i The three-month interest rate in the US right now is 1.85%. Assume that you are...
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i The three-month interest rate in the US right now is 1.85%. Assume that you are risk-neutral. You expect that the interest. rate on a three-month treasury bill bought three months from now will be 1.65% bought six months from now will be 1.55% bought nine months from now will be 1.45% What do you expect the one-year interest rate to be in the US? You can use approximations. 2. You are planning an European holiday today, but it will be a year before you actually get to go. Today, one can buy 1.2 euro for 1 USD. You look up European markets and find that the one-year interest rate in the Eurozone is 4%. What do you expect the nominal exchange rate will be when you are on your holiday? . . 3. Based on prices you see today, you conclude that your trip is comfortably within your budget. Your European friend reminds you that inflation is high in the Euro area, and claims that you should expect prices in the Euro area to rise 10%. You know that prices in the US are expected to only rise about 5%. Suppose you believe that the law of one price holds. Can you and your friends' expectations both be right? If so, what must both of you be thinking about the exchange rate? 4. Describe some reasons why you should not believe that the law of one price is an appropriate guide to predicting how much you will spend. 5. Explain the monetary trilemma faced by an economy in the international economy. (a) Suppose you pegged your exchange rate to the dollar and had open financial markets, allowing free capital flows. What would happen if you tried to independently reduce your interest rate? (b) Suppose you decide not to give up monetary autonomy and continue to peg your exchange rate. How will financial markets react to this if you try to reduce your interest rate? i The three-month interest rate in the US right now is 1.85%. Assume that you are risk-neutral. You expect that the interest. rate on a three-month treasury bill bought three months from now will be 1.65% bought six months from now will be 1.55% bought nine months from now will be 1.45% What do you expect the one-year interest rate to be in the US? You can use approximations. 2. You are planning an European holiday today, but it will be a year before you actually get to go. Today, one can buy 1.2 euro for 1 USD. You look up European markets and find that the one-year interest rate in the Eurozone is 4%. What do you expect the nominal exchange rate will be when you are on your holiday? . . 3. Based on prices you see today, you conclude that your trip is comfortably within your budget. Your European friend reminds you that inflation is high in the Euro area, and claims that you should expect prices in the Euro area to rise 10%. You know that prices in the US are expected to only rise about 5%. Suppose you believe that the law of one price holds. Can you and your friends' expectations both be right? If so, what must both of you be thinking about the exchange rate? 4. Describe some reasons why you should not believe that the law of one price is an appropriate guide to predicting how much you will spend. 5. Explain the monetary trilemma faced by an economy in the international economy. (a) Suppose you pegged your exchange rate to the dollar and had open financial markets, allowing free capital flows. What would happen if you tried to independently reduce your interest rate? (b) Suppose you decide not to give up monetary autonomy and continue to peg your exchange rate. How will financial markets react to this if you try to reduce your interest rate?
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1To estimate the expected oneyear interest rate in the US we can use the expectations theory of the term structure of interest rates According to this theory the oneyear interest rate can be approxima... View the full answer
Related Book For
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta
Posted Date:
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