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Foreign Exchange Markets
Imagine you are working for an Italian investment fund, so that Italy is the Euro area country of reference. Your boss gives you and your colleague 100,000€ to make a profitable investment. The current Turkish Lira/€ spot exchange rate is 14 Lira for one Euro. Six-month interest rates in the Euro area are at around 1%.
(A) Your colleague stubbornly insisted on investing the money in Turkey, so that you decide that your colleague goes ahead with her half (€50,000 each) and makes her investment. Six months later, the spot exchange rate is at 17 Lira/€. Calculate the percentage gain/loss from this investment.
(B) You made yourself familiar with the forward foreign exchange markets and see that the six-month forward rate is 15.5 Lira/€. Making use of the forward contract, would you invest in Turkey?
(C) What would the six-month forward exchange rate need to be such that investors are indifferent between investing in the Euro area or Turkey (i.e covered interest parity holds)?
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