Question

On May 14, 2020, the spot rate for Australian Dollars was 0.7306 USD/ 1 AUD.  The 180-day (6 month) forward rate quoted in the market was for 0.7340 USD/1 AUD and the risk-free rate on 180-day securities was 2.90 percent APR for United States LIBOR and 1.96 percent APR for Australian LIBOR.  (LIBOR rates are widely used as a reference rate for financial instruments.)  Assume that the US is the home country.

1. Are the quotes for AUD above relative to the USD direct or indirect quotations? Circle one:     direct or indirect
2. Is the USD expected to appreciate or depreciate relative to the AUD given the forward rate quoted above?   Circle one:     appreciate or depreciate
3. What is the implied forward rate if interest rate parity holds in this case?  Does interest rate parity hold here?  Use 4 decimal places for accuracy.   Implied forward rate ________
4. Which country’s risk free security offers the highest expected $ profit for a US investor, or are the $ profits the same?  Determine the $ profit for both investments using a beginning amount of 1,000 USD.   US LIBOR $ profit                             ________     Australian LIBOR $ profit                ________

Answer 1

a)

Direct quote.

explanation: when one unit of foreign currency expressed in number of units of home currency it is called Direct quote.given home currency is USD

b)

depreciate.

explanation : since interest rates in US are higher than AUS, US dollar will depreciate.

c)

as per IRPT forward rate = spot rate*[(1+interest rate of home currency) / (1+interest rate of foreign currency)]

= 0.7306*[(1+1.45%) / (1+0.98%)]

implied forward rate   = 0.7340

(given rates are annual to convert to 180 days we have to divide by 2)

d)

given forward rate = 0.7340 as per IRPT forward rate = 0.7340. since both are equal interest rate parity holds Answer is Yes.

e)

US LIBOR profit:

1000 * 1.45% = $14.5

AUS LIBOR profit:

convert 1000 using spot rate of 0.7306

AUS = 1000 / 0.7306 = 1368.738

invest in AUS @0.98%

amount after six months = 1368.738*(1+0.98%) = 1382.1516

conver to US $ using rate 0.7340

US $ = 1382.1516*0.7340 = 1014.50

Profit = 1014.50 - 1000 = $14.50

f)

both are same