Explain the theory of uncovered and uncovered interest rate parity. If you borrow Euros at 0.5%...

Explain the theory of uncovered and uncovered interest rate parity. If you borrow Euros at 0.5% interest, convert to dollars and deposit at 2.35% what future spot exchange rate would make uncovered interest rate parity hold?

Solutions

Expert Solution

This is a concept where there should be no arbitrage opportunity.

So, if no arbitrage should exist, then the currency with lower interest rate should appreciate, while the currency with high interest rate should depreciate.

The relationship between spot rate and forward rate is given as

Fp/b = Sp/b *(1+ip)/(1+ib)

Here p is Price currency

b is base currency

ip is interest rate in price currency

ib is interest rate in base currency

Fp/b is forward rate

Sp/b is spot rate

In this question interest rate in euro is 0.5%

Interest rate in USD is 2.35%

So, USD will depreciate, in future.

Spot USD/EUR = 0.91

Todays rate is 0.91 EUR is 1 USD

In future

Forward USD/EUR = Spot USD/EUR*(1+2.35%)/(1+0.5%)

Forward USD/EUR = Spot USD/EUR * 1.0184

= 0.9267

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

Questions 1 and 2 will use the results of uncovered interest rate parity. Uncovered interest rate parity...

Questions 1 and 2 will use the results of uncovered interest rate parity. Uncovered interest rate parity states that the domestic return must equal the foreign return (FR), where FR = - i* + (Ee– E)/E. This relationship can also be solved for the spot rate, which would yield E = Ee/ (1 + i - i*) 1. This question concerns the determination of the foreign return. Assume that the expected exchange rate is equal to 2.5 and that the foreign interest rate is equal...

covered and uncovered interest rate parity

What is the difference between covered and uncovered interest rate parity? What are the formulas?

Questions 1 and 2 will use the results of uncovered interest rate parity. Uncovered interest rate...

Questions 1 and 2 will use the results of uncovered interest rate parity. Uncovered interest rate parity states that the domestic return must equal the foreign return (FR), where FR = - i* + (Ee – E)/E. This relationship can also be solved for the spot rate, which would yield E = Ee / (1 + i - i*) 1. This question concerns the determination of the foreign return. Assume that the expected exchange rate is equal to 2.5 and...

Covered and uncovered interest rate parity, Purchasing Power Parity (25) Explain the difference between the covered...

Covered and uncovered interest rate parity, Purchasing Power Parity (25) Explain the difference between the covered and the uncovered interest rate parity. What is the underlying idea behind these concepts? How does it relate to the Purchasing Power Parity and what are the differences? (10) Suppose the one-year interest rate in the US is 5.5% and in Germany is 6.0%. The dollar per Euro exchange rate is 1.20. What is the current forward exchange rate on a 1-year contract? (5)...

The Central Bank of Japan increased the Japanese interest rate. Using uncovered interest parity, explain how...

The Central Bank of Japan increased the Japanese interest rate. Using uncovered interest parity, explain how this would affect the US economy. Using covered interest parity, explain how this would affect the U.S. economy.

With an unexpected increase in money supply, according to the theory of Uncovered Interest Parity (UIP),...

With an unexpected increase in money supply, according to the theory of Uncovered Interest Parity (UIP), the dollar ($) value must fall and Malaysia's real interest rate (r) must rise so that equilibrium is always stable and in long run Malaysia's price will be equal to the price in United States and Purchasing Power Parity holds. Explain this using Dornbusch overshooting exchange rate model.

9. Uncovered Interest Parity and Expectations Theory of interest rates Assume two countries, the U.S. and...

9. Uncovered Interest Parity and Expectations Theory of interest rates Assume two countries, the U.S. and the UK. In the United States, there are 1-year bonds and 5-year bonds (denominated in dollars). In the United Kingdom, there are also 1-year and 5-year bonds (denominated in pounds). There is a spot market Mathematically, come up with one equation for the Spot Exchange Rate that satisfies (1) the uncovered interest parity condition; (2) the expectation theory for interest rates in the US;...

explain why uncovered interest parity model is not useful in making exchange rate predictions? (200 words)

If the purchasing power parity and uncovered interest parity conditions simultaneously hold true, then it is...

If the purchasing power parity and uncovered interest parity conditions simultaneously hold true, then it is unambiguously true that: Select one: a. people can profit from arbitrage in goods and financial markets. b. real interest rates are equalized. c. foreign exchange markets are efficient. d. there is covered interest parity. If country X has a relative abundance of capital and country Y has a relative abundance of labor, then the factor proportions theory predicts that: Select one: a. if the...

Define uncovered interest parity. What is the relationship among the forward exchange rate, the spot exchange...

Define uncovered interest parity. What is the relationship among the forward exchange rate, the spot exchange rate, and the interest rate? Suppose the (1-year) interest rate on bank deposits is 2% in Canada and 1.75% in United States. If the (1-year) forward US$–C$ exchange rate is C$1.25 per US$ and the spot rate is C$1.2 per US$, will the C$ depreciation or appreciation against the US$ over one year, and by how much?

Subjects