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Questions and Answers of Banking

Kelly's Tavern serves Shamrock draft beer to its customers. The daily demand for beer is normally distributed, with an average of 20 gallons and a standard deviation of 4 gallons. The lead time
How does a futures contract differ from a forward contract?
What effects does “marking to market” have on futures contracts?
What are the differences between foreign currency option contracts and forward contracts for foreign currency?
What are you buying if you purchase a U.S. dollar European put option against the Mexican peso with a strike price of MXN10.0/ $ and a maturity of July? (Assume that it is May and the spot rate is
What are you buying if you purchase a Swiss franc American call option against the U.S. dollar with a strike price of CHF1.30/$ and a maturity of January? (Assume that it is November and the spot
What is the intrinsic value of a foreign currency call option? What is the intrinsic value of a foreign currency put option?
What does it mean for an American option to be “in the money”?
Why do American option values typically exceed their intrinsic values?
Suppose you go long in a foreign currency futures contract. Under what circumstances is your cumulative payoff equal to that of buying the currency forward?
What is basis risk?
Your CEO routinely approves changes in the fire insurance policies of your firm to protect the value of its buildings and manufacturing equipment. Nevertheless, he argues that the firm should not buy
Why do options provide insurance against foreign exchange risks in bidding situations? Why can’t you hedge with a forward contract in a bidding situation?
Suppose that you have a foreign currency receivable (payable). What option strategy places a floor (ceiling) on your domestic currency revenue (cost)?
Describe qualitatively how changing the strike price of the option provides either more or less expensive insurance.
Why does an increase in the strike price of an option decrease the value of a call option and increase the value of a put option?
Why does an increase in the volatility of foreign exchange rates increase the value of foreign currency options?
How does increasing time to maturity affect foreign currency option value?
What is the payoff on an average-rate pound call option against the dollar?
Suppose the current spot rate is $1.29/€. What is your payoff if you purchase a down-and-in put option on the euro with a strike price of $1.31/€, a barrier of $1.25/€, and a maturity of 2
If you sold a Swiss franc futures contract at time t and the exchange rate has evolved as shown here, what would your cash flows havebeen?
Given the following information, how much would you have paid on September 16 to purchase a British pound call option contract with a strike price of 155 and a maturity ofOctober?
Using the data in problem 2, how much would you have paid to purchase an Australian dollar put option contract with a strike price of 65 and an October maturity?Data from problem 2:Given the
Suppose that you buy a€1,000,000 call option against dollars with a strike price of $1.2750/€. Describe this option as the right to sell a specific amount of dollars for euros at a particular
Assume that today is March 7, and, as the newest hire for Goldman Sachs, you must advise a client on the costs and benefits of hedging a transaction with options. Your client (a small U.S. exporting
Assume that today is September 12. You have been asked to help a British client who is scheduled to pay €1,500,000 on December 12, 91 days in the future. Assume that your client can borrow and lend
Assume that today is June 11. Your firm is scheduled to pay £500,000 on August 15, 65 days in the future. The current spot is $1.75/£, and the 65-day forward rate is $1.73/£. You can borrow and
Upon arriving for work on Monday, you observe a violation of put–call parity. In particular, the synthetic forward price of dollars per yen is above the current forward rate. How would you
Use interest rate parity to demonstrate that you can represent putâ€“call parityas
On April 28, 1995, the Paine Webber Group introduced a new type of security on the NYSE: U.S. dollar increase warrants on the yen. At exercise, each warrant entitled the holder to an amount of U.S.
How does an interest rate swap work? In particular, what is the notional principal?
What is a currency swap? Describe the structure of and rationale for its cash flows.
What is a credit default swap? What happens in the event of default?
Banks quote interest rate and currency swaps using 6-month LIBOR as a basis for both transactions. How can a bank make money if it does not speculate on movements in either interest rates or exchange
What is the AIC of a bond issue?
What is a comparative advantage in borrowing, and how could it arise?
What is basis point adjustment? Why is it not appropriate simply to add the basis point differential associated with the first currency to the quoted swap rate that the firm will pay?
Discuss the sense in which a 5-year currency swap is a sequence of long-term forward contracts. How do the implicit forward exchange rates in a currency swap differ from the long-term forward
What are the determinants of the value of a currency swap as time evolves? Is it possible to close out a swap before it has reached maturity?
