1. Suppose that you work for the CFO of the James Company. The James Company does business in both U.S. dollars and in Polish zloty, so it regularly carries bank account balances in both currencies. The James Company observes differences in spot exchange rates for the zloty in terms of U.S. dollars at the two banks it regularly uses, and is considering whether it should try to profit from arbitrage.

	Alpha Bank	Beta Bank
Bid	$0.224	$0.228
Ask	$0.227	$0.229

a. (8 points) James Companys CFO has approved using either $100,000 or 400,000 zloty for arbitration profits using Alpha Bank and Beta Bank. What profits, if any, can James Company make using these funds for arbitrage, if it moves quickly before exchange rates adjust?

b. (6 points) The locational arbitrage opportunity described in question 1.a. will disappear fairly quickly after it is detected. Why does that happen, and how will the market adjust at each bank?

c. (8 points) The James Company CFO has also approved using another $100,000, 400,000 zloty, or 1 million Turkish lira for you to use in triangular arbitrage using dollars, zloty, or lira. You notice that that the spot rates you used for part a. have not adjusted, so the bid and ask rates from part a are still available. For the Turkish lira, all of the banks you considered are all offering the following bid and ask prices. What profits (if any) can you make using locational arbitrage involving dollars, zloty, and lira, if the following are the current exchange rates for lira?

	Quoted Bid Price	Quoted Ask Price
Exchange Rate for Turkish lira in U.S. dollars	$0.085	$0.086
Exchange Rate for Polish zloty in Turkish lira	2.69 lira	2.70 lira

2. (8 points) The CFO of James Company (from question 1) next authorizes you to use another $100,000 in U.S. dollars for covered interest arbitrage with Australian dollars. You see that the oneyear interest rate in Australia is 5 percent and the oneyear U.S. interest rate is 8 percent. The spot rate of the Australian dollar is $.94. The forward rate of the Australian dollar is $.97. What profits, if any can you make using the $100,000 in U.S. dollars for covered interest arbitrage with Australian dollars?

3. Assume that the interest rate on a one-year insured U.S. bank deposit is 4%, and the interest rate on a 1-year insured Swedish bank deposit is 2.5%.

a. (4 points) Using the simplified formula, for the actual returns of these two investments to be similar from the perspective of investors in the United States country, by how much (as a percentage) does the Swedish currency have to change over the investment horizon?

b. (4 points) Using the full formula, for the actual returns of these two investments to be similar from the perspective of investors in the United States country, by how much (as a percentage) does the Swedish currency have to change over the investment horizon?

4. (6 points) Briefly explain the technical approach forecasting exchange rates. What is at least one limitation of using technical forecasting to predict these rates? (Be sure to answer both questions in your response.)

5. (6 points) Big Box Corporation, based in Kansas City, does business in Canada and Mexico. Big Box has net inflows of 100 million Mexican pesos and net outflows of 100 million Canadian dollars. The present exchange rate of the Mexican peso is approximately $.05 and the present exchange rate of the Canadian dollar about is $.85. Big Box has not hedged these positions. Will Big Box will be favorably or adversely affected if the dollar weakens against these currencies over time. Briefly explain.

6. (8 points) Lear Jet has a new contract to build airplanes in Wichita and deliver them to a buyer in India in three years. Lear Jet will be paid 500 million rupees on delivery in 3 years. The spot rate today for Indian rupees is $0.015. Interest rates for 3-year debt are 4% in the United States and 9% in India. Assume that interest rate parity exists (so that we can determine the forward rate premium based on existing rates). How much will Lear Jet receive in 3 years if its hedges its exposure with a forward contract that it will arrange today?

7. (6 points) XYZ Corporation is based in Canada but does about half of its business in the United States. XYZ Corporation tends to have about $80 million in receivables in dollars, but rarely more than $10 million in payables in U.S. dollars. These net receivables are large relative to XYZ Corporations cash flows, so the company is worried about its exposure to unfavorable changes in the exchange rate for U.S dollars in Canadian dollars. Explain how XYZ Corporation should hedge its large net receivables in U.S. dollars with a forward contract and why this hedging will protect XYZ Corporation.

8. (6 points) Suppose that you work are the manager of the finance department for the Smith Company. Smiths operations are growing rapidly in Paraguay, and as a result of its growth in Paraguay, Smith now has a large amount of payables in Paraguayan Guarani. You noticed that historically, the forward rate of the Paraguayan Guarani shows a large discount. You have evidence that interest rate parity and purchasing power parity currently hold for the U.S. and Paraguayan economies. Does the consistent discount in the forward rate for the Paraguayan Guarani mean that the forward rate is underpriced (that is, banks should quote a higher forward rate)? Briefly explain.

9. (6 points) Company A and Company B are both U.S.-based companies that do business outside of the country. Both companies have high net receivables and could be affected by unfavorable currency exchange rate movements.

• Company A does about 50% of its business in Canada, 40% in the United States, and 10% in Mexico.
• Company B does about 10% of its business in Canada, 40% in the United States, 10% in Mexico, 10% in France, 10% in Russia, 10% in China, and 10% in several South American countries.

Which company, Company A or Company B, is likely to benefit more from hedging its net receivables against unfavorable currency exchange rate movements? Briefly explain why.

10. ABC Company, based in Wichita, has a subsidiary in Mexico that manufactures and sells its product almost entirely in Mexico, so that ABCs main exposure concern is translation exposure when profits are sent to the U.S.

a. (6 points) Using forward contracts, how can ABC Company hedge its translation exposure? Briefly explain how ABC Company would offset its translation exposure using the type of forward contract you identify.

b. (6 points) Using currency options, how can ABC Company hedge its translation exposure? Briefly explain how ABC Company would offset its translation exposure using the type of currency option you identify.

11. (6 points) Big Tech builds all of its products in Kansas. As a result of an acquisition several years ago, Big Tech, Inc. acquired a company with an established distribution network in Germany. Using this network, Big Tech, Inc. has greatly expanded the sales of its products in European countries that use the Euro as their currency. Big Tech sells its products in prices measured in Euros, but it invoices its costs of goods sold in U.S. dollars.

As a result of this growth in European counties, Big Tech now needs to build additional distribution centers in Europe to support its growing sales. Big Tech can finance its construction costs in Europe with a 5-year loan by (1) borrowing in U.S. dollars, (2) borrowing in Euros, or (3) borrowing one-half of the funds in U.S. dollars and half in Euros. The 5-year interest rates on a Euro loan and a U.S. dollar loan are the same.

If Big Tech wants to use the form of financing that will help manage its exposure to exchange rate risk the best, what is the optimal form of financing? Briefly explain your response.

12. (6 points). Shocker Corporation, based in Wichita, operates subsidiaries in several South American countries. Each of these subsidiaries operates largely independently from the parent company, with nearly all of their sales and expenses in the countries where they are located. How will Shocker Corporations consolidated earnings are be affected if the U.S. dollar appreciates against South American currencies?