Interest parity
1. Suppose the dollar interest rate is 5% and the pound sterling interest rate is 10%, per
annum. Suppose the expected exchange rate one year from now is $1.52 per pound.
According to the UIP, what should be the current interest rate?
2. Assume that a traded can borrow 1 million PLN. The current exchange rate is 3.65
PLN per USD, and the 6 month forward is 3.7650 PLN per USD. The interest rate is 5%
per annum for PLN and 3,5% per annum for USD. How much can this trader earn?
Does the covered interest parity hold? What will happen to current exchange rate?
3. Assume that the interest rate parity holds; use relevant graphs to explain, how will
the following changes affect the current exchange rate:
a. An increase of the foreign interest rate
b. A change to the expected exchange rate – the foreign currency is expected to
depreciate by more than previously expected
c. An increase in home interest rate
4. Assume that the current exchange rate is 1,67$ per pound. The interest rate on USD
deposits is 4% and on pound deposits is 8%, per annum. If covered interest parity
holds, what is the one year USD per pound forward?
5. Calculate the USD rate of return on the following assets.
a. A Polish bond pays 10% and in the same time the zloty depreciates with
respect to the USD by 8%
b. A 10 000 USD deposit exchanged to pounds, when the pound interest rate is
10% and the exchange rate changes from $ 1.50 per pound to $ 1.38 per
pound.