Suppose that the exchange rate adjusts so that interest-rate parity holds. Suppo

Question

Suppose that the exchange rate adjusts so that interest-rate parity holds. Suppose also that the interest rate on a one-year German bond is 7 percent and the interest rate on a one-year U.S. bond is 4 percent.

a) Suppose that you expect the exchange rate in one year to be 1.2 dollars per euro. What is the exchange rate today?

b) Suppose that relative purchasing-power parity holds and that the inflation rate in Germany in expected to be 2 percent over the next year. What is the expected inflation rate in the United States?

Explanation / Answer

interest rate on a one year German bond = 7%
interest rate on a one year U.S. Bond = 4%
future $/euro= 1.2

Exchange rate today be X
(1.04/1.07 )X = 1.2
X= 1.2346

exchange rate today= 1.2346 dollars pers euro

Inflation rate of us be X
1.2346x(1+x)/1.02 = 1.2
X= -.8585%

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.