Knowee
Questions
Features
Study Tools

IFE Beth Miller does not believe that the IFE holds. Current one-year interest rates in Europe are 5 percent, whereas one-year interest rates in the United States are 3 percent. 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 in one year be? If the spot rate of the euro in one year is $ 1.00 , what is Beth’s percentage return from her strategy? If the spot rate of the euro in one year is $ 1.08 , what is Beth’s percentage return from her strategy? What must the spot rate of the euro be in one year for Beth’s strategy to be successful?

Question

IFE Beth Miller does not believe that the IFE holds. Current one-year interest rates in Europe are 5 percent, whereas one-year interest rates in the United States are 3 percent. Beth converts 100,000toeurosandinveststheminGermany.Oneyearlater,sheconvertstheeurosbacktodollars.Thecurrentspotrateoftheeurois 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 in one year be? If the spot rate of the euro in one year is 1.00,whatisBeth’spercentagereturnfromherstrategy?Ifthespotrateoftheeuroinoneyearis 1.00 , what is Beth’s percentage return from her strategy? If the spot rate of the euro in one year is 1.08 , what is Beth’s percentage return from her strategy? What must the spot rate of the euro be in one year for Beth’s strategy to be successful?

...expand
🧐 Not the exact question you are looking for?Go ask a question

Solution

The International Fisher Effect (IFE) theory suggests that the expected difference in the nominal interest rates between two countries is equal to the expected percentage change in the foreign exchange rate.

  1. According to the IFE, the spot rate of the euro in one year should be:

    Spot rate in one year = Current spot rate * (1 + Interest rate of Europe) / (1 + Interest rate of US) = 1.10∗(1+5=1.10 * (1 + 5%) / (1 + 3%) = 1.10 * 1.05 / 1.03 = $1.12136

  2. If the spot rate of the euro in one year is $1.00, Beth’s percentage return from her strategy would be:

    Return = (Ending value / Beginning value) - 1 = [(1.00∗1.00 * 100,000 * 1.05) / $110,000] - 1 = -9.09%

  3. If the spot rate of the euro in one year is $1.08, Beth’s percentage return from her strategy would be:

    Return = (Ending value / Beginning value) - 1 = [(1.08∗1.08 * 100,000 * 1.05) / $110,000] - 1 = -1.82%

  4. For Beth’s strategy to be successful, the spot rate of the euro in one year must be:

    Spot rate in one year = 110,000/(110,000 / (100,000 * 1.05) = $1.04762

So, the spot rate of the euro must be $1.04762 for Beth's strategy to be successful.

This problem has been solved

Similar Questions

Suppose that the one-year interest rate is 5.0 percent in the United States. The spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.16/€. What must the one-year interest rate be in the euro zone to avoid arbitrage opportunities?Group of answer choices5.0%6.09%none of the options8.62%

Today, the annual interest rate on bank deposits is 8.15% in New York and 3% in Paris, the spot exchange rate is 1.2 US dollars per euro, and the one-year forward exchange rate is 1.236 US dollars per euro. Emily plans to deposit 1,000 US dollars in either New York or Paris for one year. Answer the following questions, using the exact equations for the UIP/CIP.(a). Where should Emily deposit her funds? Given today's spot exchange rate and interest rates, what is the equilibrium forward rate, if covered interest parity (CIP) holds? Report the intermediate steps. [3 marks](b). Suppose the forward rate takes the value given by your answer to question (a). If UIP also holds, is the US dollar expected to appreciate or depreciate against the euro over one year? By how much? Report the intermediate steps.  [3 marks]

You are an American investor who can borrow $1,000,000 or the equivalent amount in euros today.Suppose the spot rate is $1.02/€, and the one-year forward rate is $1.10/€. The annual interest rate is 5 percent in the U.S. and 3 percent in Germany. Check if IRP holds. If it does not hold, set up a covered interest arbitrage. What will be your profit from this arbitrage opportunity in dollars?

Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, that the spot exchange rate is $1.60/€ and that the forward exchange rate, with one-year maturity, is $1.50/€. Assume that an arbitrager can borrow up to $1,000,000 or €625,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?

Suppose that the one-year interest rate is 3.0 percent in Italy. The spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.18/€. What must the one-year interest rate be in the United States to avoid arbitrage opportunities?Group of answer choices1.0128%1.2833%4.75%none of the options

1/2

Upgrade your grade with Knowee

Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.