Assignmentsfrom ESM Chapter 5

Questions:6, 8 and 13

Problems:3, 6, and 12.

InternetExercise: 1

Assignmentsfrom ESM Chapter 6

Questions:3 and 17

Problems:3, 10, and 22

InternetExercise: 1

Assignmentsfrom ESM Chapter 7

Questions:6, 10, and 15.

Problems:2, 4, and 12 to 16.

InternetExercise: 5

CHAPTER 5 question 6,8 & 13 Problem 5.3 Yen Forward Use the following spot and forward bid-ask rates for the Japanese yen/U.S. dollar (/$) exchange rate from September 16, 20 the following questions: Period spot 1 month 2 months 3 months 6 months 12 months 24 months /$ Bid Rate 85.41 85.02 84.86 84.37 83.17 82.87 81.79 /$ Ask Rate 85.46 85.05 84.9 84.42 83.2 82.91 81.82 a. What is the mid-rate for each maturity? b. What is the annual forward premium for all maturities? c. Which maturities have the smallest and largest forward premiums? Since the exchange rate quotes are indirect quotes on the dollar (/$), the proper forward premium calculation is: Forward premium = ( Spot - Forward ) / (Forward) x (360 / days) Period spot 1 month 2 months 3 months 6 months 12 months 24 months Days Forward 30 60 90 180 360 720 /$ Bid Rate 85.41 85.02 84.86 84.37 83.17 82.87 81.79 /$ Ask Rate 85.46 85.05 84.9 84.42 83.2 82.91 81.82 The forward rates progressively require fewer and fewer Japanese yen per dollar than the current spot rate. Therefore the yen forward at a premium and the dollar is selling forward at a discount. c. Which maturities have the smallest and largest forward premiums? The 24 month forward rate has the smallest premium, while the 1 month forward possesses the largest premium. Problem 5.6 Moscow to Tokyo After spending a week in Moscow you get an email from your friend in Japan. He can get you a really good deal on a plane ticket and wants you to meet him in Tokyo next week to continue your postgraduation celebratory trip. You have 450,000 rubles left in your money pouch. In preparation for the trip you want to exchange your Russian rubles for Japanese yen so you get the following quotes: Spot rate on the rubles/do Rbl 30.96/$ Spot rate on the yen/doll 84.02/$ a. What is the Russian ruble/yen cross rate? b. How many yen will you obtain for your rubles? Assumptions Beginning your trip with Spot rate (Rubles/$) Spot rate (/$) Values 450,000.00 30.96 84.02 a) What is the Russian ruble/yen cross rate? 0.3685 Cross rate (Rubles/) Rubles/ = Rubles/$ /$ b) How many yen will you obtain for your rubles? Converting your Rubles 1,221,177 Problem 5.12 Transatlantic Arbit A corporate treasury working out of Vienna with operations in New York simultaneously calls Citibank in New York City and Barclays in London. The two banks give the following quotes at the same time on the euro: Citibank NYC $0.7551-61/ Barclays London $0.7545-75/ Using $1 million or its euro equivalent, show how the corporate treasury could make geographic arbitrage profit with the two different exchange rate quotes. Assumptions Beginning funds Values $1,000,000.00 Citibank NYC quotes: Bid ($/) Ask ($/) Barclays London quotes: Bid ($/) Ask ($/) 0.7551 0.7561 0.7545 0.7575 Arbitrage Strategy #1 Initial investment $1,000,000.00 Buy euros from Barclays ( 1,320,132.01 Sell euros to Citibank (at $996,831.68 Arbitrage profit (loss) ($3,168.32) Arbitrage Strategy #2 Initial investment $1,000,000.00 Buy euros from Citibank ( 1,322,576.38 Sell euros to Barclays (at $997,883.88 Arbitrage profit (loss) ($2,116.12) The arbitrager cannot make a profit using t Internet Exercise: 1 hange rate from September 16, 2010, to answer remium calculation is: a. Calculated Mid-Rate 85.435 85.035 84.88 84.395 83.185 82.89 81.805 b. Forward Premium 5.64% 3.92% 4.93% 5.41% 3.07% 2.22% urrent spot rate. Therefore the yen is selling the largest premium. Chapter 6 Questions: 3 and 17 Problem 6.3 Derek Tosh and Yen-Dollar Parity Derek Tosh is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat while the 360-day forward rate is 84.90/$. Forecast inflation is 1.100% for Japan, and 5.900% for the US. The 360-day eur deposit rate is 4.700%, and the 360-day euro-dollar deposit rate is 9.500%. a. Diagram and calculate whether international parity conditions hold between Japan and the United States. b. Find the forecasted change in the Japanese yes/U.S. dollar (/$) exchange rate one year from now. Assumptions Forecast annual rate of inflation for Japan Forecast annual rate of inflation for United States One-year interest rate for Japan One-year interest rate for United States Spot exchange rate (/$) One-year forward exchange rate (/$) Value 1.10% 5.90% 4.70% 9.50% 89 84.9 a. Approximate Form Forward rate as an unbaised predictor (E) Forward premium on foreign currency 4.80% (Japanese yen at a premium) Forecast change in spot exchange rate 4.80% (Dollar expected to weaken) International Fisher Effect (C) Purchasing Forecast differen in rates of inflati (US higher than Ja Interest rate parity (D) Difference in nominal interest rates -4.80% (higher in United States) As is the always the case with parity conditions, the future spot rate is implicitly forecast to be equal to the forward rate, the rate from the international Fisher effect, and the rate implied by purchasing power parity. According to Yazzie's calculations markets are indeed in equilibrium -- parity. b. Spot exchange rate (/$) One-year forward exchange rate (/$) Forcasted change in exchange rates 89 84.9 4.80% (Current Spot Rate - Forward Exchange Rate) / Problem 6.10 Copenhagen Covered (B) Heidi Hi Jensen is now evaluating the arbitrage profit potential in the same market after interest rates change. ( difference in interest rates does not exactly equal the forward premium, it must be possible to make CIA profit o Assumptions Arbitrage funds available Spot exchange rate (kr/$) 3-month forward rate (kr/$) US dollar 3-month interest rate Danish kroner 3-month interest rate Value ### 6.172 6.198 4.00% 5.00% a) a) Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or exp spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the expected change in the spot rate), invest in the lower yielding currency. Difference in interest rates (ikr - i$) Forward discount on the krone CIA profit potential 1.00% -1.68% -0.68% This tells Heidi that she should borrow Danish kroner and invest in the LOWER interest rate currency, the dolla exchange of dollars for kroner at the end of the period. U.S. dollar interest rate (3-month) 4.00% ### Spot (kr/$) 6.172 kr 30,860,000.00 1.01 ---------------> 90 days ----------------> 1.0125 5.00% Danish kroner interest (3-month) START a) Heidi Hi Jensen generates a covered interest arbitrage profit of kr54,150 because, although U.S. dollar intere U.S. dollar is selling forward at a premium against the Danish krone. Problem 6.22 Grupo Bimbo (Mexico) Grupo Bimbo, headquartered in Mexico City, is one of the largest bakery companies in the world. On January 1s exchange rate is Ps10.80/$, the company borrows $25.0 million from a New York bank for one year at 6.80% in had quoted 9.60% for an equivalent loan in pesos). During the year, U.S. inflation is 2% and Mexican inflation i the year the firm repays the dollar loan. a. If Bimbo expected the spot rate at the end of one year to be that equal to purchasing power parity, what would of its dollar loan in peso-denominated interest? b. What is the real interest cost (adjusted for inflation) to Bimbo, in peso-denominated terms, of borrowing the again assuming purchasing power parity ? c. If the actual spot rate at the end of the year turned out to be Ps9.60/$, what was the actual peso-denominated loan? Borrowing principal Current spot rate, pesos/dollar (Ps/$) Mexican inflation (actual) US dollar inflation (actual) PPP forecast of spot rate (Ps/$) Actual spot rate end of year (Ps/$) Actual spot rate end of year (Ps/$) ### 10.8 4.00% 2.00% 11.01 9.6 9.6 Spot (PPP) = S * (1 + Ps) U.S. dollar borrowing rate (one year) 6.80% ### Spot (Ps/$) 10.8 1.068 ---------------> 360 days ----------------> ### Mexican pesos 9.60% Quoted Mexico peso borrowing rate (one year) Implied cost = (Repaid/Initial proceeds) - 1 a. If the ending spot rate was Ps11.01/$ as PPP would predict, the actual peso-based interest cost would be 8.89 b. The real peso-denominated interest cost (corrected for inflation) would be: The calculation shown at right is the precise or exact answer. The approximate form, found simply by subtracting inflation from nominal interest, would be 4.894%. Nominal interest Actual inflation Real peso-interest b. If the actual end of year spot rate was Ps9.60/$ (just plug it into the spreadsheet for the EOY Spot rate), the ac denominated interest cost would be -5.067%. (Yes, a negative interest rate.) Internet Exercise: 1 Put answer here. e current spot rate is a flat 89.00/$, or the US. The 360-day euro-yen ed States. ow. Purchasing power parity (A) Forecast difference in rates of inflation -4.80% (US higher than Japan) Fisher effect (B) ual to the forward rate, the implied ing to Yazzie's calculations, the after interest rates change. (Note that anytime the ssible to make CIA profit one way or another.) kr Equivalent kr 30,860,000 d premium/discount, or expected change in the nterest rates is less than the forward premium (or rest rate currency, the dollar, gaining on the re- ### F-90 (kr/$) 6.198 kr 31,299,900.00 kr 31,245,750.00 kr 54,150.00 END although U.S. dollar interest rates are lower, the in the world. On January 1st, when the spot nk for one year at 6.80% interest (Mexican banks 2% and Mexican inflation is 4%. At the end of g power parity, what would be the cost to Bimbo ed terms, of borrowing the dollars for one year, e actual peso-denominated interest cost of the Spot (PPP) = S * (1 + Ps) / (1 + $ ) ### EOY Spot (Ps/$) 11.01 ### Pesos needed to repay U.S. dollar loan 8.89% interest cost would be 8.894%. 8.89% 4.00% 4.71% r the EOY Spot rate), the actual peso- Chapter 7 Questions: 6, 10, and 15. Problem 7.2 Amber McClain Amber McClain, the currency speculator we met earlier in the chapter,sells eight June futures contracts for 500,000 pesos at the closing price quoted in Exhibit 7.1. a. What is the value of her position at maturity if the ending spot rate b. What is the value of her position at maturity if the ending spot rate c. What is the value of her position at maturity if the ending spot rate Assumptions Number of pesos per futu Number of contracts Buy or sell the peso futu a. Values 500,000 8 Sell b. Values 500,000 8 Sell c. Values 500,000 8 Sell Ending spot rate ($/peso June futures settle price Spot - Futures $0.12 $0.11 $0.01 $0.10 $0.11 ($0.01) $0.11 $0.11 $0.00 $38,920.00 ($9,080.00) Value of total position a ($49,080.00) Value = - Notional x (Spot - Futures) x 8 Interpretation Amber buys at the spot price and sells at th If the futures price is greater than the ending spot price, she makes a pro Problem 7.4 Kapinsky Capital (A) Christoph Hoffeman trades currency for Kapinsky Capital of Geneva. Christoph has $10 million to begin with, and he must state all profits at the end of any speculation in U.S. dollars. The spot rate on the euro is $1.3358/, while the 30-day forward rate is $1.3350/. a. If Christoph believes the euro will continue to rise in value against the U.S. dollar, so that he expects the spot rate to be $1.3600/ at the end of 30 days, what should he do? b. If Christoph believes the euro will depreciate in value against the U.S. dollar, so that he expects the spot rate to be $1.2800/ at the end of 30 days, what should he do? a. Assumptions Values Initial investment (funds avail ### $1.34 Current spot rate (US$/) $1.34 30-day forward rate (US$/) $1.36 Expected spot rate in 30 days (US$/) b. Values ### $1.34 $1.34 $1.28 Strategy for Part a): One of the more interesting dimensions of speculating in the forward market, is that if the speculator has access to the forward market (bank lines or relationships when working on behalf of an established firm), many forward speculation strategies require no actual cash flow position up-front. In this case, Christoph believes the dollar will be trading at $1.36/ in the open market at the end of 30 days, but he has the ability to buy or sell dollars at a forward rate of $1.3350/. He should therefore buy euros forward 30 days (requires no actual cash flow up-front), and at the end of 30 days take delivery of those euros and sell in the spot market at the higher dollar rate for profit. Initial investment principle 30 day forward rate (US$/) Euros bought forward (Investment / forward rate) Spot rate in open market at end of 30 days (US$/) US$ proceeds (euros bought forward exchanged to US$ spot) Profit in US$ ### $1.34 ### $1.36 ### ### Strategy for Part b): Again, a profitable strategy can be executed without any actual cash flow changing hands at the beginning of the period. Since Christoph believes that the dollar will strengthen to $1.28 in 30 days, he should sell euros forward now at the higher dollar rate, wait 30 days and buy the euros needed on the open market at $1.28, and immediately then use those euros to fulfill his forward contract to sell euros for dollars at $1.3350. For a profit. Investment funds needed in 30 days Spot rate in open market at end of 30 days uros bought in open market in 30 days (Investment / spot rate) ### $1.28 ### had sold these euros forward at the start of the 30 day period. 30 day forward rate (US$/) US$ proceeds (euros sold forward into US$) $1.34 ### Profit in US$ ### Problem 7.12 U.S. dollar/Euro Pricing Currency Options on t A U.S.-based firm wishing to buy or sell euros (the foreign currency) s Value $1.25 $1.25 1.45% 2.19% 1 365 12.00% Call option premium (per uni Put option premium (per unit (European pricing) c p $0.05 $0.06 Call option premium (%) Put option premium (%) c p 4.28% 5.15% Spot rate (domestic/foreign) Strike rate (domestic/foreign Domestic interest rate (% p.a Foreign interest rate (% p.a. Time (years, 365 days) Days equivalent Volatility (% p.a.) Variable S0 X rd rf T When the volatility is increased to 12.000% from 10.500%, the premium on the call option on euros rises to $0. Problem 7.13 U.S. Dollar/Japanese Yen Pricing Currency Options on the Japanese yen A Japanese firm wishing to buy or sell dollars (the foreign currency) Variable S0 Spot rate (domestic/foreign) Strike rate (domestic/foreign X r Domestic interest rate (% p. d rf Foreign interest rate (% p.a. Time (years, 365 days) Days equivalent Volatility (% p.a.) T s Value JPY 105.64 JPY 100.00 0.09% 1.45% 1 365 12.00% Call option premium (per uni c JPY 7.27 Put option premium (per uni (European pricing) p JPY 3.06 Call option premium (%) Put option premium (%) c p 6.88% 2.90% A Japanese firm wishing to sell U.S. dollars would need to purchase a put on dollars. The put option premium listed a Put option premium (JPY/U JPY 3.06 Notional principal (US$) $750,000 Total cost (JPY) JPY 2,297,243 Problem 7.14 Euro/Japanese Yen Pricing Currency Options on the Euro/Yen Crossra A Japanese firm wishing to buy or sell euros (the foreign currency) s Value JPY 133.89 JPY 136.00 0.09% 2.19% 0.247 90 10.00% Call option premium (per uni Put option premium (per unit (European pricing) c p JPY 1.50 JPY 4.30 Call option premium (%) Put option premium (%) c p 1.12% 3.21% Spot rate (domestic/foreign) Strike rate (domestic/foreign Domestic interest rate (% p.a Foreign interest rate (% p.a. Time (years, 365 days) Days equivalent Volatility (% p.a.) Variable S0 X rd rf T A European-based firm like Legrand (France) would need to purchase a put option on the Japanese yen. The com rate) and a 90-day maturity. Note that the "Time" must be entered as the fraction of a 365 day year, in this case, 9 Put option premium (euro/J 0.00 Notional principal (JPY) JPY 10,400,000 Total cost (euro) 2,167.90 Problem 7.15 U.S. Dollar/British Pound Pricing Currency Options on the British pound A U.S.-based firm wishing to buy or sell pounds (the foreign currency) s Value $1.87 $1.80 1.45% 4.53% 0.493 180 9.40% Call option premium (per uni Put option premium (per unit (European pricing) c p $0.07 $0.03 Call option premium (%) Put option premium (%) c p 3.73% 1.64% Spot rate (domestic/foreign) Strike rate (domestic/foreign Domestic interest rate (% p.a Foreign interest rate (% p.a. Time (years, 365 days) Days equivalent Volatility (% p.a.) Variable S0 X rd rf T Call option premiums for a U.S.-based firm buying call options on the British pound: 180-day maturity ($/pound) 90-day maturity ($/pound) Difference ($/pound) $0.07 $0.07 $0.00 The maturity doubled while the option premium rose only about 4%. Problem 7.16 Euro/British Pound Pricing Currency Options on the British pound/Euro Crossrate A European firm wishing to buy or sell pounds (the foreign currency) Spot rate (domestic/foreign) Strike rate (domestic/foreign Domestic interest rate (% p.a Foreign interest rate (% p.a. Variable S0 X rd rf Value 1.47 1.50 4.00% 4.16% Time (years, 365 days) Days equivalent Volatility (% p.a.) T s 0.247 90 11.40% Call option premium (per uni Put option premium (per unit (European pricing) c p 0.02 0.05 Call option premium (%) Put option premium (%) c p 1.45% 3.30% When the euro's interest rate rises from 2.072% to 4.000%, the call option premium on British pounds rises: Call option on pounds when euro interest i Call option on pounds when euro interest i Change, an increase in the premium Internet Exercise: 5 Put Answer here 0.02 0.02 0.02 to buy urrency) A European firm wishing to buy or sell dollars (the foreign currency) Variable S0 s Value 0.80 0.80 2.19% 1.45% 1 365 12.00% c p 0.04 0.03 c p 5.15% 4.27% X rd rf T n the call option on euros rises to $0.0412/, or 5.15%. A U.S.-based firm wishing to buy or sell yen (the foreign currency) Variable S0 s Value $0.01 $0.01 1.45% 0.09% 1 365 12.00% c $0.00 X rd rf T p $0.00 c p 3.06% 7.27% ars. The put option premium listed above is JPY3.06/$. to buy urrency) A European firm wishing to buy or sell yen (the foreign currency) Variable S0 s Value 0.01 0.01 2.19% 0.09% 0.247 90 10.00% c p 0.00 0.00 c p 1.30% 2.90% X rd rf T t option on the Japanese yen. The company wishes a strike rate of 0.0072 euro for each yen sold (the strike action of a 365 day year, in this case, 90/365 = 0.247. to buy urrency) A British firm wishing to buy or sell dollars (the foreign currency) Variable S0 s Value 0.5355 0.5556 4.53% 1.45% 0.493 180 9.40% c p 0.0091 0.0207 c p 1.70% 3.87% X rd rf T pound/Euro Crossrate to buy urrency) A British firm wishing to buy or sell euros (the foreign currency) Variable S0 X rd rf Value 0.6789 0.6667 4.16% 4.00% premium on British pounds rises: T s 0.247 90 11.40% c p 0.0220 0.0097 c p 3.24% 1.42% Questions: 6, 8 and 13 6.Define and differentiate the different type of swap transactions in the foreign exchange markets 8. Foreign Exchange Market Characteristics. With reference to foreign exchange turnover in 2013, rank the following: The relative size of spot, forwards, and swaps The five most important geographic locations for foreign exchange turnover The three most important currencies of denomination 13.Direct and Indirect Quotes. Define and give an example of the following: Direct quote between the U.S. dollar and the Mexican peso, where the United States is designated as the home country. Indirect quote between the Japanese yen and the Chinese renminbi (yuan), where China is designated as the home count Big Mac Index. How close does the Big Mac Index conform to the t Exchange Rate Pass-Through. What is exchange rate pass-throu Options versus Futures. Explain the difference between foreign c Writing Options. Why would anyone write an option, knowing tha Option Values and Money. Options are often described as in-the- 13, rank the following: ated as the home country. ignated as the home country. conform to the theoretical requirements for a law of one price measuremen rate pass-through? tween foreign currency options and futures and when either might be mos n, knowing that the gain from receiving the option premium is fixed but the ribed as in-the-money, at-the-money, or out-of-the-money. What does that ce measurement of purchasing power parity? r might be most appropriately used. m is fixed but the loss, if the underlying price goes in the wrong direction, ca What does that mean and how is it determined? ong direction, can be extremely large? chp.5 chp.6 Chp.7