Questions (11) and (12) refer to the following situation The current spot rate b

Question

Questions (11) and (12) refer to the following situation The current spot rate between the U.S. and Mexico is Epes 15.6 and the one-year is Fpea -162. Mexican treasury bonds are currently paying S500 in Mexican treasury bonds and sign a forward contract to reconvert your earnings forward rate 56% interest. Assume you 11) What is your expected S return at the end of the year? a) $679.48 b) $548.31 c $672.83 15.6 C5oo 500) d) $508.44 )$2,696.29 12) Assume that over the course of the year, the peso depreciates versus the S. How does this affect your answer to (11)? a) the expected S return increases b) the expected S return decreases c) the expected $ return stays the same 13) Assume that a U.S. citizen exchanges dollars for peso at a U.S. bank. This transaction would lead to a) a U.S. current account surplus and financial account deficit b) a U.S. current account deficit and financial account surplus c) a U.S. financial account surplus with no overall change in the current account d) a U..S. financial account deficit with no overall change in the current account e) no overall change in either the U.S. current or financial account 14) Suppose you observe a spot exchange rate of S20E If expected inflation rates are 2% in the US, and 5% in the UK, what is the prevailing 1-year forward rate? a) £2.0588/ b) $2.0588/E c) £1.9429/S 1.9429/E 2os 15) Suppose the US $ depreciates against the Japanese yen. Who will be made better off as a result of this depreciation? a) US citizens who are traveling in Japan b) US citizens who are buying Japanese products c) US citizens who are debtors and owe interest on their loans in yen S citizens who are investing in Japan and get paid dividends in yen e No one, everyone in the US will lose if the S depreciates

Explanation / Answer

Question 11

Amount invested in dollars = $500

Mexican treasury bonds are to be purchased. So, these $500 have to be converted in Mexican peso at current exchange rate.

Current exchange rate is $1 is equal to 15.6 Mexican pesos.

So,

$500 = 500 * 15.6 = 7,800 Mexican Pesos

Thus, 7,800 Mexican Pesos are invested.

Interest rate = 5.6% or 0.056

Interest earned = 7,800 * 0.056 = 436.80 Mexican Pesos

Total amount earned after one year = 7,800 + 436.80 = 8,236.80 Mexican Pesos

One-year forward rate is $1 equals 16.2 Mexican Pesos.

Expected $ return = 8,236.80/16.2 = $508.44

So, the expected $ return at the end of the year is $508.44

Hence, the correct answer is the option (d).

Question 12

When domestic currency depreciates against foriegn currency then returns in terns of foriegn currency decreases.

On the other hand, when domestic currency appreciates against foriegn currency, returns in terms of foriegn currency increases.

The peso has depreciated against the dollar.

So, the expected $ return will decrease.

Hence, the correct answer is the option (b).

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