Question

please answer all questions.

1- The current spot exchange rate is $1.20/£ and the three-month forward rate is $1.18/£. Based on your research, you expect the exchange rate to be $1.19/£ in three months. Assume you have £1,000,000 available to you.

a. What is the current forward premium/discount on the £?

b. What action do you need to take to speculate on your expectation about the exchange rate? What is your profit/loss if your expectation is correct?

c. What is your profit/loss if the exchange rate is $1.175/£ three months later?

2- While you were visiting Turin, Italy, you purchased a Ferrari for €135,000, payable in three months. You have enough cash at your bank in New York, which pays .35 per month compounding monthly. Currently the spot exchange rate is $1.15/€ and the three month forward exchange rate is $1.14/€. In Turin, the money market investment rate is 2.0% for a cumulative three month investment. There are two ways for you to pay for your Ferrari:

a. Keep your funds in the bank in the US and buy €135,000 forward

b. Buy a certain € amount spot today and invest the amount in Turin for three months so that the maturity value becomes equal to €135,000. Which method do you prefer?

3- Assume that December 2016 Mexican Peso futures contract has a price of $.90975 per 10MXN. You believe the spot price in December will be $.9700 per10MXN. The size of 1 MXN futures contract is MXN500,000. What position do you need to enter into to benefit from your anticipation? If you use three futures contracts, what is your profit/loss if you end up correct in your belief?

4- A speculator is considering the purchase of five three-month Euro call options (size €100,000 each) with a striking price of $.869/€. The premium is 1.35 cents per €. The spot price is $.84/€ and the 90-day forward rate is $.85/€. The speculator believes the euro will appreciate to $.91/€ over the next three months. As the speculator’s assistant, you have been asked to prepare the following:

a. Determine the speculator’s profit if the euro appreciates to $.91/€.

b. Determine the speculator’s profit if the euro appreciates only to the forward rate

c. Determine the future spot rate at which the speculator will only break even.

5- Currently the spot exchange rate is $1.50/£ and the three month forward exchange rate is $1.52/£. The three month interest rate is 8.0% per annum in the US and 5.8% per annum in the UK. Assume that you can borrow as much as $1M. or £1M.

a. Is there a covered interest arbitrage opportunity for a US multinational? What is the payoff if they conducted CIA?

b. Is there a covered interest arbitrage opportunity for a UK multinational? What would be their payoff if they conducted CIA?

c. How will the covered interest rate parity be restored?

d.What should have been the “correct” forward exchange rate?

6- Suppose the current spot exchange rates are $1.15/€, and $1.25/£. Suppose also that a dealer quotes you €1.18/. Is there a triangular arbitrage opportunity? Calculate your profit for $1M. starting amount.

7- Briefly discuss advantages and disadvantages of fixed versus floating exchange rates.

8- “If a country employs a currency board, all monetary policy is on autopilot”. Explain this statement

9- What are the macroeconomic impacts of exchange rate appreciations/depreciations?

10- What is the main difference between direct and indirect interventions in foreign exchange markets?

Answer 1

1 a.) Discount or premium rate of commodity(Here £) = (fwd rate- Spot rate) / Spot rate. (1.18-1.2) / 1.2 = 0.016667 ie. 1.67%.

The annualised rate (fwd rate- Spot rate) / Spot rate x (12 / contract period) =(1.18-1.2) / 1.2 x (12/3) =

0.0166667 x 12/3 =6.67% Pa

b.) spot exchange rate is $1.20/£ and the three-month forward rate is $1.18/£. Based on your research, you expect the exchange rate to be $1.19/£ in three months. if I need to speculate, I will buy or long forward on £, then i will get pound(£) @ 1.18 and I can sell it @1.19 then i will get profit of $0.1. or 1 cent per £ total profit = 0.01 x 1,000,000 =$ 10,000

c.)   If i didnot enter forward to hedge, loss will be £1,000,000 x (1.2-1.175) = $25000 If the the exchange rate is $1.175/£ three months later

  profit/loss if i entered into forward to hedge, Iwill get will be £1,000,000 x 1.18 = $1,180,000

2. option - a. Keep funds in the bank in the US and buy €135,000 forward @1.14 so total outflow = $153900

option - b. Buy a certain € amount spot today and invest the amount in Turin for three months - the € s to be investe to reach € 135000 after three months, We have to buy € 135000/1.02 = €132352.94 today and invest. to buy €132352.94 we have to pay $1.15/€ so our total outflow today is $1.15 x 132352.94 = $152205.88, this amount is to be paid today. but under option -a, we can pay after 3 months, we have to compound this amount to 3 months later so $152205.88 x (1.0035³) = 153809.64.

so the option b is better

3 I wil long futures contracts on MXN, So I can take delivery of MXN @ $.90975 per 10MXN, and can sell @$.9700 per10MXN. Here let us assume entering into only one contract. The size of 1 MXN futures contract is MXN500,000. we have to pat $.90975/10 = 0.09075 per MXN, total 500,000 x 0.090975 = $45, 487.5 for 1 contract and sell it in the spot market @ .9700 per 10MXN, so our total receipt = 50000 x .97/10 = $48,500 so our profit will be 48500-45487.5 = $3,012.5 per contract

4 a.) speculator’s profit if the euro appreciates to $.91/€., strike price is $.869/€. his profit = Spot price - Strike price- premium = 100,000 x (0.91-0.869-.0135) $ 2750 per contract

b.) the speculator’s profit if the euro appreciates only to the forward ratei.e. $0.85 = 100,000 x(0.85-0.869- 0.0135), he will not get profit but he will have to suffer loss of $3250 per contract.

c.)  the future spot rate at which the speculator will only break even = Trike price + premium = 0.869+0.0135 = 0.8825

5 a.) Interest rate parity theory, forward rate =spot rate x (1+rf)/ (1+rh) = 1.50 x 1.08/1.058 = 1.53119, but actual forward rate =1.52 so there is arbitrage. borrow £1Million and enter into forward contract and convert to $ @ spot rate= 1,000,000 x 1.5 = $1,500,000 invest in us @8% , so will get $1,620,000 and reconvert the $s to £s at forward rate =1,620,000 / 1.52 = £1,065,487.47 and repay the £loan = £1,058,000, so profit will be £1,065,487.47-£1,058,000 = £7,789.47

b.)  Interest rate parity theory, forward rate =spot rate x (1+rf)/ (1+rh) = 1.50 x 1.08/1.058 = 1.53119, but actual forward rate =1.52 so there is arbitrage. borrow £1Million and enter into forward contract and convert to $ @ spot rate= 1,000,000 x 1.5 = $1,500,000 invest in us @8% , so will get $1,620,000 and reconvert the $s to £s at forward rate to repay the loan  £1Million with interest = £1,058,000 x 1.52 = $1,608,160 the profit will be $11,840

d.) the $1.53119/£ should have been the “correct” forward exchange rate.

the time allowed is is ending, sorry for inconvenience, the question was too long