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Find the 1-year forward exchange rate

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Reference no: EM131823469

The table below shows the information for exchange rates, interest rates and inflation rates in the US and Germany. Answer the following questions

Current spot rate:             $1.40/€

One-year forward rate:     $1.45/€

Interest rate in the US:      3%

Interest rate in Germany:  5%

Inflation rate in the US:     2%

Inflation rate in Germany: 4%

(b) Find the 1-year forward exchange rate in $ per € that satisfies IRP (interest rate parity) from the perspective of a customer that borrowed $1000 traded for € at the spot and invested in Germany.

(c)There is one profitable arbitrage at these prices. How to conduct the covered interest arbitrage if you can either borrow $1000 in the US or €1000 in Germany? What would be the profit?

(d)Explain how the IRP (interest rate parity) will be restored as a result of covered arbitrage activities.

(g) Is it the forecasted by IFE future spot rate (in (f) above) the same as the one forecasted by relative PPP (in (e) above) ? If yes, why so, if no, why not?

Reference no: EM131823469

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