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1. Suppose the current spot rate in New York is 0.0207 dollars per yen. Inflation for the coming year in the United States is expected to be 6%, while inflation for the coming year is Japan is expected to be only 3%. Using the purchasing power parity theory, what is the expected spot rate at the end of the year should be?
2. A bottle of French wine costs 45 euros in Paris. According to the purchasing power parity theory, what would the bottle sell for in New York if it costs the New York company $4 per bottle to transport the wine to the United States? Assume the exchange rate is $1.80 per euro.
3. The current spot exchange rate is $1.80/£ and the three-month forward rate is $1.75/£. Based on your analysis of the exchange rate, you are pretty confident that the spot exchange rate will be $1.78/£ in three months. Assume that you would like to buy or sell £3,000,000.
a) What actions do you need to take to speculate in the forward market? What is the expected dollar profit from speculation?
b) What would be your speculative profit in dollar terms if the spot exchange rate actually turns out to be $1.71/£.
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