International Finance Final
Suppose Mexico is a major export market for your U.S.-based company and the Mexican peso appreciates drastically against the U.S. dollar. This means
your firm will be able to charge more in dollar terms while keeping peso prices stable and your domestic competitors will enjoy a period of facing lessened price competition from Mexican imports.
June 2019 Mexican peso futures contract has a price of $0.05203 per MXN. You believe the spot price in June will be 0.04531 per MXN. a. What speculative position would you enter into to attempt to profit from your beliefs? b. Calculate your anticipated profits, assuming you take a position in three contracts. c. What is the size of your profit (loss) if the futures price is indeed an unbiased predictor of the future spot price and this price materializes?
a. If you expect the Mexican peso to depreciate from $0.05203 to $0.04531 per MXN, you would take a short position in futures since the futures price of $0.05203 is greater than your expected spot price. b. Your anticipated profit from a short position in three contracts is: 3 × ($0.05203 − $0.04531) × MXN500,000 = $10,080 where MXN500,000 is the contract size of one MXN contract. c. If the futures price is an unbiased predictor of the future spot price and this price materializes, you will not profit or lose from your long futures position.
For most countries and most firms, the domestic country beta
can be no lower than its world beta.
Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate
can have significant economic consequences for both U.S. and Japanese firms.
If the interest rate rises in the U.S. while other variables remain constant
capital inflows into the U.S. will increase.
The theory of comparative advantage
claims that economic well-being is enhanced if each country's citizens produce that which they have a comparative advantage in producing relative to the citizens of other countries, and then trade production.
Generally speaking, liberalization of financial markets when combined with a weak, underdeveloped domestic financial system tends to
create an environment susceptible to currency and financial crises.
The forward price
all of the options
The gold standard still has ardent supporters who believe that it provides
an effective hedge against price inflation.
In reference to the futures market, a "speculator"
attempts to profit from a change in the futures price.
The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is
economic exposure.
Generally speaking, a firm is subject to high degrees of operating exposure when
either its cost or its price is sensitive to exchange rate changes.
A firm may cross-list its share to
establish a broader investor base for its stock. establish name recognition in foreign capital markets, thus paving the way for the firm to source new equity and debt capital from investors in different markets. expose the firm's name to a broader investor and consumer groups.
Suppose you start with $100 and buy stock for £50 when the exchange rate is £1 = $2. One year later, the stock rises to £60. You are happy with your 20 percent return on the stock, but when you sell the stock and exchange your £60 for dollars, you only get $45 since the pound has fallen to £1 = $0.75. This loss of value is an example of
exchange rate risk.
A country experiencing a significant balance-of-payments surplus would be likely to
expand imports, offering marketing opportunities for foreign enterprises, and encourage imposing foreign exchange restrictions.
The stock market of country A has an expected return of 5 percent, and standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and standard deviation of expected return of 10 percent. Assume that the correlation of expected return between A and B is negative 1. Calculate the standard deviation of expected return of a portfolio with half invested in A and half invested in B.
σ2p = (WAσA)2 + (WBσB)2 + 2WAσAWBσBPABσ2p =(1/2 × 8%)2 + (1/2 × 10%)2 + 2 × 1/2 × 8% × 1/2 × 10% × (-1)σ2p = 16 + 25 - 40 = 1σp =1%
If the $/€ bid and ask prices are $1.50/€ and $1.51/€, respectively, the corresponding €/$ bid and ask prices are
€0.6623 and €0.6667.
As of today, the spot exchange rate is €1.00 = $1.60 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 = $1.5845 Solve the following for X: 1.6 = (1.03/1.02)X
What is the margin requirement on a futures contract? What is the difference between the initial margin and the maintenance margin? Who requires and who pays the margin?
margin requirement is the amount the trader must deposit to establish an asset postion. the difference between inital margin and maintenence margin is maintenece is needed to HOLD the postion and inital is needed in oreder to get a postion. the investor pays the margin to the broker
A dealer in pounds who thinks that the exchange rate is about to increase in volatility
may want to widen his bid-ask spread.
Hedge fund advisors typically receive a "2-plus-twenty" management fee
meaning 2 percent per year of the assets under management, plus performance fee of 20 percent of any capital appreciation.
Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate Floating-Rate Borrowing Cost Borrowing Cost Company X. 10% LIBOR Company Y. 12% LIBOR + 1.5% A swap bank proposes the following interest only swap:Y will pay the swap bank annual payments on $10,000,000 at a fixed rate of 9.90 percent. In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR − 0.15 percent; What is the value of this swap to company Y?
Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year. 9.9% − (LIBOR − 0.15%) + LIBOR + 1.5% = 11.55%; 12% − 11.55% = 0.45%, or 45 basis points.
