International Finance: Problem Sets

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International Finance
Problem Set #4

1. A. Fundamental-based Forecasting: Analyzing the future on the basis of fundamental relationships between economic variables and exchange rate. Fixed exchange rates:
The forecasting is based on indicators of sustainability such as current account deficits or surpluses, relative inflation rates and black market exchange rates. Floating exchange rates:
The forecasting is based on factors that could influence macro economy such as monetary policies and exchange rate policies. B. Technical Analysis: Forecast future exchange rate by finding behavioral patterns or correlations in financial variables. It will consider factors including trading volume and interest differentials. C. Purchasing Power Parity: Forecasting future exchange rates by estimating the amount of adjustment needed on the exchange rate between countries. It focus on finding the natural level of exchange rate between countries by considering other factors such as inflation.

2. 1) 88 yen/$ * (1-0.02)^10 = 71.90 yen/$
2) 71.90*(1-0.225) = 55.72 yen/$

3. 1.10^(-1)/0.99^(-1) * (1+0.0117/360*90) – 1
= 0.9*(1.002925) – 1
= -9.73%

4. 1) R=dividend yield + local currency cap. Gain + exchange-rate cap. Gain

=3%+6%+1=10% The expected uncovered return is 10%

2)SD(Rc) =√ (0.2^2 + 0.07^2 +2*0.2*0.07*0.2) = √ (0.04+0.0049+0.0028)
= 21.84%

3) Can over by buying currency forward to eliminate exchange rate risk. The standard deviation would be 20%. Expected return = 0.03 + 0.06 + 0.005 – 0.02 = 7.5%

5. 1) Expected return = 2% + 1% = 3%
2) Expected return = 2% + 0.5% - 2% = 0.5%
3) Risk for unhedged: SD = 7%
Risk for hedged: SD = 0
4) U.S money market investment expected return = I = 0.5% So it is the same rate to make the covered Canadian money market investment.

6. i) The beta is 1.139077285
ii) Adding some of the international funds...
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