Suppose that interest rates on Eurodollars and Eurofrancs (Swiss) follow a flat yield curve and are 12%
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Question:
Suppose that interest rates on Eurodollars and Eurofrancs (Swiss) follow a flat yield curve and are 12% and 7% per annum respectively. You are given that inflation in Switzerland is at 4% and the current spot rate for the Swiss franc is $0.3985.
- (a)Give an estimate of the inflation figure in the United States.
- (b)Further information is obtained, showing that the price level is US$6,500 in the United States and SFr15,500 in Switzerland. Use the implied absolute-PPP exchange rate for US$/SFr to explain why one currency is undervalued relative to the other.
- (c)What is the spot rate implied by these interest rates for the franc three years from now?
- (d)If the 3-year forward rate for the Swiss franc is $0.4535, calculate the arbitrage profit possible on a nominal sum, and describe the transactions necessary to obtain such a profit.
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