Consider the dollar- and euro-based borrowing opportunities of companies A and B. € borrowing $ borrowing A. €7% $8% B. €6% $9% A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as $2.00 × (1.08)/€1.00 × (1.06) = $2.0377/€1. Is there a mutually beneficial swap?
Yes, Savings = [€7% − €6%] × $2.00/€1.00 − ($8% − $9%) = $2% + $1% = $3%
Following the monetary union and the advent of the euro:
Development of a common securities regulations, even among the countries of the European Union, has not yet occurred.
In which market does a clearinghouse serve as a third party to all transactions?
Futures
Which of the following is a true statement?
Generally, exchange rate volatility is greater than bond market volatility. When investing in international bonds, it is essential to control exchange risk to enhance the efficiency of international bond portfolios. The real-world evidence suggests that investing in Swiss bonds largely amounts to investing in Swiss currency.
The degree of home bias varies across investors.
Wealthier, more experienced, and sophisticated investors are less likely to exhibit home bias.
The core of the Bretton Woods system was the
World Bank.
Intervention in the foreign exchange market is the process of
a central bank buying or selling its currency in order to influence its value.
Privatization refers to the process of
a country divesting itself of the ownership and operation of a business venture by turning it over to the free market system.
One likely effect of a company or government instituting foreign equity ownership restrictions is
a decrease in domestic stock prices.
Most governments at least try to make it difficult for people to cross their borders illegally. This barrier to the free movement of labor is an example of
a market imperfection.
A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes
a market order.
In the Capital Asset Pricing Model (CAPM), the term Beta, β, is
a measure of systematic risk inherent in a security. calculated as the "covariance of future returns between a specific security and the market portfolio" divided by the "variance of returns of the market portfolio."
Production of goods and services has become globalized to a large extent as a result of
multinational corporations' efforts to source inputs and locate production anywhere where costs are lower and profits higher.
The choice between the alternative exchange rate regimes (fixed or floating) is likely to involve a trade-off between
national monetary policy autonomy and international economic integration.
Systematic risk is
non-diversifiable risk and the risk that remains even after investors fully diversify their portfolio holdings.
Yankee stocks
often trade as ADRs, have lower risks than trading the actual shares, and are bank receipts representing a multiple of domestic shares deposited in a foreign bank.
If the United States imports more than it exports, then
one can infer that the U.S. dollar would be under pressure to depreciate against other currencies. the supply of dollars is likely to exceed the demand in the foreign exchange market, ceteris paribus.
The current spot exchange rate is $1.53=£1.00 and the three-month forward rate is $1.60=£1.00. Consider a three-month American put option on £10,000 with a strike price of $1.50=£1.00. This put option is:
out-of-the-money
An exporter faced with exposure to an appreciating currency can reduce transaction exposure with a strategy of
paying early, collecting late.
Relatively low turnover ratios indicate
poor liquidity.
When a country must make a net payment to foreigners because of a balance-of-payments deficit, the central bank of the country
should either run down its official reserve assets (e.g., gold, foreign exchanges, and SDRs) or borrow anew from foreign central banks.
Open interest in currency futures contracts
tends to be greatest for the near-term contracts, and typically decreases with the term to maturity of most futures contracts.
Under the Bretton Woods system,
the U.S. dollar was the only currency that was fully convertible to gold; other currencies were not directly convertible to gold.
An arbitrage is best defined as
the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making certain guaranteed profits.
For a U.S. trader working with American quotes, if the forward price is higher than the spot price
the currency is trading at a premium in the forward market.
A major risk faced by a swap dealer is mismatch risk. This is
the difficulty in finding a second counterparty with an exact opposite match for a swap that the bank has agreed to take with another counterparty.
Under a flexible exchange rate regime, governments can retain monetary policy independence because the external balance will be achieved by
the exchange rate adjustments.
The current account includes
the export and import of goods and services.
Operating exposure measures
the extent to which the firm's operating cash flows will be affected by unexpected changes in exchange rates.
Economic exposure refers to
the extent to which the value of the firm would be affected by unanticipated changes in exchange rate.
The "J-curve effect" shows
the initial deterioration and the eventual improvement of a country's trade balance following a currency depreciation.
The main cost of European monetary union is
the loss of national monetary and exchange rate policy independence.
The ascendance of the dollar reflects several key factors, such as
the mature and open capital markets of the U.S. economy.
The cost of capital is
the minimum rate of return an investment project must generate in order to pay its financing costs.
If the interest rate in the U.S. is i$ = 5 percent for the next year and interest rate in the U.K. is i£ = 8 percent for the next year, uncovered IRP suggests that
the pound is expected to depreciate against the dollar by about 3 percent.
