ECF2721 Economics|Exchange Rate Risk Free Profits

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ECF2721 Economics

Go to the Federal Reserve Economic Data (FRED) at the U.S. Federal Reserve Bank – St. Louis and get the daily exchange rates (https://fred.stlouisfed.org/categories/94) for the U.S. dollar against the Australian dollar, the U.K. British pound, and the New Zealand dollar, and answer the following questions. Note that the exchange rates are quoted based on American terms for the U.S. 1. On 20 January 1971, what was the exchange rate between Australian dollar and the U.K. pound, EAU$/£? (round to 3 decimal places) [2 marks] 2. The 6-month interest rate in Australia was 2.50% on 20 January 1971. If everybody knew the actual exchange rate of EAU$/£ on 20 July 1971 as of 20 January 1971, what should be the 6-month interest rate in the U.K. according to the uncovered interest parity? [3 marks] 3. On 4 January 2016, what was the exchange rate between Australian dollar and the New Zealand dollar, EAU$/NZ$? (round to 3 decimal places) [2 marks] 4. On 4 January 2016, the 1- year interest rate in Australia was 2.00%, and the 1-year interest rate in New Zealand was 2.50%. According to the uncovered interest parity, what was the expected exchange rate for 4 January 2017 between the Australian dollar and the New Zealand dollar, EeAU$/NZ$ as of 4 January 2016? (use the exact UIP equation and round to 3 decimal places) [2 marks] 5. (i) Assume that today is 6 October 2016. Today, you observe that the exchange rate between AU$ and the US$ is 1.319, EAU$/US$=1.319, the 90-day interest rate in Australia is 0.50%, the 90-day interest rate in the US is 0.22%, and the 90-day forward rate is 1.376, FAU$/US$=1.376. Note that the covered interest parity does not hold here. Explain how you can make risk free profits using spot and forward markets in 90 days, on 4 January 2017, if you can either borrow AU$1.319 million Australian dollars or borrow US$1 million dollars with the interest rates above today. The answer should have the exact amount of profits in Australian dollars. Do not forget to pay the principal and interests on 4 January 2017. [7 marks]

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