Question

EuroUSA Bank (a fictitious name) is a dealer in the currency market. It posts bid prices for euros of $1.5000 and ask (or offer) prices for euros of $1.5010 in three months’ time. The following companies decide to trade forward contracts with the EuroUSA bank at the above prices. All payments are due in three months.

• A US company has bought a machine worth 3 million euros from a German manufacturer.
• A French company will buy 1.5 million euros worth of grains from the USA and sell them in France.
• A German importer will buy 2 million euros worth of computer parts from the USA.
• An Italian company has sold 1 million euros worth of designer clothes in New York; the company will take the money back to Italy after three months.

1. What is the amount on which EuroUSA has market risk exposure after three months?

1. 0.5 million euros
2. 1 million euros
3. 4 million euros
4. 7.5 million euros
5. None of these answers are correct.

2. How much profithas the EuroUSA Bank locked in?

1. 3,500 dollars
2. 3,500 euros
3. 4,000 dollars
4. 4,000 euros
5. None of these answers are correct.

Answer 1

Simplication of the problem can be explained by the table below :

	Bid Price	Ask Price
	Bank will Buy euro at this rate	Bank will sale euro at this rate
1 Euro =	$1.50	$1.501

Gist of all the 4 conditions is mentioned below :

		Exposure	Conclusion	Rate to be used	Open Cover in Euro
US Company	Imports	3 million Euro	Bank will Sale	1.501	3 Million
German	Exports	2 million Euro	Bank will buy	1.5	2 Million
French	Exports	1.5 million Euro	Bank will buy	1.5	1.50 Million
Italian	Imports	1 million Euro	Bank will sale	1.501	1 Million
			Total		Euro 7.50 Mllion

And hence EuroUSA Banktotal exposure of Euro 7.5 million euro however market risk exposure for the dealer is 0.5 million euros (i.e difference between Sale-Buy contract 4 million - 3.50 million euros) since at the end dealer needs to encash .50 million from the market for the uncertain prices.

How much profit hs the EuroUSA Bank locked in?

Total euros purchased by Bank		3.5 Million
Total Euros sold by Bank		4 Million

For 3.5 Million Euro

=Ask - Bid Price Difference =Spread = .01*3.5 million euros = 3500 Euros