170 CHAPTER 4. UNDERSTANDING FORWARD EXCHANGE RATES FOR CURRENCY
(b) Check that if taxes are neutral, and the tax rate is 30%, also the after-tax
returns are equal. (Yes, thisistrivial.)
(c) How much of the income from swappedeuris legally interest income
and how much is capital gain or loss?
(d) If you do not have to pay taxes on capital gains and cannot deduct capital
losses, would you still be indifferent betweenusddeposits and swapped
eur?- 60-day interest rate (simple, p.a.) are 3% at home (usd) and 4% abroad (eur).
The spot rate is 1.250.
(a) Check that borrowing eur 1m (=current proceeds, not future debt),
hedged, costs as much as borrowingusd1.25m
(b) Check that if taxes are neutral, and the tax rate is 30%, also the after-tax
costs are equal. (Yes, thisistrivial.)
(c) How much of the costs of bowwowing swappedeuris legally interest paid
and how much is capital gain or loss?
(d) If you do not have to pay taxes on capital gains and cannot deduct capital
losses, would you still be indifferent betweenusdloans and swappedeur?- Groucho Marx, as Governor of Freedonia’s central bank, has problems. He
sees the value of his currency, thefdk, under constant attack from Rosor, a
wealthy mutual-fund manager. Apparently, Rosor believes that thefdkwill
soon devalue fromgbp1.000 to 0.950.
(a) Currently, bothgbpandfdkinterest rates are 6%p.a. By how much
should Groucho change the one-year interest rate so as to stabilize the
spot rate even if Rosor expects a spot rate of 0.950 in one year? Ignore
the risk premium—that is, take 0.950 to be the certainty equivalent.
(b) If the interest-rate hike also affects Rosor’s expectations about the future
spot rate, in which direction would this be? Taking into account also
this second-round effect, would Groucho have to increase the rate by
more than your first calculation, or by less?