Financial Markets & Institutions Interest Rate & FX Homework Exercise

Financial Markets & Institutions

Interest Rate & FX Homework Exercise

Homework Exercise 6

1. If the current interest rate on 1 year T-notes is 0.194% and the projected inflation rate is 1.6%, what is the anticipated Real Interest Rate?

1. If the current interest rate on the 2 year Treasury Note is 0.28% and the rate on the 3 year T-Note is 0.36%, what is the implied 1 year rate going to be two years from now?

1. Currently 5 year T-notes provide a yield to maturity of 1.74% per year. At the same time, TIPS (Treasury Inflation Protected Securities) with a 5 year maturity provide a yield (before inflation) of -0.50% per year. What is the implied annual inflation rate over the next 5 years?

1. You will be receiving payment of NP 1 million from a client in Mexico one year from now. The current spot rate for the Peso is 1 NP = US$ 0.077. The current price of Peso futures is 1NP = US$ 0.075. Your expectation of the peso spot rate one year from now is:

Possible Outcome for

The question is whether you should buy the Peso forward, to lock in the existing rate, or wait until the funds are received and then exchange them for dollars.

1. What would be your gain or loss from purchasing Pesos in the forward market under each of the 3 scenarios?

1. Given your estimated probabilities for each scenario, what would be your average gain or loss?

5. Assume the following information:

¨ British pound spot rate = $1.71

¨ British pound one-year forward rate = $1.69

¨ British one-year interest rate = 8%

¨ U.S. one-year interest rate = 5%

1. Explain how U.S. investors could use covered interest arbitrage to lock in a higher yield than 5%. What would be their net gain (per Dollar) from doing so?

1. If a large number of investors undertook this transaction, explain how the spot and forward rates of the pound would change as covered interest arbitrage occurs.

Financial Markets & Institutions

Interest Rate & FX Homework Exercise

Homework Exercise 6

1. If the current interest rate on 1 year T-notes is 0.194% and the projected inflation rate is 1.6%, what is the anticipated Real Interest Rate?

1. If the current interest rate on the 2 year Treasury Note is 0.28% and the rate on the 3 year T-Note is 0.36%, what is the implied 1 year rate going to be two years from now?

1. Currently 5 year T-notes provide a yield to maturity of 1.74% per year. At the same time, TIPS (Treasury Inflation Protected Securities) with a 5 year maturity provide a yield (before inflation) of -0.50% per year. What is the implied annual inflation rate over the next 5 years?

1. You will be receiving payment of NP 1 million from a client in Mexico one year from now. The current spot rate for the Peso is 1 NP = US$ 0.077. The current price of Peso futures is 1NP = US$ 0.075. Your expectation of the peso spot rate one year from now is:

Possible Outcome for

The question is whether you should buy the Peso forward, to lock in the existing rate, or wait until the funds are received and then exchange them for dollars.

1. What would be your gain or loss from purchasing Pesos in the forward market under each of the 3 scenarios?

1. Given your estimated probabilities for each scenario, what would be your average gain or loss?

5. Assume the following information:

¨ British pound spot rate = $1.71

¨ British pound one-year forward rate = $1.69

¨ British one-year interest rate = 8%

¨ U.S. one-year interest rate = 5%

1. Explain how U.S. investors could use covered interest arbitrage to lock in a higher yield than 5%. What would be their net gain (per Dollar) from doing so?

1. If a large number of investors undertook this transaction, explain how the spot and forward rates of the pound would change as covered interest arbitrage occurs.