A measure of liquidity for a stock market is the turnover ratio; defined as
the ratio of stock market transactions over a period of time divided by the size, or market capitalization, of the stock market.
The sale of previously issued common stock traded between investors occurs in
the secondary market.
Before you can use the hedging strategies such as a forward market hedge, options market hedge, and so on, you should consider running a regression of the form P = a + b × S + e . When reviewing the output, you should initially focus on
the slope coefficient b.
When a swap bank serves as a dealer,
the swap bank stands willing to accept either side of a swap.
When individual investors become aware of overseas investment opportunities and are willing to diversify their portfolios internationally,
they benefit from an expanded opportunity set.
Two studies found a link between exchange rates and the stock prices of U.S. firms;
this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows, as well influencing the domestic currency values of its assets and liabilities.
The two primary reasons for an interest rate swap are
to better match maturities of assets and liabilities; to obtain cost savings via the quality spread differential
The Paris Bourse was traditionally a call market. In a call market, an agent of the exchange accumulates, over a period of time, a batch of orders that are periodically executed by written or verbal auction throughout the trading day. Both market and limit orders are handled in this way.
traders are not certain about the price at which their orders will transact because bid and ask quotations are not available prior to the call.
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
transaction exposure.
The sensitivity of the firm's consolidated financial statements to unexpected changes in the exchange rate is
translation exposure.
Generally speaking, any transaction that results in a receipt from foreigners
will be recorded as a credit, with a positive sign, in the U.S. balance of payments.
Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 3 percent per annum in the U.S. and 5 percent per annum in the euro zone, what is the no-arbitrage one-year forward rate?
$1.0300/€
A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities?
$1.2471 = €1.00 Solve the following for X: (1.06/1.02) × 1.2 = X
Country. U.S. $ equiv. Currency per U.S. $ Tuesday Monday Tuesday. Monday U.K.(Pound)£62,500. 1.6000. 1.6100. 0.6250. 0.6211 1 Month Forward. 1.6100. 1.6300. 0.6211. 0.6173 3 Months Forward. 1.6300. 1.6600. 0.6173. 0.6024 6 Months Forward. 1.6600. 1.7200. 0.6024. 0.581412 12 Months Forward. 1.7200. 1.8000. 0.5814. 0.5556 Using the table shown, what is the most current spot exchange rate shown for British pounds? Use a direct quote from a U.S. perspective.
$1.60 = £1.00
Assume today's settlement price on a CME EUR futures contract is $1.3148/EUR. You have a short position in one contract. Your performance bond account currently has a balance of $2,100. The next three days' settlement prices are $1.3134, $1.3141, and $1.3057. Calculate the changes in the performance bond account from daily marking-to-market and the balance of the performance bond account after the third day. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
$2,100 + [($1.3148 − $1.3134) + ($1.3134 − $1.3141) + ($1.3141 − $1.3057)] × EUR125,000 = $3,237.50, where EUR125,000 is the contract size of one EUR contract.
Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany. The spot exchange rate is $1.12/€, and the forward exchange rate with one-year maturity is $1.16/€. Assume that an arbitrager can borrow up to $1,000,000. If an astute trader finds an arbitrage opportunity, what is the net cash flow in one year?
$21,964 [F/S] (1+i€) = (1.16/1.12) (1.035) = 1.0720, which is greater than (1+i$) = 1.05. This suggests that IRP is not holding. After adjusting for the exchange rates (F/S), the interest rate is lower in the U.S. than in Germany. The arbitrager should borrow $1,000,000, and repayment in one year will be $1,050,000 = ($1,000,000 × 1.05). Then, the $1,000,000 should be used to purchase $1,000,000 / ($1.12/€) = €892,857 at the spot rate. The euros will be invested in Germany, where the maturity value will be €892,857 × 1.035 = €924.107. Finally, agree to sell the euros in exchange for $1,071,964 (found by €924,107 × 1.16) at the forward rate. In one year, the net cash flow will be $1,071,964 − $1,050,000 = $21,964.
On the Paris bourse, shares of Avionelle trade at €45. The spot exchange rate is $1.40 = €1.00. What is the no-arbitrage U.S. dollar price of an Avionelle ADR? Assume that transactions costs are negligible and that one ADR represent one underlying share.
$63.00 Solve the following proportion for X: (X / 45) = (1.4 / 1), where X = $63.
