A Dutch investor is considering an investment in Japanese government bonds with an interest rate of 12.5% per year.The current exchange rate between the euro and the yen is 0.90 euro/yen. The investor has access to a forward contract allowing her to buy or sell euros against yen in one year from today at a rate of 0.95 euro/yen. Based on this information, compute the return on investment in Japanese bonds assuming that the investor starts with euros and wants to end up with euros. For which value of the interest rate on Dutch investments would the investor be indifferent between investing in Dutch assets and investing in Japanese bonds?(3 points)
Suppose that the current spot exchange rate between the euro and the yen, measured in euro/yen, falls. How will this impact the forward exchange rate between the euro and the yen? Explain carefully the sequence of steps that will eventually lead to a change in the forward exchange rate. (9 points)
The figure below shows the current private supply and demand curves for euros in the absence of official interventions. Suppose the Bank of England is committed to keep the exchange rate between the pound sterling and the euro within a band of +/- 3% around the target rate 0.9 pound/euro. First, explain whether the current position of the private demand and supply curves requires official interventions of the Bank of England and, if so, what is the minimum amount of pounds and euros that the Bank of England will have to sell/buy respectively.Then, assuming that the Bank of England will intervene in foreign exchange markets in a similar way for several periods, explain how these interventions will affect the price competitiveness of British firms. (11 points)
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Requirements: not define
