The following rates currently exist: Spot exchange rate: $1.000/euro. Annual interest rate on 180-day euro-denominated bonds: 3%.
Question:
Annual interest rate on 180-day euro-denominated bonds: 3%.
Annual interest rate on 180-day U.S. dollar-denominated bonds: 4%.
Investors currently expect the spot exchange rate to be about $1.005/euro in
180 days.
a. Show that uncovered interest parity holds (approximately) at these rates.
b. What is likely to be the effect on the spot exchange rate if the interest rate on 180-day dollar-denominated bonds declines to 3 percent? If the euro interest rate and the expected future spot rate are unchanged, and if uncovered interest parity is reestablished, what will the new current spot exchange rate be? Has the dollar appreciated or depreciated?
Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars...
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a The euro is expected to appreciate at an annual rate of approximately 1005 10001000 360180 100 1 T...View the full answer
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