Question

Maltese​ Falcon: The Black Bird. Imagine that the mythical solid gold​ falcon, initially intended as a tribute by the Knights of Malta to the King of Spain in appreciation for his gift of the island of Malta to the order in​ 1530, has recently been recovered. The falcon is 14 inches high and solid​ gold, weighing approximately 48 pounds. Assume that gold prices have risen to ​$438​/ounce, primarily as a result of increasing political tensions. The falcon is currently held by a private investor in​ Istanbul, who is actively negotiating with the Maltese government on its purchase and prospective return to its island home. The sale and payment are to take place one year from​ now, and the parties are negotiating over the price and currency of payment. The investor has​ decided, in a show of​ goodwill, to base the sales price only on the​ falcon's specie valuelong dashits gold value. The current spot exchange rate is 0.3903 Maltese lira​ (ML) per 1.00 U.S. dollar. Maltese inflation is expected to be about 8.496​% for the coming​ year, while U.S.​ inflation, on the heels of a​ double-dip recession, is expected to come in at only 1.497 %.  If the investor bases value in the U.S.​ dollar, would he be better off receiving Maltese lira in one year​ (assuming purchasing power​ parity), or receiving a guaranteed dollar payment​ (assuming a gold price of ​$421 per ounce one year from​ now)?

Answer 1

1.

Details about exchange rates and falcon which weights about 48 pounds are provided along with the cost per pound in order to determine the value

	year 1	year 2
falcon weight in pounds	48	48
price of gold in $/ounce	438	421
current spot exchange rate	0.3903ML
inflation in Maltese	8.4396%
inflation in US	1.497%

Calculate Falcon value for both years

Forward exchange rate based on PPP is determined.

Exchange rate changes according to the purchasing power parity (PPP) using the formula:

(exchange rate based on PPP) = (spot exchange rate) x {(1+Maltese exchange rate)/(1+US inflation rate)}

= ML 0.3903 x {(1+0.084396)/(1+0.01497)}

= ML0.4169973/$

Converting weight to ounce:

1 pound = 16 ounce

Falcon in ounce = 48x16 = 768 ounce

	year 1	year 2
falcon in ounce	768	768
price per ounce	438	421
falcon value	768x438 =336384	768x421 =323328
current spot exchange rate	0.3903ML/$	0.4169ML/$
falcon value in ML	336384x0.3903 = 131290.6	323328x0.4169 =134795.4

amount in $ in year 2 = amount in ML for year 1/exchange rate = 131290.6/0.4169 = 314921.08

Thus, from the above calculations, we can say that the investor has the basis of proceeds from the gross sales in US$ then he will be guaranteed with 421$/ounce for year 2, which will yeild higher dollar value of 323328, rather than accepting ML that yeilds 314921.08.

When accepting US$, investor will yeild return of (323328-314921.08) $8406.92