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FIN4375 Finance|Interest Rates

The following pages contain annual data on interest rates, inflation rates, and percentage change
in exchange rates (based on indirect quotes) for foreign countries, including the US, for the
period 1995 – 2007.
Each one of you is assigned to a foreign country and a six-year time period (1995-2000
or 2001-2006). Please consult the attached list to determine your assigned country and
time period.
Please use the attached sheets to answer the questions listed based on calculations using the data
for the assigned country and the US during the assigned time period.
Use geometric instead of arithmetic averages.
Use exact instead of the approximate method.
There is only one correct answer to these questions. You will be graded on whether or not
your answers are correct.
The necessary information and concepts are all from Chapter 4. I will discuss the solution
techniques to these problems only during class. I will not discuss them with anyone on an
individual basis outside the class.
Please answer the following five questions:
Q1. During the assigned time period:
US dollar appreciated / depreciated (choose one) in real terms against the currency of foreign
country.
Q2. During the assigned period, what was the average uncovered rate of return from the US
viewpoint for the foreign country?
Q3. During the assigned period, what was the average uncovered rate of return from the foreign
country’s viewpoint?
Q4. Based on your answers to questions 2 and 3, given perfect hindsight about interest rates and
exchange rate changes during the assigned time period you should have:
Invested/ borrowed (choose one) in the US and invested / borrowed (choose one) in foreign
country.
Q5. Assume that you could both borrow and invest at the average interest rates prevailing in
foreign country and in the US during the assigned time period. Also assume that you have a line
of credit for one million dollars in the US or an equivalent amount in foreign country. Given
perfect hindsight about interest rates and exchange rate changes, please calculate your total
profit in dollars using uncovered interest arbitrage during the assigned time period if you
followed the strategy chosen in
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