General Motors (GM) wants to swap out of $15,000,000 of fixed interest rate debt and into floating interest rate debt for 3 years. Suppose the fixed interest rate is 8.625% and the floating rate is
Pfizer is a U.S. firm with considerable euro assets. It is considering entering into a currency swap involving $10 million of its dollar debt for an equivalent amount of euro debt. Suppose the
At the 7-year maturity, U.S. Treasury bonds’ yield to maturity is 7.95% p.a. The Second Bank of Chicago states that it will make fixed interest rate payments on dollars at the yield on Treasury
The swap desk at UBS is quoting the following rates on 5-year swaps versus 6-month dollar LIBOR:U.S. Dollars: ....... 8.75% bid and 8.85% offeredSwiss Francs: .......5.25% bid and 5.35% offeredYou
Suppose Viacom can issue $100,000,000 of debt at an AIC of 9.42%, whereas Gaz de France can issue $100,000,000 of debt at an AIC of 10.11%. Suppose that the exchange rate is $1.35/€. If Viacom
Suppose in problem 5 that because of currency risk, Viacom would prefer to have dollar debt, and Gaz de France would prefer to have euro debt. How could an investment bank structure a currency swap
Suppose Sony issues $100,000,000 of 5-year dollar bonds. Nomura will handle the bond issue for a fee of 1.875%. Sony’s bonds will be priced at par if they carry a coupon of 8.5%. As the swap trader
Assume that 1 year has passed since you entered into the transaction described in problem 4. Assume that the new spot exchange rate is CHF1.45/$ and that UBS is now quoting the following interest
Web Question: Go to www22.verizon.com/investor/ app_resources/interactiveannual/2010/mda06.html to find an excerpt of the 2010 Annual Report of Verizon, a large telecommunications company. Determine
Should China Be Forced to Alter the Value of Its Currency?Point U.S. politicians frequently suggest that China needs to increase the value of the Chinese Yuan against the U.S. dollar, even though
Compare and contrast the fixed, freely floating, and managed float exchange rate systems. What are some advantages and disadvantages of a freely floating exchange rate system versus a fixed
Assume that Belgium, one of the European countries that uses the euro as its currency, would prefer that its currency depreciate against the U.S. dollar. Can it apply central bank intervention to
How can a central bank use direct intervention to change the value of a currency? Explain why a central bank may desire to smooth exchange rate movements of its currency.
How can a central bank use indirect intervention to change the value of a currency?
Assume there is concern that the United States may experience a recession. How should the Federal Reserve influence the dollar to prevent a recession? How might U.S. Exporters react to this policy
What is the impact of a weak home currency on the home economy, other things being equal? What is the impact of a strong home currency on the home economy, other things being equal?
Explain the potential feedback effects of a currency’s changing value on inflation.
Why would the Fed’s indirect intervention have a stronger impact on some currencies than others? Why would a central bank’s indirect intervention have a stronger impact than its direct
The Hong Kong dollar’s value is tied to the U.S. dollar. Explain how the following trade patterns would be affected by the appreciation of the Japanese yen against the dollar: (a) Hong Kong exports
U.S. bond prices are normally inversely related to U.S. inflation. If the Fed planned to use intervention to weaken the dollar, how might bond prices be affected?
If most countries in Europe experience a recession, how might the European Central Bank use direct intervention to stimulate economic growth?
Explain the difference between sterilized and non sterilized intervention.
Suppose that the government of Chile reduces one of its key interest rates. The values of several other Latin American currencies are expected to change substantially against the Chilean peso in
Should the governments of Asian countries allow their currencies to float freely? What would be the advantages of letting their currencies float freely? What would be the disadvantages?
During the Asian crisis, some Asian central banks raised their interest rates to prevent their currencies from weakening. Yet, the currencies weakened anyway. Offer your opinion as to why the central
Why do foreign market participants attempt to monitor the Fed’s direct intervention efforts? How does the Fed attempt to hide its intervention actions? The media frequently report that “the
Within a few days after the September 11, 2001, terrorist attack on the United States, the Federal Reserve reduced short-term interest rates to stimulate the U.S. economy. How might this action have
Assume you have a subsidiary in Australia. The subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from local banks. Your subsidiary purchases
Why do you think a country suddenly decides to peg its currency to the dollar or some other currency? When a currency is unable to maintain the peg, what do you think are the typical forces that
Assume that the central bank of the country Zakow periodically intervenes in the foreign exchange market to prevent large upward or downward fluctuations in its currency (called the Zak) against
1. Did the intervention effort by the Thai government constitute direct or indirect intervention? Explain. 2. Did the intervention by the Thai government constitute sterilized or non-sterilized
1. Forecast whether the British pound will weaken or strengthen based on the information provided.2. How would the performance of the Sports Exports Company be affected by the Bank of England’s
Was the depreciation of the Asian currencies during the Asian crisis due to trade flows or capital flows? Why do you think the degree of movement over a short period may depend on whether the reason
Why do you think the Indonesian rupiah was more exposed to an abrupt decline in value than the Japanese yen during the Asian crisis (even if their economies experienced the same degree of weakness)?