A U.S. firm holds an asset in Israel and faces the following scenario: State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $0.30/IS $0.20/IS $0.15/IS P* IS2,000 IS5,000 IS3,000 P $600 $1,000 $450 where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset The expected value of the investment in U.S. dollars is:
$762.50 $600 (0.25) + $1,000 (0.5) + $450 (0.25) = $762.50
The following is an outline of certain potential benefits as well as costs associated with the cross-border listings of stocks: (i) the company can expand its potential investor base (ii) issues involving the disclosure and listing requirements (iii) creates a secondary market for the company's shares (iv) volatility spillover from the overseas markets (v) liquidity (vi) control of the company by foreigners (vii) enhances the visibility of the company's name and its products in foreign marketplaces Which of the following represent all the potential benefits of the cross-border listings of stocks?
(i), (iii), (v), and (vii)
An investor believes that the price of a stock, say IBM's shares, will increase in the next 60 days. If the investor is correct, which combination of the following investment strategies will show a profit in all the choices? (i) buy the stock and hold it for 60 days (ii) buy a put option (iii) sell (write) a call option (iv) buy a call option (v) sell (write) a put option
(i), (iv), and (v)
A U.S. firm holds an asset in Israel and faces the following scenario: State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $0.30/IS $0.20/IS $0.15/IS P* IS2,000 IS5,000 IS3,000 P $600 $1,000 $450 where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset The variance of the exchange rate is:
0.002969 $0.2125 = 0.25 ($0.30) + 0.50 ($0.20) + 0.25 ($0.15); [0.25 (0.30 − 0.2125)2] + [0.5 (0.20 − 0.2125)2] + [0.25 (0.15 − 0.2125)2] = 0.001914 + 0.000078 + 0.000977 = 0.002969
Suppose that the one-year interest rate is 3.0 percent in Italy. The spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.18/€. What must the one-year interest rate be in the United States to avoid arbitrage opportunities?
1.2833%
Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1.
1/2 DV = 1/(1 + 1) = 1/2
The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 4; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent. What is the firm's cost of equity capital?
16.50 percent 16.5% = 3% + 1.5 × (9%)
Alpha and Beta Companies can borrow for a five-year term at the following rates: Alpha Beta Moody's credit rating. Aa Baa Fixed-rate borrowing cost 12.0% 15.0% Floating-rate borrowing cost LIBOR LIBOR + 1% Calculate the quality spread differential (QSD). (Enter your answers as a percent rounded to 2 decimal places.)
2.0% The QSD = (15.0% − 12.0%) minus (LIBOR + 1% − LIBOR) = 2.0%.
Assume that you have invested $100,000 in Japanese equities. When purchased, the stock's price and the exchange rate were ¥100 and ¥100/$1.00 respectively. At selling time, one year after purchase, they were ¥110 and ¥110/$1.00. If the investor had sold ¥10,000,000 forward at the forward exchange rate of ¥105/$1.00 the dollar rate of return would be
4.33 percent. [¥10,000,000 × ($1 / ¥105) + ¥1,000,000 × ($1 / ¥110) − $100,000] / $100,000 = 0.0433 = 4.33%.
13.00%=K1 5/7 =λ 8.0%=i 40.0%=τ
7.14 percent 0.0714 = 7.14% = (1 − (5/7)) (0.13) + (5/7) (1 − 0.40) (0.08)
Emerald Energy is an oil exploration and production company that trades on the London Stock Exchange. Over the past year, the stock has enjoyed a 20 percent return in pound terms, but over the same period, the exchange rate has fallen from $2.00 = £1 to $1.80 = £1. Calculate the investor's annual percentage rate of return in terms of the U.S. dollars.
8 percent ($1.80 − $2) / $2 = −0.10 = −10%; R = 0.20 − 0.10 − (0.20)(0.10) = 0.08 = 8%.
Solve for the weighted average cost of capital. 11.20%=K1=cost of equity capital for a leveraged firm 1/2 =λ=debt-to-total-market-value ratio 8.0%=i=before-tax borrowing cost 40.0%=τ=marginal corporate income tax rate
8.00 percent 0.0800 = 8% = (1 − 0.50) (0.112)) + 0.50 (1 − 0.40) (0.08)
Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a tax rate of 34 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 8 percent.
9.6 percent If DE = 3/2, then DV = 3/(3 + 2) = 3/5; 0.0960 = 9.6% = (1 − (3/5)) (0.12) + (3/5) (0.08)
Which investment is likely to be the most liquid?
A share of a publicly traded company trading on the NYSE.
Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows: The U.S. one-year interest rate: 6.10% per annum The euro zone one-year interest rate: 9.00% per annum The spot exchange rate:$1.50/€ The one-year forward exchange rate$1.46/€ Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Suppose that on the maturity date of the forward contract, the spot rate turns out to be $1.40/€ (i.e. less than the forward rate of $1.46/€). Which of the following is true?
Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract. Additionally, Boeing gained $0.6 million from forward hedging. $14,000,000 = $1.40 × €10,000,000 and $14,600,000 = $1.46 × €10,000,000. Gain = (F − ST) × €10,000,000 = ($1.46 − $1.40) × €10,000,000 = $600,000, or $0.6 million.
An Italian currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how you can realize a certain euro profit via covered interest arbitrage.
Borrow €800,000 at i€ = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to €850,000 at the forward rate of $1.20 = €1.00. Net profit will be €2,000.
Your U.S. firm has a £100,000 payable with a 3-month maturity. Which of the following will hedge your liability?
Buy a call option on £100,000 with a strike price in dollars.
Country A can produce 10 yards of textiles or 6 pounds of food per unit of input. Country B can produce 8 yards of textiles or 5 pounds of food per unit of input. Which of the following statements is true?
Country A is relatively more efficient than Country B in the production of textiles. To find the opportunity cost of producing one additional pound of food for either country, divide the textile output by food output for each country for one unit of production. For Country A, it costs 10/6 = 1.67 yards of textiles to produce one additional pound of food, and for Country B, it costs 8/5 = 1.6 yards of textiles to produce one additional pound of food. Thus, Country B is relatively more efficient than Country A in producing food as evidenced by the fact that 1.6 < 1.67. To find the opportunity cost of producing one additional yard of textiles for either country, divide the food output by textile output for each country for one unit of production. For Country A, it costs 6/10 = 0.6 pounds of food to produce one additional yard of textiles, and for Country B, is costs 5/8 = 0.625 pounds of food to produce one additional yard of textiles. Thus, Country A is relatively more efficient than Country B in producing textiles, as evidenced by the fact that 0.6 < 0.625.
Which of the following statements regarding cross-border listings of shares is not true?
Cross-listing shares may not be used as the "acquisition currency" for taking over foreign companies.
Your firm is an Italian importer of bicycles. You have placed an order with a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment (in francs) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Currency per U.S.$ Contract Size. Country Tuesday Monday Tuesday Monday £10,000 Britain (pound) $1.9600 $1.9400 £0.5102 £0.5155 1 month forward $1.9700 $1.9500 £0.5076 £0.5128 3 months forward $1.9800 $1.9600 £0.5051 £0.5102 6 months forward$1.9900 $1.9700 £0.5025 £0.5076 12 months forward$2.0000 $1.9800 £0.5000 £0.5051 €10,000 Euro $1.5600 $1.5400 €0.6410 €0.6494 1 month forward $1.5700 $1.5500 €0.6369 €0.6452 3 months forward $1.5800 $1.5600 €0.6329 €0.6410 6 months forward $1.5900 $1.5700 €0.6289 €0.6369 12 months forward $1.6000 $1.5800 €0.6250 €0.6329 SFr.10,000 Swiss franc. $0.9200 $0.9000 SFr.1.0870 SFr.1.1111 1 month forward $0.9400 $0.9200 SFr.1.0638 SFr.1.0870 3 months forward $0.9600 $0.9400 SFr.1.0417 SFr.1.0638 6 months forward $0.9800 $0.9600 SFr.1.0204 SFr.1.0417 12 months forward $1.0000 $0.9800 SFr.1.0000 SFr.1.0204
Go long 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts. 200 contracts = SFr. 2,000,000 / SFr. 10,000; $2,000,000 = SFr. 2,000,000 × $1; Solve the proportion for X: ($2,000,000 / X) = ($1.60 / €1), where X = €1,250,000. Next, €1,250,000 / €10,000 = 125 contracts.
Suppose the futures price is below the price predicted by IRP. What steps would a speculator take to attempt to profit?
Go long in the futures contract.
Which of the following statements regarding triangular arbitrage true?
It can involve trading out of the US dollar into a second currency, then trading it for a third currency, which is in turn traded for US dollars. The purpose is to earn an arbitrage profit via trading among three currencies, where the direct cross-exchange rate between the second and the third currency is not in alignment with the implied cross-exchange rate.
The world's largest foreign exchange trading center is
London
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?
Loss of $100 (1.5 × 1,000) = $1,500 and (1.6 × 1,000) = $1,600. $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 $1.20 = €1.00 and the dollar-pound exchange rate is quoted at $1.80 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.50, how much money can an astute trader make?
No arbitrage is possible
Suppose that Britain pegs the pound to gold at six pounds per ounce, whereas the exchange rate between pounds and U.S. dollars is $1 = £5. What would an ounce of gold be worth in U.S. dollars?
