Condition of covered interest parity, Business Economics

(a) Suppose that the British Pound is quoted at $1.4419-36 and the Swiss Franc is quoted at $0.6250-67. What is the direct quote for the British Pound in Zurich? Note that a direct quote is the home currency price of a foreign currency and that it must include both the bid and ask cross rates of the British Pound.                             

(b) The covered interest parity condition states that the rates of return on dollar deposits and "covered" foreign deposits must be the same. Let F$/€ be the one year forward price of euros in terms of dollars, R$ be the dollar interest rate, Rbe the euro interest rate, and that the current euro-dollar exchange rate is denoted by E$/€.


a. Show the covered return on euro deposit and the condition of covered interest parity (CIP). How does the CIP condition change in the presence of transaction costs?

b. Assume that the current euro-dollar exchange rate (E$/€) is $1.05 per euro and the one-year forward price of euro in terms of dollars (F$/€) is $1.113. Further suppose that the dollar interest rate (R$) is 10 percent and the euro interest rate (R) is 5 percent. Assess if the covered interest parity holds in this case?

c. The interest rate in the US is 10% per annum; in Japan, the comparable rate is 7%. The spot rate for the yen is $0.003800. If the covered interest parity holds, what is the 90-day forward rate in the presence of a 0.25% transaction costs?

Posted Date: 2/21/2013 2:06:02 AM | Location : United States

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