Question

1. You are given the sovereign ratings for the following countries: Brazil (BB-), Colombia (BBB-), Mexico (BBB), Peru (BBB+), and Chile (A-). Based only on this information about the sovereign ratings for hard currency debt,  which of the following statements about hard currency debt trading is FALSE

   	A.	Brazilian sovereign bond yields are higher than Chilean bond yields.
   	B.	If you want to "pick up yield" you go long Brazilian hard currency debt and sell Peruvian hard currency debt.
   	C.	Of all the countries listed, Chile has the lowest probability of defaulting on its sovereign debt
   	D.	Colombian sovereign bond yields spreads trade below Mexican sovereign bonds yields
   	E.	Chilean hard currency debt would be more suitable for risk-averse investors but this would come at the expense of earnings lower interest income

QUESTION 2

As an FX Trader, you are looking for currencies in Latin America that offer high carry and could be a good long for your trading book. One of the criteria for choosing the currency is to measure how undervalued (cheap) or overvalued (rich) the target currency is. Assuming that the currencies below pay the same interest rate in local currency terms and that a USD deposit pays 0%, which of the following five currencies would you choose to go long?

	A.	BRL (Brazilian real) is 5% overvalued
	B.	MXN (Mexican Peso) is 15% undervalued
	C.	COP (Colombian Peso) is 25% undervalued
	D.	PEN (Peruvian sol) is fair valued
	E.	CLP (Chilean Peso) is 10% overvalued

QUESTION 3

Research tells the FX trading desk that Brazil will soon experience a significant deterioration in its terms of trade (lower iron ore, oil, and soy prices). In addition BACEN will cut interest rates by 200bps, while a newly elected government will boost spending and increase the fiscal deficit. Please mark the only trade that would NOT be suitable for this rapid deterioration (3 to 6 months) in Brazil's sovereign outlook.

	A.	Buy out of the money USD calls in the Brazilian exchange B3 expiring in 6 months
	B.	Sell BRL futures in Chicago with expiration in 3 months
	C.	Buy USD forward over-the-counter in Brazil with settlement in 3 months
	D.	Go long Brazilian EWZ ETF index in the US
	E.	Buy 5-year Credit Default Swap (CDS) protection for the Federative Republic of Brazil

QUESTION 4

Bored with the world of zero rates, Mike Maverik (a junior analyst at PJ Stanley, a global investment bank) decides to do the famous carry trade. Mike borrows in the US US$100 million at a rate of 0.25%, and converts it into BRL at the spot rate of R$5.00 = US$1.00. He then invests the loan proceeds in Brazil, earning an annual rate of 4.00% in BRL. Instead of selling today the proceeds from the investment forward, Mike will wait one year to convert the investment at the Spot rate one year from now. One year later the spot rate moves to R$5.20 per US$1.00. please mark the only FALSE answer.

	A.	Mike will neither gain nor lose from the trade because of the covered interest rate parity condition
	B.	The BRL is trading at a forward discount to the USD
	C.	Mike estimated that he will profit R$20 million from this trade
	D.	Mike will received a hefty bonus from PJ Stanley because the trade will make US$250,000 for the bank
	E.	If today the one year forward rate is R$5.1870324 per US$1.00 then, as the covered interest arbitrage condition predicts, there is no money to be made on this trade

QUESTION 5

Mildred is a trader at Turtle Funds based in the Cayman Island, where she can investor go long/short. Mildred is bullish about the upside for IRONX (a major Brazilian exporter of iron ore) shares based on attractive valuations versus competitors and strong projected earnings growth for the next three years. Mark the only hedge that WOULD NOT work for Mildred's position.

	A.	Short the stock of Vale, another Brazilian iron ore exporter
	B.	Short the Australian Dollar (AUD)
	C.	Buy out of the money protective puts for IRONX at a lower strike price than the current share price
	D.	Write out of the money USD calls from the Brazilian exchange B3
	E.	Short iron ore futures in the Brazilian commodities exchange

Answer 1

The ratings in the order of Strong to weak by S&P can be given as

AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC

In this obviuosly the AAA reprents the highest credit quality whereas the CCC reflects the lowest credit quality

Now the yields of the highest credit quality are lower because of their less probability of default whereas the yields of the lowest credit quality will be highest

So the yields will increase as the credit quality worsens

Now as per the data given for the credit rating of different countries and after rearranging the ratings from strong to weak we get the following

Chile(A-), Peru(BBB+), Mexico (BBB), Colombia (BBB-), Brazil (BB-)

A. TRUE - Brazil bonds will have the highest yields and Chile bonds will have the lowest yield

B. TRUE - Yield pickup is the additional interest rate an investor will receive by selling a lower-yielding bond and buying a higher-yielding bond.

Now when you go long Brazilian hard currency debt and sell Peruvian hard currency debt you are buying a higher yielding bond and selling a lower yielding bond which is Yield Pickup

C. TRUE - Chile has the highest credit rarting and hence the lowest probabilty of default

D. FALSE - Mexico bond yields are lower than Colombia bond yields, hence Colombia bond yields trade above the Mexico bond yields