ECON 3372 International Finance

Boston College
Spring, 2017

Problem Set 2
(Due Thursday, Feb. 23)

1. (10 points)

What is the expected dollar rate of return on euro deposits if today's exchange rae is
$1.10 per euro, next year's expected exchange rate is $1.166 per euro, the dollar
interest rate is 10%, and the euro interest rate is 5%? Show your work.

2. (10 points)

Assume the dollar interest rate is 10 percent while the euro interest rate is 6 percent.
Under what circumstances would an investor be indifferent between holding deposits
denominated in dollars and holding deposits denominated in euros? Explain.

3. (30 points)

Assume that the euro interest rate is constant at 5 percent, and that the expected
exchange rate is 1.05 dollars per one euro. Find the expected dollar return on euro
deposits for the following cases.
4. (35 points)

Determine for each of the cases below, whether the interest parity condition holds or
not, if the expected dollars per euro exchange rate = 1.10

5. (15 points)

EuroDisney, near Paris, conducts its operations in euros. However, assume that next
year Disney plans to undertake a major expansion of Disney World in Orlando, and
will need to utilize money from EuroDisney to help fund the project. Of course, the
American project must be paid for in dollars.

a. (5 points)

Explain what forex risk Disney faces in utilizing the European funds.

b. (10 points)

Explain how, using derivatives, Disney could hedge the forex risk they face.