University:
CFA Institute
Course:
CFA Level 2 - Economics
Academic year:

2023
Views:

10

Pages:

3
Author:

anon

CFA Level 2 - Economics Session 4 - Reading 19 Measuring Economic Activity-LOS l (Practice Questions, Sample Questions) LOS l: Calculate the expected change in the exchange rate, given interest rates and the assumption that uncovered interest rate parity holds. Michael Zotov, CFA, is the economist and portfolio manager of the Zotov Investment Fund based in Germany. Zotov believes that the Polish economy is due for a significant recovery as a result of governmental austerity programs enacted this year. Nominal interest rates and inflation have begun to trend lower. The current spot exchange rate is 4.6404 Polish Zioty per euro. Zotov believes that there is an opportunity to speculate on the Polish Zioty. Zotov wants to determine an expected exchange price one year from today. Assuming the one-year nominal interest rate for the European Economic Community is 11.76% and the Polish one-year nominal interest rate is 12.3%, what would be the expected exchange rate for the Polish Zioty one year from today? A) 4.6627 PZ/EUR. B) 4.6181 PZ/EUR. C) 4.5430 PZ/EUR. Explanation: (A) The formula for uncovered interest rate parity is: E (S1) / S0 = (1 + rFC) / (1 + rDC) or (E (S1) – S0) / S0 = %ΔS = [(1 + rFC) / (1 + rDC)] – 1 Where: E (S1) = expected spot rate in the period, quoted in FC per unit of DC S0 = spot rate today, quoted in FC per unit of DC rFC = interest rate in the FC rDC = interest rate in the DC %ΔS = percentage change in the spot rate By substituting: %ΔS = [(1 + 0.123) / (1 + 0.1176)] – 1 = [1.123 / 1.1176] – 1 = 0.0048 E (S1) = 4.6404 PZ/EUR × (1 + 0.0048) = 4.6627 PZ/EUR The Polish Zioty is expected to depreciate 0.48% against the euro over the next year. It will require more Polish Ziotys to convert into euro by next year. This is the case because of higher inflation expectations for Poland that are implied in its nominal interest rate. The Asian Spec Fund, managed by Jonathan Khamal, CFA, engages in currency speculation for its clients. Based in Paris, Khamal believes that there is an opportunity to speculate on the Malaysian Ringgit. The current spot exchange rate is 4.417 Malaysian Ringgit per euro. Khamal wants to determine an expected exchange price one year from today. Assuming the one-year nominal interest rate for the European Economic Community is 11.76% and the Malaysian oneyear nominal interest rate is 7.6%, what would be the expected exchange rate for the Malaysian Ringgit one year from today? A) 4.586 MR/EUR. B) 4.246 MR/EUR. C) 4.253 MR/EUR. Explanation: (C) The formula for uncovered interest rate parity is: E (S1) / S0 = (1 + rFC) / (1 + rDC) or (E (S1) – S0) / S0 = %ΔS = [(1 + rFC) / (1 + rDC)] – 1 where: E (S1) = expected spot rate in one period, quoted in FC per unit of DC S0 = spot rate today, quoted in FC per unit of DC rFC = interest rate on the FC rDC = interest rate on the DC %ΔS = percentage change in the spot rate By substituting: %ΔS = [(1 + 0.076) / (1 + 0.1176)] – 1 = [ 1.076 / 1.1176 ] – 1 = - 0.0372 E (S1) = 4.417 MR/EUR × (1 – 0.0372) = 4.253 MR/EUR The Malaysian Ringgit is expected to appreciate 3.72% against the euro over the next year. It will require less Malaysian Ringgits to convert into euro by next year. This is the case because of lower inflation expectations for Malaysia that are implied in its nominal interest rate.