Please work your answers on a separate piece of paper. Make sure to label neatly each question. This is an individual assignment. You can work with your peers, ask me about these questions and consult your textbook. You are not allowed to consult with tutors, parents, friends, outside consultants or solution manuals from the internet. Failure to comply with this rule will imply a grade of F in this assignment and loss of any extra-credit accumulated during the semester. Please use this assignment as an opportunity to review the course material and learn. Please be honest! 1. (10 pts.) General Electric (US) exports blenders to Germany. Annual sales are 1,000,000 blenders, at US$100 each. EUR exchange rate is currently EUR1/$, but is expected to change to EUR 1.10/$. General Electric faces a pricing decision: (1) maintain same initial EUR price after EUR depreciation, and so get fewer US$ (the number of blenders sold will not change in that case), or (2) maintain same US$ price (i.e. raise EUR price), and experience a 20% drop in unit volume sales. The direct cost per unit is 60% of the initial US$ sales price. What is the gross profit margin in cases (1) & (2)? What is your recommendation for General Electric? 2. (5 pts.) Deutsche Bank and HSBC have posted the following prices for the Swedish krone this morning Deutsche Bank HSBC Bid Bid Ask $0.635 $0.640 $0.645 $0.650 Ask Is there an arbitrage opportunity here? How much money can you make by the end of the day if you had $10,000 on hand? 3 (5 pts.) Suppose that one-year interest rates are 6% in the US and 8% in UK. The current spot rate between the British pound and US$ is $ 1.48/pound. What would you expect the spot rate for the pound to be in one year if you believe that the international Fisher effect holds? 4. (5 pts.) Suppose the spot price of the Indian rupee is $46.75. The 12 month zero-coupon bond rate is 5% in the US and 11% in India. A bank is quoting a one-year forward rate of $43.35. Do these prices give rise to an arbitrage opportunity? If so, how can a trader benefit from this opportunity? 5. (5 pts.) The expected inflation rate in Great Britain is 4% per year, and 6% per year in Switzerland. What is the three-month forward rate if currently the British pound trades at SF 12.50? 6. (5 pts.) Suppose that on January 1st, the cost of borrowing Euros for the year is 18%. During the year, U.S. inflation is 5%, and European inflation is 9%. At the same time, the exchange rate changes from EUR 1 = $0.15 on January 1 to EUR 1 = $0.10 on December 31. What was the nominal cost of borrowing US dollars during the year? 7. (5 pts.) Suppose today's exchange rate is $0.62/Euro. The 6-month interest rates on dollars and Euro are 6% and 3%, respectively. The 6-month forward rate is $0.6185. A foreign exchange advisory service has predicted that the Euro will appreciate to $0.64 within six months. a. How would you use forward contracts to profit in the above situation? b. How would you use money market instruments (i.e. borrowing and lending) to profit? c. Which alternatives (forward contracts or money market instruments) would you prefer? Why? 8. (5 pts.) Suppose you work for a U.S. firm. You receive the following quarterly Consumer Price Index (CPI) information for the US and the UK from the first quarter of 2018 to the third quarter of 2019. You also receive Spot rates of the British pound during that period. Your job is to generate estimates of the equilibrium exchange rates using PPP and make a forecast of the spot rate for the second quarter of 2019 using the forecasted inflation rates provided by the consumer price research team in your firm: Date CPI US CPI UK Inflation Actual Inflation US (TUS) PPP Estimate (SA+1) | (S) Forecast Error Et+1 = +1 - St+1 (TUK) 2018:I 2018:II 2018:III 2018:IV 2019: 2019:11 108.6 111.0 112.3 109.1 108.6 109.7 106.2 108.2 109.3 108.4 | 106.1 106.9. 1.9754 1.9914 1.7705 1.4378 1.4381 a. Determine the equilibrium spot rates from 2018:II to 2019:II using PPP b. Determine the forecast errors from 2018:II to 2019:I of the future spot rate based on PPP. Compute the Mean squared error (MSE) of these forecasts. c. You receive forward rate information for the 90 day forwards during the period 2018:II to 2019:1, they are: 1.9992 (2018:11); 1.8123 (2018:III); 1.5298 (2018:IV) and 1.4401 (2019:1). Use these rates to compute the MSE of the three-month forward as a forecast of the spot rate. d. Based on the MSEs you calculated in b. and c. what recommendation would you give your boss: to use the PPP based forecast of the future spot rate or rely on the forward to make predictions on future spot rates? Explain your reasons. 