#### Covers Chapters 7 and 8 – Homework Assignments General Instructions

Chapter 7:

To recognize the relationship between interest rates and the forward (or futures) discount or premium, review here your responses in Chapters 3 and 5. In order to determine if Interest Rate Parity (IRP) exists between the U.S. and Japan NOW, you will need to compare the current size of the forward-spot differential, to the size of the current interest rate differential between the U.S. and Japan, as shown in the examples we covered in the Chapter 7 lecture video.

**Question 1** – Use the IRP equation to compare the two differentials mentioned above (that is, show the IRP equation using your data and explain what your results mean). According to interest rate parity, a foreign currency with a higher interest rate should have a discount in its futures price. Does that relationship exist here?

**Question 2** – If not, do you think that the size of the discrepancy allows for Covered Interest Arbitrage (CIA), or is it due to transactions costs and data limitations? Make a choice and Explain your rationale.

Chapter 8:

Go to www.tradingeconomics.com/ to assess recent changes in the Japanese inflation rate (include a graph of current trends from this site if you like). Compare the current level of inflation in the Japan to that of the U.S. In order to determine if Purchasing Power Parity (PPP) exists between the U.S. and Japan NOW, you will need to compare the current size of the forward-spot differential, to the size of the current inflation rate differential between the U.S. and Japan.

**Question 3** – Use the PPP equation to compare the two differentials mentioned above (that is, show the PPP equation using your data and explain what your results mean). According to purchasing power parity, a foreign currency with a higher inflation rate should have a discount in its futures price. Does that relationship exist here?

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