FIN 4300: INTERNATIONAL FINANCE

Problem Set 1.

I.

FIVE MULTIPLE CHOICE QUESTIONS (One Point Each)

1. The current exchange rate for the Brazilian real is 3.85 BRL per US dollar. The current exchange rate for

the British pound is 0.69 GBP per US dollar.

Please circle all of the true statements below:

a.

The direct quote for the BRL is 3.85, and the indirect quote for the GBP is 0.69.

b. The indirect quote for the BRL is 3.85, and the indirect quote for the GBP is 0.69.

c.

The indirect quote for the BRL is 3.85, and the direct quote for the GBP is 1.45.

d. The direct quote for the BRL is 3.85, and the indirect quote for the GBP is 1.45.

e. None of the above.

2. A manager signs a contract with a French company. The spot exchange rate is 1.15 US dollars per euro,

and the French company agrees to pay one million euro in three business days. Hours after the contract

was signed, a key economic data release was weaker than expected, and the exchange rate moves to 1.11.

Please circle all of the true statements below:

a.

The euro has appreciated, and the US dollar value of the incoming payment has increased.

b. The euro has appreciated, and the US dollar value of the incoming payment has decreased.

c.

The euro has depreciated, and the US dollar value of the incoming payment has increased.

d. The euro has depreciated, and the US dollar value of the incoming payment has decreased.

e. None of the above.

3. The current spot exchange rate is 3.75 BRL per US dollar, the one-year forward rate is 3.95, and the

one-year US interest rate is 2%.

a.

The implied interest rate offered by the BRL forward contract is 5.3%.

b. The implied interest rate offered by the BRL forward contract is 7.4%.

c.

The implied interest rate offered by the BRL forward contract is -5.1%.

d. The implied interest rate cannot be calculated using the information provided.

e. None of the above.

4. Which of the following is / are examples of a Eurodollar deposit? (Please circle all that apply.)

a.

A US dollar deposit held at a New York bank by a French firm.

b. A US dollar deposit held at a London bank by a French firm.

c. A US dollar deposit held at a London bank by a US firm.

d. A British pound deposit held at a London bank by a French firm.

e. None of the above.

5. Please circle all of the correct statements below about foreign exchange forward and futures contracts.

a.

Futures contracts are traded on an exchange, while forward contracts are traded over the counter.

b. Forward contracts have standardized delivery dates, while futures contracts have tailored delivery

dates.

c.

Forward contracts can be nondeliverable, while futures contracts are always deliverable.

d. Forward contracts bear counterparty credit risk, while futures contracts bear the credit risk of the

exchange.

e. Forward contracts do not involve credit risk, while futures contracts bear the credit risk of the

exchange.

II. FOUR SHORT ANSWER QUESTIONS (THREE POINTS EACH)

Note.

Please show your work and clearly label your answer.

6. Youre shopping around online for the cheapest version of a finance textbook, and youve gathered

information on prices and exchange rates.

The US store: price = 120 USD.

The UK store: price = 90 GBP, exchange rate = 1.30 USD per GBP.

The Moscow store: price = 8,500 RUB, exchange rate = 91 RUB per GBP.

The New Zealand store: price = 140 NZD, exchange rate = 58 RUB per NZD.

The Frankfurt store: price = 110 EUR, exchange rate = 0.90 EUR per USD

Please fill in the blanks:

The most expensive option is:

The cheapest option is:

7. The US interest rate is 2%. In the blank space below, please state (YES or NO) whether the forward

exchange rate is consistent with covered interest parity.

3-Month

3-Month

Spot Exchange Rate

Interest Rate

Forward Exchange Rate

Consistent with CIP?

a.

101 JPY per USD

4%

102.5 JPY per USD

b. 80 RUB per USD

30%

85 RUB per USD

c.

1.250 USD per GBP

0%

1.245 USD per GBP

8. You observe the following exchange rate quotes in the market. Consistent with market convention,

each quote has five significant digits.

0.7525 USD per AUD

1.3500 USD per GBP

110.75 JPY per USD

3.7535 BRL per USD

a.

Triangular arbitrage would ensure the following cross rates (please fill in the blanks and use five

significant digits):

i.

JPY per BRL:

ii.

AUD per GBP:

iii. BRL per AUD:

b. What are the pips in the BRL per AUD quote above?

9. Please fill in the blanks for the FX forward curve below.

Spot Exchange Rate = 1.20 USD per EUR

3 month

6 month

1 Year

2 Year

5 Year

10 Year

US Interest Rate

1.25%

1.50%

2.00%

3.00%

3.25%

3.50%

EUR Interest Rate

-0.50%

-0.25%

0.00%

0.50%

1.00%

1.25%

Forward Exchange Rate

III. TWO LONGER QUESTIONS (Four Points Each)

QUESTION 10.

Youre the Chief Investment Officer of an investment management company. Your teams

put together the table below, summarizing spot and forward exchange rates, expected exchange rates,

deposit rates, and expected returns on local currency stock markets.

For convenience, they have converted all exchange rates to direct quotes (USD per local currency).

Your USD hurdle rate for investing in a countrys stock market is 6%. Your USD hurdle rate for investing in a

countrys deposits is 2%. The one-year US interest rate is 1%.

Exchange Rates

Expected Stock

Spot

Forward*

Expected*

Market Return

1-year deposit rate

Brazil

0.25

0.225

0.20

15%

10%

Eurozone

1.10

1.12

1.15

4%

-1%

Australia

0.75

0.73

0.76

6%

1%

*Notes:

Expected and forward exchange rates are in one years time.

Expected stock market returns are in local currency terms.

PART 1.

Youre worried that exchange rates could move dramatically, so at first you decide that you want

to use forward contracts to remove exchange rate risk.

a. Calculate the covered returns for stock markets for the three countries above. Which countries would

your firm invest in? Which market is the best investment?

b. Calculate the covered returns for bank deposits for the three countries above. Which countries would

your firm invest in? Which country is the best investment?

PART 2.

After thinking about it, you decide that youre less worried about exchange rate risk. You decide

that you should not use forward contracts to remove exchange rate risk.

a. Calculate the uncovered returns for stock markets for the three countries above. Which countries would

your firm invest in? Which market is the best investment?

b. Calculate the uncovered returns for bank deposits for the three countries above. Which countries would

your firm invest in? Which country is the best investment?

QUESTION 11.

You observe the following spot exchange rates, one-year forward exchange rates, and one-

year interest rates.

Spot

One Year

One Year

Exchange Rate

Forward Rate

Interest Rate

UK Pound

1.45 USD per GBP

1.51 USD per GBP

1.5%

Mexican peso

17.5 MXN per USD

20.0 MXN per USD

9%

United States

2%

a.

Calculate the forward premium for the GBP and the MXN versus the USD, and state whether each is

trading at a forward premium or discount. (

Note.

For consistency, translate the MXN into a direct quote

before calculating the forward premium.)

b. Please describe two arbitrage transactions, one for the MXN and one for the GBP, that would provide

riskless profits. If no such transaction exists, please say so.

c.

Please calculate the one-year forward rates for the GBP and MXN that are consistent with covered

interest parity.