what was the average
uncovered rate of return
from the
US
viewpoint for the foreign country?
Q3.
During the assigned period, what was the average
uncovered rate of return
from the foreign
country’s viewpoint?
Q4.
Based on your answers to questions 2 and 3, given perfect hindsight about interest rates and
exchange rate changes during the assigned time period you should have:
Invested/ borrowed
(choose one) in the US and
invested / borrowed
(choose one) in foreign
country.
Q5.
Assume that you could both borrow and invest at the average interest rates prevailing in
foreign country and in the US during the assigned time period. Also assume that you have a line
of credit for one million dollars in the US or an equivalent amount in foreign country. Given
perfect hindsight about interest rates and exchange rate changes, please calculate your
total
profit in dollars using uncovered interest arbitrage
during the assigned time period
if you
followed the strategy chosen in
Q4.

Country Denmark

six-year time period 2001 2002 2003 2004 2005 2006 Geom Avg
Inflation Rate: US 2.8 1.6 2.3 2.7 3.4 3.2 2.6649
Inflation Rate: Foreign Country 2.4 2.4 2.1 1.2 1.8 1.9 1.9658
Interest Rate: US 3.7 1.7 1.2 1.6 3.5 5.2 2.8067
Interest Rate: Foreign Country 4.6 3.5 2.4 2.1 2.2 3.1 2.9796
% Change in (Indirect quote) US Dollar 2.9 -5.3 -16.6 -9.0 0.1 -0.9 -5.031
% Change in (Direct quote)
= [1/(1 + % change in IQ)] – 1 Denmark -2.8 5.5 19.9 9.8 -0.09 0.90 5.2705
PPP Implications:
The purchasing power parity suggests that since the inflation rate in the US is more than the inflation Rate in Denmark the US dollar will depreciate against the Danish Krone.
Annual Uncovered Rate (for US) Ruh=(1+ % change in DQ)*(1+rf)-1. Ruh for 2001=(1+0.029)*(1+0.046)-1= 7.6334%

Annual Uncovered Rate (for Denmark)
Ruf for 2001=(1+ % change in IQ)*(1+rh)-1. Ruf=(1-0.028)*(1+0.037)-1=0.7964%

Suggest investment strategy based on IFE: Since RUH is greater than RH you should borrow in US and invest in Denmark.

 
Q1. During the assigned time period: US dollar appreciated / depreciated (choose one) in real terms against the currency of foreign country.

(1+ih)/(1+if)-1= 0.00685 which means that the Danish Krone should have appreciated by “0.00685” where as it appreciated by “0.0527” which means in real terms the Danish Krone appreciated and the US dollar deprecated.

 

Q2.During the assigned period, what was the average uncovered rate of return from the US viewpoint for the foreign country?

Ruh=(1+ % change in DQ)*(1+rf)-1. Ruh=(1+0.052705)*(1+0.029796)-1= 8.40713%
Q3. During the assigned period, what was the average uncovered rate of return from the foreign country’s viewpoint?
Ruf=(1+ % change in IQ)*(1+rh)-1. Ruf=(1-0.05031)*(1+0.028067)-1=-2.3655%
Q4. Based on your answers to questions 2 and 3, given perfect hindsight about interest rates and exchange rate changes during the assigned time period you should have: Invested/ borrowed (choose one) in the US and invested / borrowed (choose one) in foreign country.

Since RUH is greater than RH borrow in the US and invest in Denmark

Q5. Assume that you could both borrow and invest at the average interest rates prevailing in foreign country and in the US during the assigned time period. Also assume that you have a line of credit for one million dollars in the US or an equivalent amount in foreign country. Given perfect hindsight about interest rates and exchange rate changes, please calculate your total profit in dollars using uncovered interest arbitrage during the assigned time period if you followed the strategy chosen in Q4.

Ruh-Rh= profit margin * line of credit
0.084713-0.028067=0.056646
0.056646*1000000= $56646
:)