Question

Interest rates are 7% in the U.S. Foreign interest rates are 10%. If you expect the foreign currency to depreciate 5%, where are you better off investing?

A U.S. firm has a future receivable (cash inflow) denominated in Euros. The U.S. firm faces foreign exchange risk in the form of the Euro _____________ between now and the time the U.S. firm receives Euros.

In the current international trade environment, countries are increasingly taking steps to strengthen their home currency so as to maximize purchasing power.

A U.S. firm has a receivable of €100,000 in one year. Forward rate quotes are $1.1850/€ bid and $1.1875/€ ask. If the U.S. firm hedges with a forward, what is the guaranteed amount of USD the U.S. firm will get from the receivable?

True or false. Firms hedge because exchange rates are hard to predict and the firm may want to eliminate the risk associated with these unpredictable exchange rate moves.

Baylor Bank believes the New Zealand dollar will depreciate over the next 6 months from $.41/NZ$ to $.38/NZ$. The following 6-month interest rates apply: (the rates are periodic rates so you do not need to adjust them at all – we do not need to multiply by 180/360 or anything like that)

       Currency                    Lending Rate               Borrowing Rate

       Dollars    3.0% 3.25%

       New Zealand dollar (NZ$)    4.0% 4.25%

Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank’s forecast if correct, what will its U.S. dollar profit be from speculation over the 6-month period?

Suppose a U.S. firm issues a bond denominated in a foreign currency at a 2% lower interest rate than they could issue in the U.S. Over time, the foreign currency depreciates 2% against the U.S. dollar. The U.S. firm’s dollar-denominated equivalent cost of funding for this foreign issue is?

Assume a Japanese firm invoices exports to the U.S. dollars. Assume that the forward rate and spot rate of the Japanese yen and equal. If the Japanese firm expects the yen to____ against the dollar, it would likely wish to hedge. It could hedge by____ yen forward.

Suppose you have the following exchange rate: $1.155/C$ and euro 0.7294/$. Compute the cross exchange rate with the Canadian dollar as the terms currency and the Euro as the vase currency.

Interest rates are 2% in the U.S. and 5% in Mexico. Joe carry trader borrows $10,000,000 to execute a carry trade. At the start, the exchange rate is MXN9.5411/$. After one year, the exchange rate is MXN9.7144/$.

Answer 1

Let the foreign currency be denoted by K

Also assume that the initial exchange rate is 1 $ = 1 K

Now if you invest 1 $ for 1 year in the US your payoff after a year at 7% per annum interest rate would be 1 x (1.07) = $ 1.07

The same amount in the foreign currency invested for one year at the foreign interest rate of 10% per annum would be 1 x (1.1) = 1.1K

After one year the foreign currency depreciates by 5% relative to the USD. This means that 1USD would be able to buy 5% more of the foreign currency after one year as compared to today.

This implies that after one year 1$ = 1x(1.05) = 1.05 K

The investment pay off after one year in the foreign currency when converted to USD = 1.1 K / 1.05 = $ 1.048

The investment in USD on the other hand pays off a greater sum of $1.07 which means that its better to invest in the US. This happens despite the US possessig a lower interest rate because the higher interest rate abroad depreciates the foreign currency thereby making returns in real USD terms lesser for an investor.

NOTE: Please raise separate queries for solutions to the remaining unrelated questions.