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Question 1: April 23rd, 2011 issue of the Economist reports 1 year Treasury yields in the...

Question 1: April 23rd, 2011 issue of the Economist reports 1 year Treasury yields in the US and Turkey as 0.28% and 6.25% respectively.

a. Why do you think the interest rates are so high in Turkey as compared to the US?

b. Based on the reported interest rates, what would be the 1 year forecast of Turkish Lira. (Assume that current spot rate is USD/TRY 1.5300). Can the interest rate differentials explain the change in the exchange rate?

Solutions

Expert Solution

Why do you think the interest rates are so high in Turkey as compared to the US

1) The rates of interest rates are so high in Turkey in comparison to US because Turkey is expecting a high rate of inflation. The International Fisher Effect states that a high treasury yield in one nation (in the given case it is Turkey) in comparison to another nations (in the given case it is U.S.) depicts that Turkey is expecting a high rate of inflation

2) One year forward rate (United States dollar / Turkey Yen = Spot rate * (1 + United States treasury rate) / (1 + Turkey treasury rate)

= 1.53 * (1+0.28%) / (1+6.25%)

= 1.44

Devaluation in Percentage = (One-year forward rate - Spot rate) / spot rate

= (1.44 - 1.53) / 1.53

= -5.62%

The change in the rate of exchange is related to rate of interest differentials. According to International Fisher Effect the expected change in the current exchange rate among any two currencies is nearly equivalent to the difference between the two nation's nominal rates of interest for that time

Rahul Sunny answered 1 year ago
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