# RESP 1107- Suppose a basket of goods costs 210,000 Mexican pesos in Mexico

1. Suppose a basket of goods costs 210,000 Mexican pesos in Mexico, while the same basket costs $16,800 in Australia. The nominal exchange rate is currently at E$/Peso = 0.10. Assume that the prices in two countries do not change at all over time (the inflation rates in two countries are always zero). Assume that the uncovered interest parity (UIP) holds.(A) Calculate the real exchange rate, q$/Peso.Hint: Use the real exchange rate definition.(B) Underthepurchasingpowerparity(PPP),whatwillbethenominalexchangerateinthelongrun? Hint: Use the real exchange rate definition and apply the PPP.(C) IstheAustraliandollarunderorovervaluedagainstMexicanpesosatthemoment?Hint: Check the definition of the under/over valuation of a currency.(D) The nominal exchange rate in 1 year is expected to become Ee$/Peso = 0.097. Using the definition of the real exchange rate with zero inflation rates in two countries, calculate the expected real exchange rate in 1 year, qe$/Peso.Hint: Check the definition of the real exchange rate in growth rates and apply the inflation rates given.(E) The exchange rate in 1 year is expected to be 0.097, Ee$/Peso = 0.097 as in (D), the current 1- year interest rate in Australia is 2%, and the 1-year forward rate is F$/Peso = 0.10. If you can borrow $1 million from a bank in Australia or 10 million pesos from a bank in Mexico, explain how you can make money without any exchange rate risks. The answer should have the specific amount of profits in Australian dollars in 1 year.Hint: Check the UIP equation and find the interest rate in Mexico. Then, apply the way to makemoney when the CIP does not holdCompanies often buy bonds to meet a future liability or cash outlay. Such an investment is called a dedicated portfolio since the proceeds of the portfolio are dedicated to the future liability. In such a case, the portfolio is subject to reinvestment risk. Reinvestment risk occurs because the company will be reinvesting the coupon payments it receives. If the YTM on similar bonds falls, these coupon payments will be reinvested at a lower interest rate, which will result in a portfolio value that is lower than desired at maturity. Of course, if interest rates increase, the portfolio value at maturity will be higher than needed.Suppose Ice Cubes, Inc. has the following liability due in five years. The company is going to buy bonds today in order to meet the future obligation. The liability and current YTM are below.Amount of liability: $100,000,000 Current YTM:8%At the current YTM, what is the face value of the bonds the company has to purchase today in order to meet its future obligation? Assume that the bonds in the relevant range will have the same coupon rate as the current YTM and these bonds make semiannual coupon payments.Assume that the interest rates remain constant for the next five years. Thus, when the company reinvests the coupon payments, it will reinvest at the current YTM. What is the value of the portfolio in five years?Assume that immediately after the company purchases the bonds, interest rates either rise or fall by one percent. What is the value of the portfolio in five years under these circumstances?One way to eliminate reinvestment risk is called immunization. Rather than buying bonds with the same maturity as the liability, the company instead buys bonds with the same duration as the liability. If you think about the dedicated portfolio, if the interest rate falls, the future value of the reinvested coupon payments decreases. However, as interest rates fall, the price of the bond increases. These effects offset each other in an immunized portfolio. Another advantage of using duration to immunize a portfolio is that the duration of a portfolio is simply the weighted average of the duration of the assets in the portfolio. In other words, to find the duration of a portfolio, you simply take the weight of each asset multiplied by its duration and then sum the results.Linda needs to have $50,000 in eight year, how much would she have to invest today, if she earns 10 percent annually on her money? How much would she have to put away annually to have $50,000 in eight years?Which of these two bonds first the highest current yield? Which one has the highest yield to maturity?A 7 percent, 20-year bond quoted 101.000A 10 percent, 30-year bond quoted at 105.00Suppose you want to retire in exactly 30 years. At that time, you wish to have $500,000 in your retirement account. If the applicable rate is 5.78%, compounded monthly, how much would you need to put into the account at the end of each month to meet your goal?Jacqueline is 25-year old now. If she earns 6% on savings of $3,000 a year, how much will her retirement fund be by age 65?Please refer to worksheet 14.1: Estimating future retirement Needs. Assume Jared and Trish Roberts needs 26,792 each year for the first 20 years after their retirement, and 20,000 each year for the next 5 years, re-compute the amounts for Line N and Line Q. Other information has no change.