Economics--Introduction International Econ Relations
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PracticeProblemQuiz4key.docQuiz 4 Practice Problem-Key
1. Suppose you are in charge of investing 300 million dollars either in the U.S. or in Japan over one year period. Given the following information where would you invest?
Spot exchange rate is 120 yen per dollar.
One year forward rate is 115 yen per dollar
Annual interest rate in Japan 2%
Annual interest rate in the U.S. 2.5%
Answer: If $300 million was invested in the U.S. over one year, it will grow to 300 + 0.025(300) = 300 (1+ 0.025) = $307.5 million.
However, if it was invested in Japan we first need to convert it to yen using the sport exchange rate.
Step 1: 300 (120) = 36000 million yen
Step 2: Invest 36000 yen in Japan over one year. It will grow to:
36000(1+0.02) = 36720 million yen
Step 3: Now we sell 36720 million yen in the forward market to see how
many dollars will we have one year from today.
36720 / 115 = 319.3 million dollar.
Thus, we decide to invest in Japan because 319.3 > 307.5.
2. Suppose you are in charge of investing 300 million dollars either in the U.S. or in Japan over a three months period. Given the following information where would you invest?
Spot exchange rate is 120 yen per dollar.
Three months forward rate is 115 yen per dollar
Annual interest rate in Japan 2%
Annual interest rate in the U.S. 3%
Answer: If $300 is invested in the U.S. over three months period, it will grow to:
million
25
.
302
$
)
4
03
.
0
1
(
300
=
+
If invested in Japan at the end of three month, it will grow to:
.
6
.
314
$
)
115
1
)(
4
02
.
0
1
)(
120
(
300
million
=
+
Again, the decision is to invest in Japan.
3. Now suppose you are to invest your 300 million dollars either in the U.S. or in the U.K. for a six months period. Given the following information where would invest?
Spot exchange rate is 2 dollar per pound
Six months forward exchange rate is 2.1 dollar per pound
Annual in interest rate in the U.S. is 5%
Annual interest rate in the U.K. is 4%.
Answer: If $300 million was invested in the US for six month period, it will grow to:
million
5
.
307
$
)
2
05
.
0
1
(
300
=
+
However, if $300 was invested in US over six month period, we will end up
Having:
million
3
.
321
$
)
1
.
2
)(
2
04
.
0
1
(
2
300
=
+
Invest in U.K.