9.(5 pts.) The following chart shows the price of the Canadian dollar (blue line) and two moving averages: a 30-day average (the red line) and a 100-day average (the green line). Use the moving- average crossover rule to identify times in which a trader could have benefitted from taking a short or a long position in the futures market between March 2017 and March 2020. Explain when you should have taken a long position in CAD futures, when you should have taken a short position in CAD futures and why. Price of the Canadian Dollar 1.38 1.36 1.34 1.32 1.3 1.28 1.26 1.24 1.22 10/3/2017 11/3/2017 12/3/2017 1/3/2018 2/3/2018 3/3/2018 4/3/2018 5/3/2018 6/3/2018 7/3/2018 8/3/2018 9/3/2018 10/3/2018 11/3/2018 12/3/2018 1/3/2019 2/3/2019 3/3/2019 4/3/2019 5/3/2019 6/3/2019 7/3/2019 8/3/2019 9/3/2019 10/3/2019 11/3/2019 12/3/2019 1/3/2020 2/3/2020 3/3/2020 - USD/CAD Close 100-day MA 30-day MA 10. (5 pts. Consider a call option and a put option on the euro with strike price on both options $0.95/EUR. The call is sold at a premium of $0.0090/EUR, while the put is sold at a premium of $0.0150/EUR. Both options are with expiration date three months from now and the contract size is EUR 100,000. Calculate net profit for each of the options at maturity when the euro is traded spot at $1.00/EU. 11. (5 pts.) Suppose you expect that the Canadian dollar will depreciate versus the US$ in the coming 90 days. The current spot rate is $0.69/CAD. You expect depreciation to $0.60/CAD. The following options are available to you: Strike Price Premium Put on CAD $0.65/CAD $0.004/CAD Call on CAD $0.65/CAD $0.001/CAD Option a. (2 pts.) What option would you buy to take advantage of expected depreciation of the Canadian dollar? Why? b. (3 pts.) What is the net profit from the option you chose in a. (i.e. accounting for option premium) if the spot rate at end of 90 days is $0.62/C$? Please work your answers on a separate piece of paper. Make sure to label neatly each question. This is an individual assignment. You can work with your peers, ask me about these questions and consult your textbook. You are not allowed to consult with tutors, parents, friends, outside consultants or solution manuals from the internet. Failure to comply with this rule will imply a grade of F in this assignment and loss of any extra-credit accumulated during the semester. Please use this assignment as an opportunity to review the course material and learn. Please be honest! 1. (10 pts.) General Electric (US) exports blenders to Germany. Annual sales are 1,000,000 blenders, at US$100 each. EUR exchange rate is currently EUR1/$, but is expected to change to EUR 1.10/$. General Electric faces a pricing decision: (1) maintain same initial EUR price after EUR depreciation, and so get fewer US$ (the number of blenders sold will not change in that case), or (2) maintain same US$ price (i.e. raise EUR price), and experience a 20% drop in unit volume sales. The direct cost per unit is 60% of the initial US$ sales price. What is the gross profit margin in cases (1) & (2)? What is your recommendation for General Electric? 2. (5 pts.) Deutsche Bank and HSBC have posted the following prices for the Swedish krone this morning Deutsche Bank HSBC Bid Bid Ask $0.635 $0.640 $0.645 $0.650 Ask Is there an arbitrage opportunity here? How much money can you make by the end of the day if you had $10,000 on hand? 3 (5 pts.) Suppose that one-year interest rates are 6% in the US and 8% in UK. The current spot rate between the British pound and US$ is $ 1.48/pound. What would you expect the spot rate for the pound to be in one year if you believe that the international Fisher effect holds? 4. (5 pts.) Suppose the spot price of the Indian rupee is $46.75. The 12 month zero-coupon bond rate is 5% in the US and 11% in India. A bank is quoting a one-year forward rate of $43.35. Do these prices give rise to an arbitrage opportunity? If so, how can a trader benefit from this opportunity? 