Question

In: Finance

Beth Miller does not believe that the International Fisher Effect holds. Current 1-year interest rates in...

Beth Miller does not believe that the International Fisher Effect holds. Current 1-year interest rates in Europe are 5%, while 1-year interest rates in the U.S. are 3%. Beth converts $100,000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.10.

According to the IFE, what should the spot rate of the euro be in 1 year?

If the spot rate of the euro in 1 year is $1.00, what is Beth's percentage return from her strategy?

If the spot rate of the euro in 1 year is $1.08, what is Beth's percentage return from her strategy?

What must the spot rate of the euro be in 1 year for Beth's strategy to be successful?

Solutions

Expert Solution

Part A:

Fwd rate :

Acc to IFE,

Fwd rate = Spot rate * [ (1+Hi) / ( 1 + Fi) ]

Hi = Int rate in US
Fi = Int rate UK

Particulars Amount
Spot Rate $ 1.1000
Hi 3.000%
Fi 5.000%
Home Country US
Foreign Country Germany
Forward rate for 1

According to Int Rate parity Theorm,
Fwd rate After 1 Years = Spot rate * [ ( 1 + Hi ) ^ n ] / [ ( 1 + Fi ) ^ n ]
= $ 1.1 * [ ( 1 + 0.03) ^ 1 ] / [ ( 1 + 0.05 ) ^ 1 ]
= $ 1.1 * [ ( 1.03) ^ 1 ] / [ ( 1.05 ) ^ 1 ]
= $ 1.1 * [ 1.03 ] / [ 1.05 ]
= $ 1.1 * [ 0.981 ]
= $ 1.079
Part B:

Amount Invested = $ 100000
Convert them into Euro using spot Rate
= 100000 / 1.1
= 90909.09
Invest them in Gemany for 1 Year and realize the matuiry
Maturity Value = 90909.09 * 1.05
= Euro 95454.55
Convert Them into USD using Spot Rate on Maturity
= 95454.55 * 1.00
= 95454.55

Ret = [ AMount Returned - AMount Invested ] / AMount Invested
= [ 95454.55 - 100000 ] / 100000
= -4545.45 / 100000
= -0.0455 I.e -4.55%

Part C:

Amount Invested = $ 100000
Convert them into Euro using spot Rate
= 100000 / 1.1
= 90909.09
Invest them in Gemany for 1 Year and realize the matuiry
Maturity Value = 90909.09 * 1.05
= Euro 95454.55
Convert Them into USD using Spot Rate on Maturity
= 95454.55 * 1.08
= 103090.91

Ret = [ AMount Returned - AMount Invested ] / AMount Invested
= [ 103090.91 - 100000 ] / 100000
= 3090.91 / 100000
= 0.0309 I.e 3.09%

Part D:

Strategy to be successful, The exchange rate shall be more than IFE forward Rate ( $ 1.079 ) as calculated in Part A.

jeff jeffy answered 1 year ago
Next > < Previous

Related Solutions

If international Fisher effect (IFE) holds interest rates will be able to forecast exchange rates real...
If international Fisher effect (IFE) holds interest rates will be able to forecast exchange rates real exchange rates will be equal across the two countries inflation rates will be equal across the two countries
Describe how the Fisher Effect explains the interaction of expected inflation and changes in interest rates.
Describe how the Fisher Effect explains the interaction of expected inflation and changes in interest rates.
Describe how the Fisher Effect explains the interaction of expected inflation and changes in interest rates.
Describe how the Fisher Effect explains the interaction of expected inflation and changes in interest rates.
When International Fisher Effect (IFE) does not hold Select one: a. the financial markets are in...
When International Fisher Effect (IFE) does not hold Select one: a. the financial markets are in equilibrium. b. there are opportunities for covered interest arbitrage. c. there are opportunities for uncovered interest arbitrage. d. there is usually a low degree of inflation in both countries.
The international Fisher effect theory (IFE) says that interest rate differences between two completely different countries...
The international Fisher effect theory (IFE) says that interest rate differences between two completely different countries will be offset equally by opposite changes in _________. A. The American Dollar B.Euro C. Future spot rate D. Future interest rate
Current one-year interest rates in Europe is 4 percent, while one-year interest rates in the U.S....
Current one-year interest rates in Europe is 4 percent, while one-year interest rates in the U.S. is 2 percent. You convert $200,000 to euros and invests them in France. One year later, you convert the euros back to dollars. The current spot rate of the euro is $1.20. a. According to the IFE, what should the spot rate of the euro in one year be? b. If the spot rate of the euro in one year is $1.12, what is...
If the theorys of purchasing power parity and international fisher effect hold is there any reasons...
If the theorys of purchasing power parity and international fisher effect hold is there any reasons international companies should hedge? In other word is there exchange rate risk for companies if purchasing power parity and the international fisher effect were true?
The table below shows current and expected future​ one-year interest​ rates, as well as current interest...
The table below shows current and expected future​ one-year interest​ rates, as well as current interest rates on multiyear bonds. Use the table to calculate the liquidity premium for each multiyear bond. Year ​One-Year Bond Rate Multiyear Bond Rate 1 2.00​% 2.00​% 2 3.00​% 5.00​% 3 4.00​% 7.00​% 4 5.00​% 8.00​% 5 6.00​% 10.00​% The liquidity premiums for each year are given​ as: ​(Enter your responses rounded to two decimal​ places.) l11 = ​% l21 = ​% l31 = ​%...
Define fisher effect and explain three reasons why it is also applied to international markets.
Define fisher effect and explain three reasons why it is also applied to international markets.
Deriving Current Interest Rates. Assume thatinterest rates for one-year securities are expected to be 0.04...
Deriving Current Interest Rates. Assume that interest rates for one-year securities are expected to be 0.04 today, 0.07 one year from now and 0.06 two years from now. Using only the pure expectations theory, what are the current interest rates on two-year securities. Enter the answer as a decimal using 4 decimals (e.g. 0.1234).
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT