A Namibia firm has an obligation to pay 1,000,000 in 3 months time and has exported goods worth US$500,000, payment of which is also expected in 3 months time. It is the end of the year, when the exchange rate between the Namibian dollar and the US dollar (NamD/USD) is 16.975 and the exchange rate between the Namibian dollar and the British pound (Nam/Pound) is 19.485. The exchange rate outlook is very blurred as it is believed that the exchange rates could move either way. The following probability distributions are available for the value of the exchange rates expected to prevail at the end of the 3-months period: NamD/USD Probability NamD/GBP Probability 16.575 0.20 19.378 0.10 16.960 0.15 19.475 0.20 17,125 0.35 19.672 0.15 17.595 0.30 19.895 0.40 19.915 0.15 (a) Explain how are the exchange rates are defined in this case. (2 marks) (b) How much will the Namibian firm receive from its exports if the exchange rates stay the same? (3 marks) (c) How much will the Namibian firm pay in domestic currency for its imports if the exchange rates stay the same? (3 marks) 2 (d) What is the worst expected Namibian dollar/US dollar exchange rate? (1 mark) (e) What are the expected spot exchange rates for the United States dollar and the British Pound against the Namibian dollar? (6 marks) (f) How much does the Namibian firm expect to receive from its exports? (3 marks) (g) How much does the Namibian firm expect to pay for its imports? (3 marks) (h) What is the probability that the Namibian dollar will appreciate against the United States dollar? (2 marks) (i) What is the probability that the Namibian dollar will depreciate against the British Pound? (2 marks) Question 2 (10 marks) The Table below provides quotes from three Banks A,B, and C for the British Pound in U.S. dollars (A), the US dollar in Euros (B) and the British Pound in Euros (C). Bid price Ask price A USD/POUND 1.4871 1.4900 B EURO/USD 0.8794 0.8852 C EUR/POUND 1.3050 1.3062 (a) Calculate the appropriate EUR/POUND bid and -ask cross exchange rates. (4 marks) (b) Give your answers to (a), which currency is overvalued? Explain your answer. (2 marks) (c) Assuming no other trading costs, explain if there are arbitrage opportunities for a US dealer with US$800,000. If there are no arbitrage opportunities explain why. (5 marks) Question 3 (15 marks) 3 A firm wants to undertake an investment project which costs N$25,000, which it wants to finance through a bank loan. The project has a 60 percent probability of success. If the project succeeds the firm will make a cash flow of N$75,000 after a year. If it fails the firm will get a cash flow of N$10,000 and will be required to pay the whole amount to the bank. The bank has a required return of 25%. (a) What will be the banks loan rate at which it will be willing to lend? Explain. (4 marks) (b) How much will be the banks safe income? (1 mark) (c) How is the banks lending rate related to the probability of failure? Explain your answer. (2 marks) (d) What will be the firms expected profit at the rate in (a)? Will the firm be willing to participate at that rate? (4 marks) (e) How much will be the banks uncertain income? What will be the expected values of these incomes? (4 marks) END