Problems: IRP and PPP 1. Assume that the following spot exchange rates exist today: 1 = $1:50, C$ = $:75, 1 = C$2 Assume no transaction costs. Based on these exchange rates, can triangular arbitrage be used to earn a profit? Explain. 2. Assume the following information: Spot rate of = $1:60, 180-day forward rate of 14=$1:56, 180-day British interest rate = $4%, 180-day U:S interest rate = $3%. Based on this information, is covered interest arbitrage by U.S. investors feasible (assuming that U.S. investors use their own funds)? Explain. 3. Assume the following information:

BEAL BANK YARDLEY BANK Bid price of New Zealand dollar $.401 $.398 Ask price of New Zealand dollar $.404 $.400 Given this information, is locational arbitrage possible? If so, explain the steps involved in locational arbitrage, and compute the profit from this arbitrage if you had $1 million to use. 4. Assume the following information:

QUOTED PRICE Value of Canadian dollar in U.S. dollars $.90 Value of New Zealand dollar in U.S. dollars $.30 Value of Canadian dollar in New Zealand dollars NZ$3.02 Given this information, is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy if you had $1 million to use. 5. Assume the following information: Spot rate of Canadian dollar $.80 90-day forward rate of Canadian dollar $.79

90-day Canadian interest rate 4% 90-day U.S. interest rate 2.5% Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1 million.) 6. Assume the following information: Spot rate of Mexican peso $.100 180-day forward rate of Mexican peso $.098 180-day Mexican interest rate 6% 180-day U.S. interest rate 5% Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer 7. The 1-year interest rate in Singapore is 11 percent. The 1-year interest rate in the United States is 6 percent. The spot rate of the Singapore dollar (S$) is $.50 and the forward rate of the S$ is $.46. Assume zero transaction costs. a. Does interest rate parity exist? b. Can a U.S. firm benefit from investing funds in Singapore using covered interest arbitrage? 8. You go to a bank and are given these quotes: You can buy a euro for 14 pesos. The bank will pay you 13 pesos for a euro. You can buy a U.S. dollar for .9 euros. The bank will pay you .8 euros for a U.S. dollar. You can buy a U.S. dollar for 10 pesos. The bank will pay you 9 pesos for a U.S. dollar. You have $1,000. Can you use triangular arbitrage to generate a profit? If so, explain the order of the transactions that you would execute and the profit that you would earn. If you cannot earn a profit from triangular arbitrage, explain why. 9. The bank is willing to buy dollars for 0.9 euros per dollar. It is willing to sell dollars for 0.91 euros per dollar. You can sell Australian dollars (A$) to the bank for $.72. You can buy Australian dollars from the bank for $.74. The bank is willing to buy Australian dollars (A$) for 0.68 euros per A$. The bank is willing to sell Australian dollars (A$) for 0.70 euros per A$. You have $100,000. Estimate your profit or loss if you were to attempt triangular arbitrage by converting your dollars to Australian dollars, then converting Australian dollars to euros, and then converting euros to U.S. dollars. 10. Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 2 percent? 11. Assume that the spot exchange rate of the Singapore dollar is $.70. The 1-year interest rate is 11 percent in the United States and 7 percent in Singapore. What will the spot rate be in 1 year?

Problems: Exposure 1. Your employer, a large MNC, has asked you to assess its transaction exposure. Its projected cash flows are as follows for the next year. Danish krone inflows equal DK50,000,000 while outflows equal DK40,000,000. British pound inflows equal 2,000,000 while out flows equal 1,000,000. The spot rate of the krone is $.15, while the spot rate of the pound is $1.50. Assume that the movements in the Danish krone and the British pound are highly correlated. Provide your assessment as to your firms degree of transaction exposure (as to whether the exposure is high or low).