Homework Assignment 2

The $/CD spot bid-ask rates are $0.7560-$0.7625. The 3-month forward points are 12-16. Determine the $/CD 3-month forward bid-ask rates.

$0.7572-$0.7641 Forward bid = $0.7560 + 0.0012 = $0.7572;Forward ask = $0.7625 + 0.0016 = $0.7641.

Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/€. What must the spot exchange rate be?

$1.1434/€

You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.20 how much money can an astute trader make?

$41,667 $1.60 = €1.00 i.e.: S($/€)=1.60; $2.00 = £1.00 i.e.: S($/£)=2.00 ; £1.00 = €1.20 i.e.: S(€/£)=1.201. Exchange $1m for £500,000 at S($/£)=2.00 $1m/ S($/£)=$1,000,000/2.00=£500,000;2. Buy €600,000 at S(€/£)=1.20 £500,000 S(€/£)=£500,0001.20=€600,000;3. trade for $900.000 at S($/€)=1.60 €600,000 S($/€)=€600,000 1.60=$960,000<$1,000,000 (initial investment), arbitrage loss $-40,000.4. Go from reverse direction to get arbitrage profit $1,000,000/1.6/1.2*2-$1,000,000=$1,041,667-$1,000,000=$41,667.

The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. You enter into a short position on €1,000. At maturity, the spot exchange rate is $1.60/€. How much have you made or lost?

A) Lost $100. Explanation: Short position involves selling the currency. You will get (1.5 × 1,000) = $1,500. But you could get (1.6 × 1,000) = $1,600 if you didn't have the forward contract. So you lost $1,600 - $1,500 = $100.

You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.50 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.25 how can you make money?

Buy euro at $1.50/€, buy £ at €1.25/£, sell £ at $2/£ Calculate the actual cross rate. S(€/£) = S($/£) / S($/€) = (2 / 1.5) = €1.33. Thus, you now know that the euro is undervalued with respect to pounds under the cross rate offered by the bank, meaning you should buy the euro, convert to pounds, and finally convert back to dollars

Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 5% APR in the U.S. and 3% APR in the euro zone, what is the no-arbitrage 1-year forward rate?

F($/€) = S($/€)×(1+i$)/(1+i€) = 1.0500×(1+5%)/(1+3%) = $1.0704/€

The moving average crossover rule

States that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is appreciating

Suppose that the one-year interest rate is 5.0 percent in the United States; the spot exchange rate is $1.20/€; and the one-year forward exchange rate is $1.16/€. What must the one-year interest rate be in the euro zone to avoid arbitrage?

c. 8.62% 1.16/1.20 = 1.05/1+x

A dealer in British pounds who thinks that the pound is about to depreciate

may want to lower his bid price and ask price

The random walk hypothesis suggests that

the best predictor of the future exchange rate is the current exchange rate.

The SF/$ spot exchange rate is SF1.25/$ and the 180 day forward exchange rate is SF1.30/$. The forward premium (discount) is

the dollar is trading at an 8% premium to the swiss franc for delivery in 180 days

USD equivalent BID ASK Switzerland (Franc) CHF 0.7648 0.7652 Euro € 1.4000 1.420030 What is the BID cross-exchange rate for Swiss Francs priced in euro? Hint:Find the price that a currency dealer will pay in euro to buy Swiss francs.

€0.5386/CHF

As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the one-year forward rate that should prevail?

€1.00 = $1.2379 - calculating one year Forward rate: (Forward rate)/$1.25 per Euro = (1+0.02)/(1+0.03) (Forward rate)/$1.25 per euro Euro = 0.99029 Forward rate = $1.2379 per euro

Suppose you observe the following exchange rates: €1 = $1.50; £1 = $2.00. Calculate the euro-pound exchange rate.

€1.3333 = £1.00 S(€/£) = S($/£) / S($/€) = (2/1) / (1.50/1), or (2/1) × (1/1.50) = €1.3333