2. Assume that you are able to borrow $1,000,000 from a local bank. Explain how you could make profits from arbitrage in the following situations. Explain also the amount of profits that you would make, assuming that there are no brokerage or transactions costs.
a. The current dollar-Euro exchange rate (E$/â¬) is equal to 1.1 in Frankfurt and 1.05 in New York.
b. The dollar-Euro exchange rate (E$/â¬) = 1.1, the dollar-pound exchange rate (E$/£)= 1.5, and the pound-Euro rate (E£/⬠)= .8.
c. The nominal interest rate equals 3% in the U.S. and 1% in Europe, the current dollar-Euro exchange rate (E$/â¬) is equal to 1, the forward exchange rate (F$/â¬) is equal to 1.02 and your expected exchange rate one year from now (Ee$/â¬) equals 1.05.
3. Use the information below to answer question 3.
L M Y
U.S 0.1 2,000 10,000
U.K 0.04 500 5,000
a. Calculate the price levels in both the U.S. and the U.K. according to the quantity theory of money.
b. Calculate the nominal exchange rate (dollars per pound) assuming the quantity theory of money and absolute PPP.
c. Assume that output rises in the U.S. to 11,000. Calculate the new nominal exchange rate.
d. Assume that output in the U.S. is 10,000 but that the money supply rises to 2,200 in the U.S. and to 600 in the U.K. Calculate the new nominal exchange rate.
e. Assume values at the beginning of the problem but assumethat L in the U.K. rises to .06. Calculate the new nominal exchange rate.
2. Assume that you are able to borrow $1,000,000 from a local bank. Explain how you could make profits from arbitrage in the following situations. Explain also the amount of profits that you would make, assuming that there are no brokerage or transactions costs.
a. The current dollar-Euro exchange rate (E$/â¬) is equal to 1.1 in Frankfurt and 1.05 in New York.
b. The dollar-Euro exchange rate (E$/â¬) = 1.1, the dollar-pound exchange rate (E$/£)= 1.5, and the pound-Euro rate (E£/⬠)= .8.
c. The nominal interest rate equals 3% in the U.S. and 1% in Europe, the current dollar-Euro exchange rate (E$/â¬) is equal to 1, the forward exchange rate (F$/â¬) is equal to 1.02 and your expected exchange rate one year from now (Ee$/â¬) equals 1.05.
3. Use the information below to answer question 3.
L M Y
U.S 0.1 2,000 10,000
U.K 0.04 500 5,000
a. Calculate the price levels in both the U.S. and the U.K. according to the quantity theory of money.
b. Calculate the nominal exchange rate (dollars per pound) assuming the quantity theory of money and absolute PPP.
c. Assume that output rises in the U.S. to 11,000. Calculate the new nominal exchange rate.
d. Assume that output in the U.S. is 10,000 but that the money supply rises to 2,200 in the U.S. and to 600 in the U.K. Calculate the new nominal exchange rate.
e. Assume values at the beginning of the problem but assumethat L in the U.K. rises to .06. Calculate the new nominal exchange rate.
