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Paper Topic:

currency

Congratulations , you just won the Irish Lottery ! You bought a ticket while you were on vacation in Ireland , and you just won a 1 million Euro jackpot after all taxes were taken out

1 . If the current exchange rate is US 1 equals 1 .25 Euros , how much did you win in US dollars

At the current exchange rate of US 1 to 1 .25 Eu , then 1 million Euro is equivalent to US 1 .25 million

2 . Suppose that the interest rate in Irish banks is 5 for a one year

CD . In the USA , the rate is 2 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

Ireland (1 ,000 ,000 x 0 .05 1 ,000 ,000 1 ,050 ,000 euros

USA (1 ,250 ,000 x 0 .02 1 ,250 ,000 1 ,275 ,000 US dollars 3 . Suppose when you cashed in your CD in Ireland a year from now , the exchange rate had changed from US 1 to 1 .25 Euro , to US 1 to 1 .30 Euro How much would your Irish bank account be worth in US at that point Did you do better off leaving your winnings in Ireland or bringing them home to the USA

Ireland (1 ,000 ,000 x 0 .05 1 ,000 ,000 1 ,050 ,000 euros x 1 .3 1 ,365 ,000 euros

USA 1 (1 ,250 ,000 x 0 .02 1 ,250 ,000 1 ,275 ,000 US dollars (exchange rate assumption

USA 2 (1 ,300 ,000 x 0 .02 1 ,300 ,000 1 ,326 ,000 US dollars (exchange rate assumption

The better option in this scenario would have been to leave the winnings in Ireland as opposed to bringing it home to the USA

4 . Explain how banks and individuals can use covered interest arbitrage ' to protect themselves when they make international financial investments

By using the covered interest arbitrage , which is an investment strategy where an investor buys a foreign denominated foreign currency , and hedges his foreign exchange risk by selling a forward contract in the amount of the proceeds of the investment back into his base currency banks and individuals can protect themselves by taking advantage of favorable interest rates because of the utilization of the forward selling contract . Instead of risking unstable exchange rates , banks and individuals can sell at a predetermined rate but lose the chance to earn more because the effective interest rate at that time can be made more favorable

In this example the investor is based in the United States and assumes the following prices and rates : HYPERLINK "http /en .wikipedia .org /wiki /Foreign_exchange_spot_trading " \o "Foreign exchange spot trading " spot USD /EUR 1 .2000 , HYPERLINK "http /en .wikipedia .org /wiki /Forward_contract " \o "Forward contract forward USD /EUR for 1 year delivery 1 .2300 , dollar interest rate 4 .0 , euro interest rate 2 .5

Exchange...

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