1. 1(Ch. 3) Cross Exchange Rate. Assume Brazil's real (BRL) is worth USD .45 and the Mexican peso (MXN) is worth USD .076.What is the cross rate BRL/MXN?

1.2 (Ch. 4) Aggregate Effects on Exchange Rates. Your firm exports goods to the U.K., you are assigned to forecast the value of GBP against the USD -i.e., you forecast S_t(USD/GBP).Explain how each of the following conditions will affect the value of the GBP, holding other things equal.Then, aggregate all of these impacts to develop an overall forecast of the GBP's movement against the USD.

a.U.S. inflation has suddenly increased substantially, while U.K.'s inflation remains low.

b.U.S. interest rates have increased substantially, while U.K.'s interest rates remain low.

c.The U.S. income level increased substantially, while the U.K.'s income level has remained unchanged.

d.The U.S. is expected to impose a small tariff on goods imported from the U.K.

e.The U.K. government plans to leave the European Union.

f.Combine all expected impacts to develop an overall forecast.

1.3 (Ch. 4) Speculation. Deacon Bank expects that the Mexican peso (MXN) will depreciate against the USD from its spot rate of USD .08 to USD .072 in 20 days.The following interbank lending and borrowing rates exist:

LendingRate BorrowingRate

U.S. dollar (USD)2.0%2.1%

Mexican peso (MXN)4.7%5.0%

Assume that Deacon Bank has a borrowing capacity of either USD 10 million or MXN 70 million in the interbank market, depending on which currency it wants to borrow.

a.How could Deacon Bank attempt to capitalize on its expectations without using deposited funds?Estimate the profits that could be generated from this strategy.

1.4 (Ch. 5) Selling Currency Call Options. Farrokh Bulsara sold a call option on Canadian dollars (CAD) for USD.02 per unit.The strike price was USD.86, and the spot rate at the time the option was exercised was USD.82.Assume Mr. Bulsara did not obtain CAD until the option was exercised.Also assume that there are 50,000 units in a CAD option.What was Mr. Bulsara's net profit on the call option?

1.5 (Ch. 5) Selling Currency Put Options. Brian May sold a put option on CAD for USD .04 per unit.The strike price was USD .85, and the spot rate at the time the option was exercised was USD .82.Assume Brian immediately sold off the CAD received when the option was exercised. Also assume that there are 50,000 units in a CAD option.What was Brian's net profit on the put option?

1.6 (Ch. 5) Speculating with Currency Put Options. Queen Co. has purchased CAD options for speculative purposes.Each option was purchased for a premium of USD .02 per unit, with an exercise price of USD .89 per unit.Queen Co. will purchase the CAD just before it exercises the options (if it is feasible to exercise the options).It plans to wait until the expiration date before deciding whether to exercise the options.In the following table, fill in the net profit (or loss) per unit to Queen Co. based on the listed possible spot rates of the CAD on the expiration date.

Possible S_t (USD/CAD) Net Profit (Loss) per Unit

on Expiration Dateif Spot Rate Occurs

.81

.86

.89

.92

.95

1.01

1.7 (Ch. 6) Effects on Currencies Tied to the Dollar. The Hong Kong dollar's (HKD) value is tied to the USD.Explain how the following trade patterns would be affected by the appreciation of the Japanese yen against the dollar:(a) Hong Kong exports to Japan and (b) Hong Kong exports to the United States.

1.8 (Ch. 6) Intervention Effects on Bond Prices.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?

1.9 (Ch. 6) Effect of High Oil Prices and CB Intervention. During the past decade, oil prices have reached historically high levels, getting to over USD 100 per barrel. Suppose you work for the Central Bank of the UAE, which keeps a fixed FX system (S_t= 3.6725 AED/USD). The UAE's economy is dependent on oil exports.

(a) Describe the pressures the AED faces due to the increase in oil prices? What does the CB of the UAE have to do in order to support the fixed FX exchange rate? Do the FX reserves increase or decrease in the UAE?

(b) What is the impact on the UAE's domestic money supply and interest rates?

(c) How can the CB neutralize (sterilize) the effect of high oil prices on the UAE's money supply?

1.10(Ch. 6) Direct ECB Intervention. If most countries in Europe experience a recession, how might the European Central Bank (ECB) use direct intervention in FX markets to stimulate economic growth? What is the effect of this ECB intervention on European Money Markets?

1.11(Ch. 7) Triangular Arbitrage.Assume the following information:

S_t = .8 USD/CAD

S_t = 1.40 USD/GBP

S_t = 2 CAD/GBP

Is triangular arbitrage possible?If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy (expressed as a % per unit borrowed). What market forces would occur to eliminate any further possibilities of triangular arbitrage?

1.12(Ch. 7) Covered Interest Arbitrage. Assume the following information:

S_t = 1.50 USD/EUR

F_t,90 = 1.48 USD/EUR

i_EUR = 5.50%

i_USD = 3.75%

T = 90 days

Given this information, is covered interest arbitrage possible? Design a covered arbitrage strategy and calculate its profits.

1.13(Ch. 7) Covered Interest Arbitrage. Assume the following information:

S_t = 6 ARS/EUR

F_t,180 = 6.25 ARS/EUR

i_EUR = 2%

i_ARS = 7%

T = 180 days

Given this information, is covered interest arbitrage possible? Design a covered arbitrage strategy and calculate its profits.

1.14(Ch. 8) Estimating Depreciation Due to PPP. Assume that S_t = 1.60 USD/GBP.How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 5% while the U.S. experiences an inflation rate of 3%?

1.15(Ch. 8) Forecasting the Future Spot Rate Based on IFE. Assume S_t= .75 USD/SGD that (SGD = Singapore dollar.The 180-day interest rate is 2% in the U.S. and 5% in Singapore.What will the spot rate be in 6 months according to the IFE?(You may use the approximate formula to answer this question.)

1.16(Ch. 8) Deriving Forecasts of the Future Spot Rate. As of today, assume the following information is available:

U.S.Mexico

Real rate of interest required by investors1%1%

Nominal interest rate2%6%

Spot Rate (S_t).056 USD/MXN

Oneyear forward rate (F_t,_1-yr) .052 USD/MXN

a.Use the forward rate to forecast the percentage change in the USD/MXN over the next year.

b.Use the differential in expected inflation to forecast the percentage change in the USD/MXN over the next year. (Hint: you can get the expected inflation using Fisher's formula -i.e., the nominal interest rate is equal to the real interest rate plus expected inflation.)

c.Use the spot rate to forecast the percentage change in the USD/MXN over the next year.