1. a. Suppose the interest parity condition holds and that the domestic interest rate is greater than the foreign interest rate. What does this imply about the current versus future expected exchange rate? Explain.
b. Suppose the one-year nominal interest rate is 2.0% in the United States and 5.0% in Canada. Should you hold Canadian bonds or U.S. bonds? Explain.
c. Suppose the CFO of a German corporation with surplus cash flow has 1 million Euros to invest. Suppose that interest rates on 1-year CD deposits in US banks are 2%, while rates on 1year CD deposits denominated in euros in German banks are currently 4.5%. Suppose further that the CFO expects that the (euro/$) exchange rate will increase from 1euro per $ to 1.1 euros per $ during the coming year. Should the CFO invest in CD's denominated in dollars or in euros? Show your work of estimation to substantiate your response as credible!
d. Suppose the CFO of an American corporation with surplus cash flow had $100 million to invest last July 15 and the corporation did not believe it would need to utilize these funds to retool or expand production capacity for 1 year. Suppose further that the interest rate on 1 year CD deposits in US banks was .5%, while the rate on 1 year CD deposits in England (denominated in British Pounds) was 2% at the time. Suppose further that the exchange rate at that time was $1.68 per British pound.
1.d.1. Suppose that now a year later the exchange rate is $1.55 per US pound. What rate of return did the CFO earn on the investment in the British CD? (Note: a specific numeric answer is required for full credit.)
1.d.2. What must the CFO have expected about the value of the British pound in $ today to believe that investment in British CD's was more profitable than investment in US CD's last July?