Question

1)You observed the bid rate of the New Zealand dollar is $.3232 while the ask rate is $.3245 at Bank X. The bid rate of a New Zealand dollar is $.3324 while the ask rate is $.3342 at Bank Y. What would be your dollar amount profit if you use $1,000,000 to execute locational arbitrage?

2)Derek Jones, a foreign exchange trader at Charles Schwab, can invest $1 million, or the foreign currency equivalent of the bank’s short-term funds, in a covered interest arbitrage with Japan. Using the following quotes, can Derek make a covered interest arbitrage profit? If so, show the steps and calculate the amount of profit in USD.

Arbitrage funds available	$1,000,000
Spot exchange rate (¥/$)	¥106.00/$
6-month forward rate (¥/$)	¥103.50/$
US dollar 6-month interest rate	4%
Japanese yen 6-month interest rate	2%

3)Heidi Jensen is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat ¥89.00/$, while the 360-day forward rate is ¥84.90/$. Forecast inflation is 1.100% for Japan, and 5.900% for the US. The 360-day yen deposit rate is 4.700%, and the 360-day dollar deposit rate is 9.500%.

a)Calculate whether interest rate parity, purchasing power parity, and international fisher effect conditions hold between Japan and the US.

b)Find the forecasted change in the Japanese yen/US dollar exchange rate one year from now.

4)In China a Big Mac costs Yuan 16 (local currency), while in the US the same Big Mac costs $4.56. The exchange rate between Yuan and US dollar is Yuan6.1341/$. According to purchasing power parity, is Chinese Yuan overvalued or undervalued? Why?

5) The interest rate in the U.K. is 2%, while the interest rate in the U.S. is 1.5%. The spot rate for the British pound is $1.55. According to the international Fisher effect (IFE), what is new level of the British pound?

6) Bronco Co. is a U.S.-based MNC that has subsidiaries in Spain and Germany. Both subsidiaries frequently remit their earnings back to the parent company. The Spain subsidiary generated a net outflow of €1,000,000 this year, while the German subsidiary generated a net inflow of €2,500,000. What is the net inflow or outflow as measured in U.S. dollars this year? The exchange rate for the euro is $1.18.

7)If one-year nominal interest rate in the U.S. is 3%, while the one-year nominal interest rate in Australia is 5%. The spot rate of the Australian dollar is $.97. Interest Parity is held. You will need 1 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many U.S. dollars will you have in one year from your forward contract?

8)Today, the one-year U.S. interest rate is 2.53%, while the one-year interest rate in Mexico is 6%. The spot rate of the Mexico peso (MXP) is $.08 The one-year forward rate of the MXP exhibits a 11% discount. Determine the yield (percentage return on investment) to an investor from Mexico who engages in covered interest arbitrage.

9)Current one-year interest rates in Europe are 2 percent, while one-year interest rates in the U.S. are 1.6 percent. You convert $100,000 to euros and invests them in France. One year later, you convert the euros back to dollars. The current spot rate of the euro is $1.28.

a. According to the IFE, what should the spot rate of the euro in one year be?

b. If the spot rate of the euro in one year is $1.20, what is your percentage return from your investment?

c. If the spot rate of the euro in one year is $1.35, what is your percentage return from your investment?

d. What must the spot rate of the euro be in one year for your strategy to be successful?

Answer 1

1)You observed the bid rate of the New Zealand dollar is $.3232 while the ask rate is $.3245 at Bank X. The bid rate of a New Zealand dollar is $.3324 while the ask rate is $.3342 at Bank Y. What would be your dollar amount profit if you use $1,000,000 to execute locational arbitrage?

	$		Rate		NewZealand Dollar
Purchase at Bid rate at Bank X	100000	X	0.3232	=	32320	(A)
Sell at Ask rate at Bank Y	100000	X	0.3342	=	33420	(B)
Gain Arbitrage					1100	(B)- (A)

2)Derek Jones, a foreign exchange trader at Charles Schwab, can invest $1 million, or the foreign currency equivalent of the bank’s short-term funds, in a covered interest arbitrage with Japan. Using the following quotes, can Derek make a covered interest arbitrage profit? If so, show the steps and calculate the amount of profit in USD.

Arbitrage funds available	$1,000,000
Spot exchange rate (¥/$)	¥106.00/$
6-month forward rate (¥/$)	¥103.50/$
US dollar 6-month interest rate	4%
Japanese yen 6-month interest rate	2%

3)Heidi Jensen is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat ¥89.00/$, while the 360-day forward rate is ¥84.90/$. Forecast inflation is 1.100% for Japan, and 5.900% for the US. The 360-day yen deposit rate is 4.700%, and the 360-day dollar deposit rate is 9.500%.

a)Calculate whether interest rate parity, purchasing power parity, and international fisher effect conditions hold between Japan and the US.

b)Find the forecasted change in the Japanese yen/US dollar exchange rate one year from now.

4)In China a Big Mac costs Yuan 16 (local currency), while in the US the same Big Mac costs $4.56. The exchange rate between Yuan and US dollar is Yuan6.1341/$. According to purchasing power parity, is Chinese Yuan overvalued or undervalued? Why?

As a light-hearted annual test of PPP, The Economist has tracked the price of McDonald's Corp.’s Big Mac burger in many countries since 1986.The highly publicized Big Mac Index is used to measure the purchasing power parity (PPP) between nations, using the price of a Big Mac as the benchmark. The Big Mac index suggests that, in theory, changes in exchange rates between currencies should affect the price that consumers pay for a Big Mac in a particular nation, replacing the "basket" with the famous hamburger.

In such a case, Exchange rate to be Yuan3.5/$.

But it is higher than PPP exchange rate.

It implies that Yuan is overvalued

5) The interest rate in the U.K. is 2%, while the interest rate in the U.S. is 1.5%. The spot rate for the British pound is $1.55. According to the international Fisher effect (IFE), what is new level of the British pound?

6) Bronco Co. is a U.S.-based MNC that has subsidiaries in Spain and Germany. Both subsidiaries frequently remit their earnings back to the parent company. The Spain subsidiary generated a net outflow of €1,000,000 this year, while the German subsidiary generated a net inflow of €2,500,000. What is the net inflow or outflow as measured in U.S. dollars this year? The exchange rate for the euro is $1.18.

Exchange rate: $1.18/€

Outflow of Spain Subsidiary (a)= €1000000*$1.18/€=$1180000

Inflow of German Subsidiary (b)=€2500000*$1.18/€=$2950000

Net Inflow/ (Outflow)- (b-a)= $1770000

7)If one-year nominal interest rate in the U.S. is 3%, while the one-year nominal interest rate in Australia is 5%. The spot rate of the Australian dollar is $.97. Interest Parity is held. You will need 1 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many U.S. dollars will you have in one year from your forward contract?