5. Interest rate parity Aa Aa The rise of globalization is due to the many compa

Question

5. Interest rate parity Aa Aa The rise of globalization is due to the many companies that have become multinational corporations for various reasons-for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence exposes companies to different kinds of risk as well-for example, political risk and exchange rate risk. Several factors affect the exchange rate of a currency with another currency. Which of the following statements are true about the factors that have an impact on exchange rates? Check all that apply When a government limits imports and restricts foreign exchange transactions, its currency's value tends to increase relative to other currencies. If a govemment intends to prevent its currency's value from falling relative to other currencies, it will purchase its currency from sellers in the market If the demand for a currency increases, the currency's value will increase relative to other amendes. An increase in inflation tends to increase the arrency's value with respect to other currendes with lower inflation. The relationship between interest rates and exchange rates can be represented through the concept of interest rate parity. Consider the following: An American investor is considering investing $1,000 in default-free 90-day Japanese bonds that promise a 4% annual nominal return. " The spot exchange rate is ¥102.19 per dollar The 90-day forward exchange rate is ¥100.66 per dollar.

Explanation / Answer

TRUE When a government limits imports and restricts foreign exchange transactions, its currency's value tends to increase relative to other currencies

TRUE If a government intends to prevent its currency’s values from falling relative to other currencies, it will purchase its currency from sellers in the market.

TRUE If the demand for a currency increases, the currency’s value will increase relative to other currencies

FALSE An increase in inflation tends to decrease the currency’s value with respect to other currencies with lower inflation

Answer 2

FALSE An investment in one’s home country should have the different return as a similar investment in a foreign country.

FALSE A product bought in one country should have the different price in other countries, adjusted for exchange rate.

FALSE : since many others factors also affect interest rate.

TRUE If two countries have the same inflation rate, they should have the same interest rate too.

Interest Rate Japan Bonds 4% Perid 90 days Interest rate 0.01 Spot Exchange Rate 102.19 90 days forward exchange rate 100.66 100.66=102.19*(1+0.01)^1

Answer 2

Spot rate 102.19 Purchase Yen 102190 Interest 0.04 90 Days Interest rate 0.04*(90/360) 0.01 Interst 102190*0.01 1021.9 Total Amount 103211.9 Sell yen & Purchase $ Forward rate 100.66 $ after conversion 1025.352 Return=(1025.352-1000)/1000 0.025352 Annualized return 0.025352*(360/90) 0.101408 10.14%

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