Reference no: EM132006615

Suppose that on January 1, 2018 you have $8,000 which you wish to hold in an interest-bearing deposit for one year. One of your choices is to exchange $8,000 for euros at the current exchange rate of E_$/€ = 1.60 and hold the proceeds of that exchange as a euro deposit earning interest at an annual rate of R_€ = 0.01 (or 1%). Then on January 1, 2019 you plan to convert that euro deposit (principal plus interest) back into dollars at an expected exchange rate of E^e_$/€ = 1.64. 

a) Fill in the blanks in the following statements to compute the expected dollar rate of return on the euro deposit:

i) Conversion of $8,000 into euros on January 1, 2018 yields € ____________

ii) By January 1, 2019 the value of your deposit has increased to € _____­­­_____

iii) On January 1, 2019 the expected $ value of your deposit is $ ___________  

iv) The expected dollar rate of return on holding a euro deposit from January 1, 2018 to January 1, 2019, (stated in decimal form to 4 decimal places) is __________

b) In the space below show that the sum of the euro interest rate and the expected rate of appreciation of the euro in terms of the dollar is approximately equal to the value of expected dollar rate of return on the euro deposit which you calculated in answer to part iv) above.