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# Interest rate parity and Purchasing power parity

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1. Implication of IRP. Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the U.S. is 7%, while the one-year nominal interest rate in Australia is 11%. The spot rate of the Australian dollar is \$.60. You will need 10 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many U.S. dollars will you need in one year to fulfill your forward contract?

2. Implication of PPP. Today's spot rate of the Mexican peso is \$.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7%, while the Mexican inflation over this year is expected to be 3%. Wake Forest Co. plans to import from Mexico and will need 20 million Mexican pesos in one year. Determine the expected amount of dollars to be paid by the Wake Forest Co. for the pesos in one year.

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1. Implication of IRP. Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the U.S. is 7%, while the one-year nominal interest rate in Australia is 11%. The spot rate of the Australian dollar is \$.60. You will need 10 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many U.S. dollars will you need in one year to fulfill your forward contract?

Interest rate Parity condition says that the currency of a country that has a higher ...

#### Solution Summary

Calculates forward rate using Interest rate parity and Purchasing power parity conditions.

\$2.19
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## Interest rate parity/purchasing power parity

Does interest rate parity imply that interest rates are the same in all countries? Why might purchasing power parity fail to hold?

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