BPt = b0 + b1 INFt-1 + b2 INCt +ut Regression Coefficients Estimates b0 0.002 b1

Question

BPt = b0 + b1 INFt-1 + b2 INCt +ut
Regression Coefficients   Estimates
b0    0.002
b1    0.8
b2    1.0
Inflation in the last period, INFt-1, is 4%.
The income change in current period, INCt, can be estimated from the following:
Probability   Possible changes
   In INCt
20%   1.5%
50%   2%
30%   2.2%

1. What is the expected income differential (INCt)?

2. What is the expected change in BP in period t?

Annual interest rate for 5 years
U.S.   10%   
U.K.   13%
Spot rate of BP is $1.50

1. What is the forward premium (discount) if the 5-year forward rate is used as a forecast?

2. What is the expected change in BP in 5 years?

3. What is the future spot rate of BP in 5 years?

Explanation / Answer

1. expected income differential= 1.5%*.20+2%*.50+2.2%*.30=1.96%

2. Expected change in BP = .002+0.8*4%+1.0*1.96%=5.162

1. discount= 1.50-(1.50*{1.10}5/{1.13}5)=.19

2.expected change in BP=1.31-1.50=.019

3. Future spot rate= (1.50*{1.10}5/{1.13}5)=1.31

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.