5. (5 pts.) The expected inflation rate in Great Britain is 4% per year, and 6% per year in Switzerland. What is the three-month forward rate if currently the British pound trades at SF 12.50? 6. (5 pts.) Suppose that on January 1st, the cost of borrowing Euros for the year is 18%. During the year, U.S. inflation is 5%, and European inflation is 9%. At the same time, the exchange rate changes from EUR 1 = $0.15 on January 1 to EUR 1 = $0.10 on December 31. What was the nominal cost of borrowing US dollars during the year? 7. (5 pts.) Suppose today's exchange rate is $0.62/Euro. The 6-month interest rates on dollars and Euro are 6% and 3%, respectively. The 6-month forward rate is $0.6185. A foreign exchange advisory service has predicted that the Euro will appreciate to $0.64 within six months. a. How would you use forward contracts to profit in the above situation? b. How would you use money market instruments (i.e. borrowing and lending) to profit? c. Which alternatives (forward contracts or money market instruments) would you prefer? Why? 8. (5 pts.) Suppose you work for a U.S. firm. You receive the following quarterly Consumer Price Index (CPI) information for the US and the UK from the first quarter of 2018 to the third quarter of 2019. You also receive Spot rates of the British pound during that period. Your job is to generate estimates of the equilibrium exchange rates using PPP and make a forecast of the spot rate for the second quarter of 2019 using the forecasted inflation rates provided by the consumer price research team in your firm: Date CPI US CPI UK Inflation Actual Inflation US (TUS) PPP Estimate (SA+1) | (S) Forecast Error Et+1 = +1 - St+1 (TUK) 2018:I 2018:II 2018:III 2018:IV 2019: 2019:11 108.6 111.0 112.3 109.1 108.6 109.7 106.2 108.2 109.3 108.4 | 106.1 106.9. 1.9754 1.9914 1.7705 1.4378 1.4381 a. Determine the equilibrium spot rates from 2018:II to 2019:II using PPP b. Determine the forecast errors from 2018:II to 2019:I of the future spot rate based on PPP. Compute the Mean squared error (MSE) of these forecasts. c. You receive forward rate information for the 90 day forwards during the period 2018:II to 2019:1, they are: 1.9992 (2018:11); 1.8123 (2018:III); 1.5298 (2018:IV) and 1.4401 (2019:1). Use these rates to compute the MSE of the three-month forward as a forecast of the spot rate. d. Based on the MSEs you calculated in b. and c. what recommendation would you give your boss: to use the PPP based forecast of the future spot rate or rely on the forward to make predictions on future spot rates? Explain your reasons. 9.(5 pts.) The following chart shows the price of the Canadian dollar (blue line) and two moving averages: a 30-day average (the red line) and a 100-day average (the green line). Use the moving- average crossover rule to identify times in which a trader could have benefitted from taking a short or a long position in the futures market between March 2017 and March 2020. Explain when you should have taken a long position in CAD futures, when you should have taken a short position in CAD futures and why. Price of the Canadian Dollar 1.38 1.36 1.34 1.32 1.3 1.28 1.26 1.24 1.22 10/3/2017 11/3/2017 12/3/2017 1/3/2018 2/3/2018 3/3/2018 4/3/2018 5/3/2018 6/3/2018 7/3/2018 8/3/2018 9/3/2018 10/3/2018 11/3/2018 12/3/2018 1/3/2019 2/3/2019 3/3/2019 4/3/2019 5/3/2019 6/3/2019 7/3/2019 8/3/2019 9/3/2019 10/3/2019 11/3/2019 12/3/2019 1/3/2020 2/3/2020 3/3/2020 - USD/CAD Close 100-day MA 30-day MA 10. (5 pts. Consider a call option and a put option on the euro with strike price on both options $0.95/EUR. The call is sold at a premium of $0.0090/EUR, while the put is sold at a premium of $0.0150/EUR. Both options are with expiration date three months from now and the contract size is EUR 100,000. Calculate net profit for each of the options at maturity when the euro is traded spot at $1.00/EU. 11. (5 pts.) Suppose you expect that the Canadian dollar will depreciate versus the US$ in the coming 90 days. The current spot rate is $0.69/CAD. You expect depreciation to $0.60/CAD. The following options are available to you: Strike Price Premium Put on CAD $0.65/CAD $0.004/CAD Call on CAD $0.65/CAD $0.001/CAD Option a. (2 pts.) What option would you buy to take advantage of expected depreciation of the Canadian dollar? Why? b. (3 pts.) What is the net profit from the option you chose in a. (i.e. accounting for option premium) if the spot rate at end of 90 days is $0.62/C$