Homework #2

4. The Jan 1 current spot rate for EUR-JPY exchange rate is 1 EUR = 122 JPY. The JPY annual inflation rate is 3%. The EUR annual inflation rate is 2%. What does Purchasing Power Parity predict that the 1-year forward EUR-JPY rate will be?

=122(1.03/1.02) =123.1960 =123.20 JPY = 1 EUR***

4. The Jan 1 current spot rate for USD-CNY exchange rate is CNY 6 = 1 USD. The USD annual interest rate is 4%. The CNY annual interest rate is 6%. What does Interest Rate Parity predict that the 1-year forward USD-CNY rate will be?

=6(1.06/1.04) = 6.1153 = 6.12%***

The sensitivity of "realized" domestic currency values of the firm's contractual cash flows denominated in foreign currency to unexpected changes in the exchange rate is A. transaction exposure. B. translation exposure. C. economic exposure. D. none of the above

A

Five macroeconomic factors influencing exchange rates:

1. Political and economic stability 2. Differentials is Inflation 3. Differentials in Interest Rates 4. Current-Account Deficits & Debt 5. Terms of Trade-relative demand for the home currency

What is the difference between a futures contract and a forward contract?

A forward contract is an agreement that is private between two parties. The agreement gives the parties the ability to buy and sell and asset at a decided upon price in the future. A futures contract is not private and is able to be traded on exchanges. They are standardized contracts with the prices set by the market.

An "option" is A. a contract giving the seller (writer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future. B. a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future. C. a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put) or sell (call) a given quantity of an asset at a specified price at some time in the future. D. a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put) or sell (sell) a given quantity of an asset at a specified price at some time in the future.

B

Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the one-year forward exchange rate, is $1.16/€. Assume that an arbitrageur can borrow up to $1,000,000. A. This is an example where interest rate parity holds. B. This is an example of an arbitrage opportunity; interest rate parity does NOT hold. C. This is an example of a Purchasing Power Parity violation and an arbitrage opportunity. D. None of the above

B

The most direct and popular way of hedging transaction exposure is by A. exchange-traded futures options. B. currency forward contracts. C. foreign currency warrants. D. borrowing and lending in the domestic and foreign money markets.

B

The sensitivity of the firm's consolidated financial statements to unexpected changes in the exchange rate is A. transaction exposure. B. translation exposure. C. economic exposure. D. none of the above

B

Interest Rate Parity (IRP) is best defined as A. when a government brings its domestic interest rate in line with other major financial markets. B. when the central bank of a country brings its domestic interest rate in line with its major trading partners. C. an arbitrage condition that must hold when international financial markets are in equilibrium. D. None of the above

C

The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is A. transaction exposure. B. translation exposure. C. economic exposure. D. none of the above

C

When Interest Rate Parity (IRP) does not hold A. there is usually a high degree of inflation in at least one country. B. the financial markets are in equilibrium. C. there are opportunities for covered interest arbitrage. D. both b and c

C

4. The Illinois Teachers Retirement System manages a pension fund that holds $100 million in Japanese government bonds. It believes that Japanese interest rates will be rising soon, causing the bond prices to decline. How can the investment managers use a swap contract to hedge the interest rate risk it is facing?

The investment manager can hedge their risk on their bonds by doing a swap on the interest of the bonds. They will look to swap interest rates with another investment bank so they will have a fixed rate. The investment rate that they swap with will then assume the risk and will be betting on interest rates to lower. By getting a fixed rate, The Illinois Teachers Retirement System will guarantee that the rates do no go up above the amount of the trade.

Malaysia currently expands it money supply as a faster rate than Switzerland does. In general, do we expect the Malaysian Ringgit to appreciate or depreciate vs. the Swiss franc?

We would expect the Malaysian Ringgit to depreciate vs. the Swiss franc since more is being produced it will become less valuable to the stronger Swiss franc.