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Lecture

answer_key_Topic1.pdf

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Department
Economics
Course
ECO365H1
Professor
All Professors
Semester
Fall

Description
ANSWER KEY ECO365 - Topic 1 Ee 1. (a) Exact UIP : (1 +Hi ) = (1 + F E . You must explain why, if this condition does not hold, there would be arbitrage opportunities. (b) Refer to class notes. (c) Approximate UIP : i = i + E ▯E H F E (d) The exact UIP can be re-written as: E ▯ E 1 + iH = (1 + iF)( + 1) E E ▯ E E ▯ E = 1 + iF+ + iF E E For two develop countries, exchange rate fluctuations are usually quite small - for example, 0.05. At the same time, interest rates are also low - for example, 0.02. Hence, the product of these two terms would be really small - for example, 0.001. By ignoring this term, i.e., setting E ▯E iF E ▯ 0, we get the approximate UIP. 2. (a) Yes, he can make profit. He should sell CAD for $, then $ for Y, and finally Y for CAD. He will make a profit of CAD 10. (b) The return of return
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