One gold ounce is equivalent to 6 pounds, which is equal to $1.2 (6 / 5). $1.20
Suppose you are a British venture capitalist holding a major stake in an e-commerce start-up in Silicon Valley. As a British resident, you are concerned with the pound value of your U.S. equity position. Assume that if the American economy booms in the future, your equity stake will be worth $1,000,860, and the exchange rate will be $1.4/£. If the American economy experiences a recession, on the other hand, your American equity stake will be worth $500,960, and the exchange rate will be $1.6/£. You assess that the American economy will experience a boom with a 50 percent probability and a recession with a 50 percent probability. a. Estimate your exposure to the exchange risk. b. Compute the variance of the pound value of your American equity position that is attributable to the exchange rate uncertainty.
Prob = .50P* = $1,000,860S = $1.4P = £714,900Prob = .50P* = $500,960S = $1.6P = £313,100 E(S) = (.50)/(1.4) + (.50)/(1.6) = £.670/$ E(P) = (.50) × (714,900) + (.50) × (313,100) = £514,000/$ Var(S)=(.5)(1/1.40 − .6696)2 + (.5)(1/1.60 − .6696)2 =.00100 + .00100 =.00199 Cov(P,S)=(.5)(714,900 - 514,000)(1/1.4 − .6696)+(.5)(313,100 - 514,000)(1/1.6 − .6696) =4,485 + 4,485 =8,969(rounding) a. b = Cov(P,S)/Var(S) = 8,969/.00199 = $4,500,160 b. b2Var(S) = (4,500,160)2 × (.00199) = 40,360,810,000
Suppose you are a euro-based investor who just sold Microsoft shares that you had bought six months ago. You had invested 10,000 euros to buy Microsoft shares for $120 per share; the exchange rate was $1.12 per euro. You sold the stock for $144 per share and converted the dollar proceeds into euro at the exchange rate of $1.03 per euro. First, determine the profit from this investment in euro terms. Second, compute the rate of return on your investment in euro terms. How much of the return is due to the exchange rate movement? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal places.)
Profit €2,870 Rate of return 28.7% Rate of return due to exchange rate movement 8.7% It is useful first to compute the rate of return in euro terms: r∈¯≅r$+e =144-120120+11.03-11.1211.12 = 0.200 + 0.087 = 0.287 This indicates that this euro-based investor benefited from an appreciation of dollar against the euro, as well as from an appreciation of the dollar value of Microsoft shares. The profit in euro terms is about €2,870, and the rate of return is about 28.7% in euro terms, of which 8.7% is due to the exchange rate movement.
Regarding the mechanics of international portfolio diversification, which statement is true?
Security returns are much less correlated across countries than within a county.
Doug Bernard specializes in cross-rate arbitrage. He notices the following quotes: Swiss franc/dollar = SFr1.6043/$ Australian dollar/U.S. dollar = A$1.8296/$ Australian dollar/Swiss franc = A$1.1494/SFr Ignoring transaction costs, does Doug Bernard have an arbitrage opportunity based on these quotes? If there is an arbitrage opportunity, what steps would he take to make an arbitrage profit, and how much would he profit if he has $1,000,000 available for this purpose?
Sell dollars to get Swiss francs: Sell $1,000,000 to get $1,000,000 × SFr1.6043/$ = SFr1,604,300. ii. Sell Swiss francs to buy Australian dollars: Sell SFr1,604,300 to buy SFr1,604,300 × A$1.1494/SFr = A$1,843,982.42. iii. Sell Australian dollars for dollars: Sell A$1,843,982.42 for A$1,843,982.42/A$1.8296/$ = $1,007,860.96. Thus, your arbitrage profit is $1,007,860.96 − $1,000,000 = $7,860.96.
Case I Case II South Dakota. North Dakota. South Dakota North Dakota Wheat (bushels). 4 1 3 1 Beer (bottles) 1 2 4 2 Which state has an absolute advantage in producing wheat in Case I?
South Dakota
The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. Based on your analysis of the exchange rate, you are confident that the spot exchange rate will be $1.52/€ in three months. Assume that you would like to buy or sell €1,000,000. What actions do you need to take to speculate in the forward market?
Take a long position in a forward contract on €1,000,000 at $1.50/€.
Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following conclusions are correct?
The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace. A given operating cash flow in euro will be converted to a higher U.S. dollar cash flow.
In your own words, briefly describe the Purchasing Power Parity (PPP) and discuss its meaning.
The exchange rate between currencies of two different countries should be the same as the ratio of the countries price levels of a commodity basket. Which really means comparing the purchasing power (strength) of two differnt currencies
On the Tokyo Stock Exchange, Honda Motor Company stock closed at ¥2,913 per share on Monday, June 6, 2016. Honda trades as an ADR on the NYSE. One underlying Honda share equals one ADR. On June 6, 2016, the ¥/$ exchange rate was ¥107.63/$1.00. (Round your answer to 2 decimal places.) At this exchange rate, what is the no-arbitrage U.S. dollar price of one ADR?
