International Financial Management 2nd Edition by Geert Bekaert ,Robert Hodrick

Exercise 27

Argentina's monetary stabilization plan in 1991 included introducing a currency board that tied the Argentine peso (ARS) to the U.S. dollar at an exchange rate of ARS1 USD1. On June 21, 2000, the 3-month interest rates quoted by Argentine banks were 6.71% in USD and 7.33% in ARS. Suppose the difference reflected some probability that the currency board would be abandoned and the peso devalued, and investors think a 10% devaluation to ARS1.10 USD is possible. What is the probability of this happening if uncovered interest rate parity holds In early 2001, confidence in the currency board eroded and interest rates soared to well over 10%. What is the possibility of a 10% devaluation if the 3-month interest rates are 20% in ARS and 6.0% in USD