Beth Miller does not believe that the international Fisher effect (1FE) holds. C
ID: 2720599 • Letter: B
Question
Beth Miller does not believe that the international Fisher effect (1FE) holds. Current one-year interest rates in Europe are 6 percent, while one-year interest rates in the U.S. are 4 percent. Beth converts dollar 100, 000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is dollar 1.30/euro. According to the IFE, what should the spot rate of the euro in one year be? If the spot rate of the euro in one year is dollar 1.35/euro, what is Beth's rate of return from her strategy ? If the spot rate of the euro in one year is dollar 1.25/euro, what is Beth's rate of return from her strategy?Explanation / Answer
Answer:a
ef=[(1+ik)/(1+if)]-1
=[(1.04)/(1.06)]-1
=-1.89%
If the IFE holds, the euro should depreciate by 1.89 percent in one year. This translates to a spot rate of $1.30 × (1 – 1.89%) = $1.275.
Answer:b
1. Convert dollars to euros: $100,000/$1.30 = €76,923.08
2. Invest euros for one year and receive €76,923.08× 1.06 = €81,538.46
3. Convert euros back to dollars and receive €81,538.46× $1.35 = $110,076.921
The percentage return is $110,076.921/$100,000 – 1 =10.08%
Answer:c
1. Convert dollars to euros: $100,000/$1.30 = €76,923.08
2. Invest euros for one year and receive €76,923.08× 1.06 = €81,538.46
3. Convert euros back to dollars and receive €81,538.46× $1.25 = $101923.075
The percentage return is $101923.075/$100,000 – 1 =1.923%
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