The no-arbitrage ADR U.S. dollar price is: ¥2,913 ÷ 107.63 = $27.06.
Which of the following is significant because it indicates a country's international payment gap that must be accommodated with a government's official reserve transactions?
The official settlement balance
Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate Floating-Rate Borrowing Cost Borrowing Cost Company X. 10% LIBOR Company Y. 12% LIBOR + 1.5% A swap bank proposes the following interest only swap:X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR − 0.15 percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90 percent. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR − 0.15 percent. What is the value of this swap to the swap bank?
The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. (LIBOR − 0.15%) − (LIBOR − 0.15%) + 10.3% − 9.9% = 0.4%, or 40 basis points.
The Singapore dollar—U.S. dollar (S$/$) spot exchange rate is S$1.60/$, the Canadian dollar—U.S. dollar (CAD/$) spot rate is CAD1.33/$ and S$/CAD1.15.Determine the triangular arbitrage profit that is possible if you have $1,000,000.
The triangle should be in the form of USD to S$, then S$ to CAD, and then back to USD. $1,000,000 (1.6) = S$ 1,600 000 / 1.15 = CAD 1,391,304.35 / 1.33 = $1,046,093. To find the profit, you must subtract the initial $1,000,000 from $1,046,093, which leaves you with $46,093. $46,093 profit
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.
This is an example of an arbitrage opportunity; interest rate parity does not hold. 1.12 (1.05 / 1.035) = 1.13, which is less than 1.16, suggesting that an arbitrage opportunity exists.
In which type of policy actions by the Fed can liquidity "dry up"?
Tight money
Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €10.06 million payable in one year. The current spot exchange rate is $1.05/€ and the one-year forward rate is $1.10/€. The annual interest rate is 6 percent in the United States and 5 percent in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and would like to hedge exchange exposure. a. It is considering two hedging alternatives: sell the euro proceeds from the sale forward or borrow euros from Crédit Lyonnaise against the euro receivable. Which alternative would you recommend? b. Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods?
a. In the case of forward hedge, the future dollar proceeds will be (10,060,000)(1.10) = $11,066,000. In the case of money market hedge (MMH), the firm has to first borrow the PV of its euro receivable, i.e., 10,060,000/1.05 = €9,580,952. Then the firm should exchange this euro amount into dollars at the current spot rate to receive: (€9,580,952)($1.05/€) = $10,060,000, which can be invested at the dollar interest rate for one year to yield: $10,060,000(1.06) = $10,663,600. Clearly, the firm can receive $402,400 more by using forward hedging. Forward hedge $11,066,000 Money market hedge$10,663,600 Recommend alternative Forward hedge b. According to IRP, F = S(1+i$)/(1+iF). Thus the "indifferent" forward rate will be: F = 1.05(1.06)/1.05 = $1.06/€.
Due to the integrated nature of their capital markets, investors in both the United States and the U.K. require the same real interest rate, 4.3 percent, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 5.3 percent in the United States and 3.3 percent in the U.K. for the next three years. The spot exchange rate is currently $3.3/£. a. Compute the nominal interest rate per annum in both the United States and the U.K., assuming that the Fisher effect holds b. What is your expected future spot dollar-pound exchange rate in three years from now? c. Can you infer the forward dollar-pound exchange rate for one-year maturity?
a. Nominal rate in U.S. = (1+ρ) (1+E(π$)) − 1 = (1.043)(1.053) − 1 = 0.0983 or 9.83%. Nominal rate in U.K.= (1+ρ) (1+E(π₤)) − 1 = (1.043)(1.033) − 1 = 0.0774 or 7.74%. b. E(ST) = [(1.0983)3/(1.0774)3] (3.30) = $3.4954/₤. c. F = [1.0983/1.0774](3.30) = $3.3639/₤.
A foreign country could provide low cost production sites
because the factors of production are underpriced and because the currency is undervalued.
A bank is quoting the following exchange rates against the dollar for the Swiss franc and the Australian dollar: SFr/$ = 1.4962 − 72 A$/$ = 1.7289 − 99 An Australian firm asks the bank for an SFr/A$ quote. What cross-rate would the bank quote?
bid SFr/A$ = (bid SFr/$)/(ask A$/$) = 1.4962/1.7299 = .8649 The SFr/A$ ask price is the number of SFr the bank is asking for one A$. This transaction (sell A$—buy SFr) is equivalent to buying SFr with dollars (at the ask rate of 1.4972 and then simultaneously purchasing these dollars against A$ (at a bid rate of 1.7289). This may be expressed as follows: ask SFr/A$ = (ask SFr/$)/(bid A$/$) = 1.4972/1.7289 = .8660 The resulting quotation by the bank is SFr/A$ = .8649-.8660
The interest rate at which the arbitrager borrows tends to be higher than the rate at which he lends, reflecting the
bid-ask spread.