During the Asian crisis, direct intervention did not prevent depreciation of currencies. Offer your explanation for why the interventions did not work.
During the Asian crisis, some local firms in Asia borrowed U.S. dollars rather than local currency to support local operations. Why would they borrow dollars when they really needed their local
The Asian crisis showed that a currency crisis could affect interest rates. Why did the crisis put upward pressure on interest rates in Asian countries? Why did it put downward pressure on U.S.
It is commonly argued that high interest rates reflect high expected inflation and can signal future weakness in a currency. Based on this theory, how would expectations of Asian exchange rates
During the Asian crisis, why did the discount of the forward rate of Asian currencies change? Do you think it increased or decreased? Why?
During the Hong Kong crisis, the Hong Kong stock market declined substantially over a 4-day period due to concerns in the foreign exchange market. Why would stock prices decline due to concerns in
On August 26, 1998, the day that Russia decided to let the ruble float freely, the ruble declined by about 50 percent. On the following day, called “Bloody Thursday,” stock markets around the
Normally, a weak local currency is expected to stimulate the local economy. Yet, it appeared that the weak currencies of Asia adversely affected their economies. Why do you think the weakening of the
During the Asian crisis, Hong Kong and China successfully intervened (by raising their interest rates) to protect their local currencies from depreciating. Nevertheless, these countries were also
Why do you think the values of bonds issued by Asian governments declined during the Asian crisis? Why do you think the values of Latin American bonds declined in response to the Asian crisis?
Why do you think the depreciation of the Asian currencies adversely affected U.S. firms? (There are at least three reasons, each related to a different type of exposure of some U.S. firms to exchange
During the Asian crisis, the currencies of many Asian countries declined even though their governments attempted to intervene with direct intervention or by raising interest rates. Given that the
Does Arbitrage Destabilize Foreign Exchange Markets?Point Yes. Large financial institutions have the technology to recognize when one participant in the foreign exchange market is trying to sell a
Explain the concept of locational arbitrage and the scenario necessary for it to be plausible.
Assume the following information:Given this information, is locational arbitrage possible? If so, explain the steps involved in locational arbitrage, and compute the profit from this arbitrage if you
Explain the concept of triangular arbitrage and the scenario necessary for it to be plausible.
Assume the following information:Quoted PriceValue of Canadian dollar in U.S. dollars ........$.90Value of New Zealand dollar in U.S. dollars ........$.30Value of Canadian dollar in New Zealand
Explain the concept of covered interest arbitrage and the scenario necessary for it to be plausible.
Assume the following information:Spot rate of Canadian dollar ...........= $.8090-day forward rate of Canadian dollar ........= $.7990-day Canadian interest rate ............= 4%90-day U.S. interest
Assume the following information:Spot rate of Mexican peso ..........= $.100180-day forward rate of Mexican peso .....= $.098180-day Mexican interest rate ..........= 6%180-day U.S. interest rate
The terrorist attack on the United States on September 11, 2001, caused expectations of a weaker U.S. economy. Explain how such expectations could have affected U.S. interest rates and therefore have
Explain the concept of interest rate parity. Provide the rationale for its possible existence.
Assume that the existing U.S. one-year interest rate is 10 percent and the Canadian one-year interest rate is 11 percent. Also assume that interest rate parity exists. Should the forward rate of the
Why would U.S. investors consider covered interest arbitrage in France when the interest rate on euros in France is lower than the U.S. interest rate?
Assume that the Japanese yen’s forward rate currently exhibits a premium of 6 percent and that interest rate parity exists. If U.S. interest rates decrease, how must this premium change to maintain
If the relationship that is specified by interest rate parity does not exist at any period but does exist on average, then covered interest arbitrage should not be considered by U.S. firms. Do you
The one-year interest rate in New Zealand is 6 percent. The one-year U.S. interest rate is 10 percent. The spot rate of the New Zealand dollar (NZ$) is $.50. The forward rate of the New Zealand

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