Irish Lottery and Exchange Rates
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Congratulations, you just won the Irish Lottery! You bought a ticket while you were on vacation in Ireland, and your winnings amount to 1 million euros after all taxes were taken out.
1. If the current exchange rate is US$1 equals â?¬ .70, how much did you win in US dollars?
2. Suppose that the interest rate in Irish banks is 2% for a one year CD. In the USA, the rate is 4% for a one year CD. If you left your winnings in Ireland, how many euros would you have in a year? If you had taken your winnings back to the USA, how many dollars would you have?
3. Suppose when you cashed in your CD in Ireland a year from now, the exchange rate had changed from US$1 to .70 euros to US$1 to .65 euros. How much would your Irish bank account be worth in US dollars at that point? Would you have been better off leaving your winnings in Ireland or bringing them home to the USA?
4. Explain how banks and individuals can use 'covered interest arbitrage' to protect themselves when they make international financial investments.
5. Using the theory of purchasing power parity, explain how inflation impacts exchange rates. Based on the theory of purchasing power parity, what can we infer about the difference in inflation between Ireland and the USA during the year your lottery winnings were invested?
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Solution Summary
The aim of the paper is to discuss the exchange rate between two currencies of different countries and their impact on each others due to sudden and uncertain changes in the countries. In the paper, the discussion will took place on exchange rates and taxes on Euro and Dollar. This paper will provide detail information and issues related to the currency exchange rate risk. This response addresses the queries posted in 609 words with references.
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The response addresses the queries posted in 609 words with references.
//The aim of the paper is to discuss the exchange rate between two currencies of different countries and their impact on each others due to sudden and uncertain changes in the countries. In the paper, the discussion will took place on exchange rates and taxes on Euro and Dollar. This paper will provide detail information and issues related to the currency exchange rate risk//
Irish Lottery
1. Current Exchange Rate:
US $1 equals to £0.70
$1= £0.70
Divide both sides by 0.70
$1/ 0.70 = £0.70/0.70
$1.42 = £1
To convert 1 million into US Dollars, multiply
£1,000,000*1.42$/£ = $1,420,000
2. Interest Rate- 2% for 1year CD (Irish Banks)
Principle + Interest
= 1,000,000+ 0.02* 1,000,000
= £1,020,000
In U.S.A. 4% for 1 year CD
Assuming the same exchange rate:
=$1,420,000+0.04*1,420,000
=$1,476,800
According to calculation based on the exchange rate, the ...
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