1. You observe that six month T-bills trade at 6.0% in Italy and 8.0% in Greece....

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1. You observe that six month T-bills trade at 6.0% in Italy and 8.0% in Greece. As well, annual inflation expectations are 4% in Italy and 6% in Greece. The six month forward rate is 105 Drachmas to one Euro. The current spot rate is 100 drachmas to the Euro. a. You can buy a twelve pack of beer in Greece on holiday for 1200 Drachmas-then how much should that same case of beer cost in Italy if exchange markets are in equilibrium? b. Before your holiday, your travel agent agrees that six month from now he will then sell you Drachmas for your trip at 90 Drachmas to one Euro? Is that a fair price? c. Before your trip you decide to invest 5,000 Euros into a Drachma account at the quoted T-bills. You could have otherwise invested in local Euro's. What should you do? Will you make a loss or again? 1. You observe that six month T-bills trade at 6.0% in Italy and 8.0% in Greece. As well, annual inflation expectations are 4% in Italy and 6% in Greece. The six month forward rate is 105 Drachmas to one Euro. The current spot rate is 100 drachmas to the Euro. a. You can buy a twelve pack of beer in Greece on holiday for 1200 Drachmas-then how much should that same case of beer cost in Italy if exchange markets are in equilibrium? b. Before your holiday, your travel agent agrees that six month from now he will then sell you Drachmas for your trip at 90 Drachmas to one Euro? Is that a fair price? c. Before your trip you decide to invest 5,000 Euros into a Drachma account at the quoted T-bills. You could have otherwise invested in local Euro's. What should you do? Will you make a loss or again?

Answer rating: 100% (QA)

SOLUTION a To compare prices of the beer in Italy and Greece we need to adjust for the exchange rate and the inflation differential between the two co... View the full answer