Question

Solve this problem with steps by steps

A.1)We know that the yen and the swiss franc have a 120yen/ sf 1 exchange rate, meaning one swiss franc buys 120 yen in the spot ER market. If the swiss franc has an interest rate of .06 and the yen rate is -.02, what is the forward exchange rate for IPT (interest parity theory) to be attained? Show everything in yen terms, i., e., how much yen one Swiss franc buys (yen is in the numerator.) 2) If there is no equilibrium initially, will there be equilibrium eventually? If so, what will transpire? Be extremely thorough. Your answer should include CIA. B. 1) Countries Mali and South Africa have their interest rates to be 16% and 12 %, respectively. If their currencies trade according to 50 CFA francs buy one rand in the spot market, what will their future spot rate be in the aforementioned context? 2) Define IFE and explain the fact of how it occurs. Is there any deviation from it?

Answer 1

A) 1)Spot Rate 120Yen/1SF hhyY Interest Rate on Swiss Franc .06 Interest Rate on Yen-.02 As per Interest Rate parity forward rate is calculated as (1id) *(1if) where: id The interest rate in the domestic currency or the base currency ifThe interest rate in the foreign currency or the quoted currency s=The current spot exchange rate F=The forward foreign exchange rate ww F= (.98/1.06) 120 =Yen 110.9434/ 1 SF 2) Initially if there is no equilibrium, eventually equilibrium will be there. CIA is an strategy of using interest rate differential and investing in high yielding currency and hedging the risk through a forward contract. In case of any opportunity, market participants will participate in exploiting it and the demand on one side creates will nullify the available arbitrage opportunity

B) 1) Spot Rate 50 CFA/1 Rand Interest Rate Mali= 16% Interest Rate Africa =12% Future Spot Rate = (1.16/1.12)*50 CFA 51.7857/ 1 Rand 2) International Fisher Effect there states that differences in nominal interest rate reflect expected changes in the spot exchange rate between 2 countries. As per IRP the country with higher nominal interest rate is expected to depreciate against the currency of the country with lower nominal interest rate. In the short run it is not necessary for the IRP to hold good as many a times in short run countries with higher interest rate appreciate against the currency with lower interest rates.