Financial Market Homework

Short questions:

1.-Suppose the rate of inflation in Mexico will run about 3 percent higher than the U.S. inflation rate over the next several years. All other things being the same, what will happen to the Mexican peso versus dollar exchange rate? What relationship are you relying on in answering?

2.- If you are an exporter who must make payments in foreign currency three months after receiving each shipment and you predict that the domestic currency will appreciate over this period, is there any value in hedging your currency exposure?

3.- The same television set costs $500 in the United States, €450 in France, £300 in the United Kingdom, and ¥100,000 in Japan. If the law of one price holds, what are the euro-dollar, pound-dollar, and yen-dollar exchange rates? Why might the law of one price fail?

4.- Can purchasing power parity help predict short-term movements in exchange rates?

5.- During the 1990s, the U.S. Secretary of the Treasury often stated, “a strong dollar is in the interest of the United States.”

Is this statement true? Explain your answer.

Problems:

a.- Suppose the spot exchange rate for the Hungarian forint is HUF 150. The inflation rate in the United States is 2.8 percent per year and is 3.5 percent in Hungary. What do you predict the exchange rate will be in one year? In two years? In five years? What relationship are you using?

b.- You observe that the inflation rate in the United States is 1.8 percent per year and that T-bills currently yield 2.3 percent annually. What do you estimate the inflation rate to be in:

Australia if short-term Australian government securities yield 4 percent per year?

Canada if short-term Canadian government securities yield 6 percent per year?

Taiwan if short-term Taiwanese government securities yield 9 percent per year?

c.- Tomolomo International has operations in Spain. The balance sheet for this division shows assets of 50,000 euros, debt in the amount of 30,000 euros, and equity of 20,000 euros.

1-If the current exchange ratio is 1.20 euros per dollar, what does the balance sheet look like in dollars?

2-Assume that one year from now the balance sheet in Tomolomo is exactly the same as at the beginning of the year. If the exchange rate is 1.30 euros per dollar, what does the balance sheet look like in dollars now?

3-Rework part (2) assuming the exchange rate is 1.12 euros per dollar.

d.- You observe that the inflation rate in the United States is 2 percent per year and that T-bills currently yield 2.4 percent annually. What do you estimate the inflation rate to be in:

Brazil if short-term Brazilian government securities yield 8 percent per year?

Kenia if short-term Canadian government securities yield 10 percent per year?

Andorra if short-term Andorra´s government securities yield 3 percent per year?

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