Introduction to Finance

17. 
Challenge Problem
Following are currency exchange “cross-
rates” between pairs of major currencies. Currency crossrates 
include both direct and indirect methods for expressing relative 
exchange rates.
U.S. 
Dollar
UK 
Pound
Swiss 
Franc
Japanese 
Yen
European 
Euro
European
Monetary 
Union
1.1406
?
0.6783
0.0087
—
Japan
130.66
185.98
77.705
—
114.60
Switzerland
1.6817
2.3936
—
0.0129
?
United 
Kingdom
?
—
0.4178
?
0.6162
United 
States
—
1.4231
?
0.0077
0.8767
a. 
Fill in the missing exchange rates in the crossrates table.
b. 
If the infl ation rate is expected to be 3 percent in the European 
Monetary Union and 4 percent in the United States next year, es-
timate the forward rate of one euro in U.S. dollars one year from 
now.
c. 
If the one-year government interest rate is 6 percent in Japan 
and 4 percent in the United Kingdom, estimate the amount of yen 
that will be needed to purchase one British pound one year from 
now.
d. 
Based solely on purchasing power parity theory, calculate the 
expected one-year infl ation rate in the United States if the Swiss in-
fl ation rate is expected to be 3.5 percent next year and the one-year 
forward rate of a Swiss franc is $.6100.
e. 
Assume the U.S. dollar is expected to depreciate by 15 percent 
relative to the euro at the end of one year from now and the interest 
rate on one-year government securities in the European Monetary 
Union is 5.5 percent. What would be the current U.S. one-year 
government security interest rate, based solely on the use of inter-
national Fisher eff ect theory to forecast forward currency exchange 
rates?

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