Chapter 27 Managing International Risks 727
bre44380_ch27_707-731.indd 727 09/30/15 12:10 PM
f. According to the expectations theory, what is the expected spot rate for yen in three
mont hs’ t i me?
g. According to purchasing power parity theory, what then is the expected difference in the
three-month rate of price inflation in the United States and Japan?
- Terminology Define each of the following theories in a sentence or simple equation:
a. Interest rate parity.
b. Expectations theory of forward rates.
c. Purchasing power parity.
d. International capital market equilibrium (relationship of real and nominal interest rates in
different countries).
- Purchasing power parity In March 1997, the exchange rate for the Indonesian rupiah was
R2,419 = $1. Inflation in the year to March 1998 was about 30% in Indonesia and 2% in the
United States.
a. If purchasing power parity held, what should have been the nominal exchange rate in
March 1998?
b. The actual exchange rate in March 1998 (in the middle of the Asian currency crisis) was
R8,325 = $1. What was the change in the real exchange rate?
- Interest rate parity The following table shows interest rates and exchange rates for the
U.S. dollar and the Lilliputian nano. The spot exchange rate is 15 nanos = $1. Complete the
missing entries:
1 Month 3 Months 1 YearDollar interest rate (annually compounded) 4.0 4.5?
Nano interest rate (annually compounded) 8.2? 9.8
Forward nanos per dollar?? 15.6
Forward discount on nano (% per year)? 4.8?- Currency hedging An importer in the United States is due to take delivery of clothing
from Mexico in six months. The price is fixed in Mexican pesos. Which of the following
transactions could eliminate the importer’s exchange risk?
a. Sell six-month call options on pesos.
b. Buy pesos forward.
c. Sell pesos forward.
d. Sell pesos in the currency futures market.
e. Borrow pesos; buy dollars at the spot exchange rate.
f. Sell pesos at the spot exchange rate; lend dollars.
- Currency hedging A U.S. company has committed to pay 10 million kronor to a Swedish
company in one year. What is the cost (in present value) of covering this liability by buying
kronor forward? The Swedish interest rate is .6%, and exchange rates are shown in Table 27.1.
Briefly explain. - Currency hedging A firm in the United States is due to receive payment of €1 million in
eight years’ time. It would like to protect itself against a decline in the value of the euro, but
finds it difficult to get forward cover for such a long period. Is there any other way in which
it can protect itself? - Currency risk Suppose that in 2023 one- and two-year interest rates are 5.2% in the United
States and 1.0% in Japan. The spot exchange rate is ¥120.22/$. Suppose that one year later
interest rates are 3% in both countries, while the value of the yen has appreciated to ¥115.00/$.