I’m beginning to get very frustrated with the quality of Schweser’s questions - they are very uneven, difficult to understand, at times too easy and another times, simply don’t make any sense. I’m also beginning to suspect their answers are wrong, please see below: U.S. Dollar ($) per British pound (₤): 0.5100 Current 1-year interest rates: United States 4.50% Great Britain 6.25% Expected one-year inflation rates: United States 2.25% Great Britain 5.00% Santana wants to quantify the additional exchange rate risk associated with the purchase of the British securities. Calculate the expected exchange rate change at the end of one year. A) 0.4960. B) 0.5215. C) 0.5240. If real rates remain constant, the change in the exchange rate is equal to the inflation differential. The current difference between the two countries rates is 2.75% (5.00% − 2.25%), so the expected depreciation of the pound is 2.75%. The expected exchange rate is calculated as: $0.5100/₤ × (1 − 0.0275) = $0.4960/₤ DOESN’T GOING FROM 51 CENTS/POUND TO 49.6 CENTS TO A POUND MAKES THE POUND STRONGER???
Ans is 0.495975 $/Pound And pound weakens
no, it means the pound is getting weaker. you used to have to put up 51 cents to get a pound. now you only have to put up 49.6 cents to get a pound. so the dollar is appreciating, pound is depreciating here.
I see, you are absolutely right - I can’t get the currency bias out of my head where i am very familiar with the currency relationships (never has the dollar/pound between 1:2 - its always the other way around). It is very frustrating how they don’t use the general currency relationships.
PPP relation .51* 1.0275= .5240 IRP relation .5240*1.065/1.045= .5341 whats going on here?? what was right answer?
since they have given us both inflation and interest rate changes how do we know which one to use in this case?
I forgot this guys rdc - rfc = E(I)dc - E(I)fc from International Fisher Relation right?
What’s the Question ID? I can’t read the answer…
Help us, somebody!
&8722; is the MINUS sign &8356; is the POUND sign.
“quantify the additional exchange rate risk associated with the purchase of the British securities. Calculate the expected exchange rate change at the end of one year” i think they’re asking (maybe not in the most clear manner), aside from the exchange rates that are posted there, give us the *additional* risk, which is where inflation comes into play. they say “expected” exchange rate, so you i think with that use the approximation method. GB has 5% - US 2.25% = 2.75% is the differential. they just took 1 - 0.0275 x .51 = .495975 i guess if you did the exact method you’d get almost the same, 1.0225/1.05 x .51 = .496643 even if you didn’t calc a thing, inflation in GB is higher than the US, so you’d think the pound should depreciate vs the $$ and that only leads to one answer. now, is it a crappily worded question and/or by giving interest rates for both countries is it distracting? yes. and yes. but i think in a badly phrased q maybe, they were trying to get at the simple concept that inflation differentials should account for exchange rate movement. which parity equaition is that again? i always forget which is which. PPP?
rel. ppp reiterate rel ppp => Expected exchange rate movements & Inflation Intl Fisher ==> Inflation rate differential and interest rate differential IRP --> forward discount/premium and interest rate differential Uncovered IRP --> Expected exchange rate movements and interest rate differential Foreign exchange expectations -> Expected exchange rate movements and forward discount/premium
inflation and interest rate diffrential is fisher. R -PPP =exchange rate exp movement + inflation