The exchange markets in the U.S. are
both agency/auction markets.
An example(s) of a political risk is
both the expropriation of assets and adverse changes in tax rules are correct.
Suppose that the treasurer of IBM has an extra cash reserve of $100,000,000 to invest for six months. The interest rate is 8 percent per annum in the United States and 7 percent per annum in Germany. Currently, the spot exchange rate is €1.21 per dollar and the six-month forward exchange rate is €1.19 per dollar. The treasurer of IBM does not wish to bear any exchange risk. Where should he or she invest to maximize the return?
i$ = 8% x 6/12 = 4.0%; i€ = 7% x 6/12 = 3.5%; S = €1.21/$; F = €1.19/$. If $100,000,000 is invested in the U.S., the maturity value in six months will be $104,000,000 = $100,000,000 (1 + .040). Alternatively, $100,000,000 can be converted into euros and invested at the German interest rate, with the euro maturity value sold forward. In this case the dollar maturity value will be $105,239,496 = ($100,000,000 × 1.21)(1 + 0.035)(1/1.19) Clearly, it is better to invest $100,000,000 in Germany with exchange risk hedging. Germany
Suppose the quote for a five-year swap with semiannual payments is 8.50-8.60 percent. This means
if the swap bank is successful in getting counterparties to both legs of the swap at these prices, he will have an annual profit of ten basis points.
The current spot exchange rate is $1.63=€1.00 and the three-month forward rate is $1.65=€1.00. Consider a three-month American call option on €62,500 with a strike price of $1.60=€1.00. This call option is:
in-the-money
Japan has experienced large trade surpluses. Japanese investors have responded to this by
investing heavily in U.S. and other foreign financial markets.
The forward market
involves contracting today for the future purchase or sale of foreign exchange at a price agreed upon today.
The spot market
involves the almost-immediate purchase or sale of foreign exchange.
A limit order
is an instruction from a customer to a broker to buy or sell in at a particular price (or better). can be a "day order"—that is the order is cancelled if not executed during that day's trading. can be "good-till-cancelled."
The bid price
is the price that a dealer stands ready to pay.
When Honda, a Japanese auto maker, built a factory in Ohio,
it was engaged in foreign direct investment.
If a foreign county experiences a hyperinflation,
its currency will depreciate against stable currencies.
A "good" (or ideal) international monetary system should provide
liquidity, adjustments, and confidence.
In countries like France and Germany,
managers have often viewed shareholders as one of the "stakeholders" of the firm, others being employees, customers, suppliers, banks and so forth.
Country. U.S. $ equiv. Currency per U.S. $ Tuesday. Monday. Tuesday. Monday U.K. (Pound)£62,500 2.0000. 1.9800. 0.5000. 0.5051 1 Month Forward 2.0100. 1.9900. 0.4975. 0.5025 3 Months Forward 2.0200. 2.0000. 0.4950. 0.5000 6 Months Forward 2.0300. 2.0100. 0.4926. 0.49751 2 Months Forward 2.0400. 2.0200. 0.4902. 0.4950 Euro £62,500 1.5000. 1.4800. 0.6667. 0.6757 1 Month Forward 1.5100. 1.4900. 0.6623. 0.6711 3 Months Forward 1.5200. 1.5000. 0.6579. 0.6667 6 Months Forward 1.5300. 1.5100. 0.6536. 0.6623 12 Months Forward 1.5400. 1.5200. 0.6494. 0.6579 Using the table shown, what is the spot cross-exchange rate between pounds and euro on Tuesday?
€1.00 = £0.75 S(£/€) = S($/€) / S($/£), or S(£/€) = €1.5/£2 = £0.75/€.
Suppose that the current exchange rate is €1.00 = $1.60. The indirect quote, from the U.S. perspective is
€1/$1.6 = €0.625 €0.6250 = $1.00.
The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. Immediate exercise of this option will generate a profit of
€62,500 ($1.55 − $1.50) = $3,125 $3,125.
A U.S. firm holds an asset in Israel and faces the following scenario: State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $0.30/IS $0.20/IS $0.15/IS P* IS2,000 IS5,000 IS3,000 P $600 $1,000 $450 where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset The "exposure" (i.e., the regression coefficient beta) is: Hint: Calculate the expression Cov(P,S)/Var(S).
−52.6316
