11. The Foreign Exchange Market

1. If the spot exchange rate is $1.80/£1 and the 12 month forward exchange rate is $1.75/£1. Then the pound is at a forward:

premium and the one year UK interest rate is lower than the one year US interest rate. premium and the one year UK interest rate is higher than the one year US interest rate. discount and the one year UK interest rate is lower than the one year US interest rate. discount and the one year UK interest rate is higher than the one year US interest rate.

2. The spot exchange rate between sterling and the dollar is $1.80/£1 and the spot exchange rate between the dollar and the Euro is $1.20/€1 the appropriate cross rate is.

£1.50/€1 €1.50/£1 €0.666/£1 €2.16/£1

3. A speculator observes that the dollar-Euro 12 month forward exchange rate is $1.20/€1 and expects the spot dollar-Euro exchange rate to be $1.30/€1 in a year’s time. The speculator buys or sells $1 million forward today. Assume that the speculator is proved correct and the spot exchange rate is $1.30/€1 in a year’s time. Then the speculator will have:

sold dollars forward and made a profit of $83,333 sold dollars forward and made a profit of €83,333 bought dollars forward and made a profit of $83,333 bought dollars forward and made a profit of €83,333

4. The dollar-pound rate is initially $1.80/£1 and moves to $1.98/£1 two year’s later. Over the same period the UK price index rises from 100 to 105, while the US price index moves from 100 to 110. Which of the following statement is true concerning the real exchange rate of the pound against the dollar?

It will have appreciated to 105 It will have depreciated to 105 It will have appreciated to 110 It will have depreciated to 110

5. The UK does 25% of its trade with the US and 75% of its trade with Europe. The nominal exchange rate index of the pound against the dollar has moved from 100 to 130, while the nominal exchange rate of the pound against the Euro has moved from 100 to 85. Assuming the initial nominal effective exchange rate of the pound was 100 then the nominal effective exchange rate of the pound will have:

appreciated to 96.25 depreciated to 96.25 appreciated to 106.25 depreciated to 106.25

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