Q-20

Based on the concept of covered interest arbitrage, the annual interest rate is 5.0 percent in the USA and 3.5 percent in Spain, the spot exchange rate is $1.12/ and the forward exchange rate, with one-year maturity, is $1.16/. The above mentioned situation:

A. is a typical example of covered interest arbitrage, and interest rate parity holds.

B. is a typical example of Purchasing Power Parity, and hyperinflation.

C. is a typical example of covered interest arbitrage, and interest rate parity does NOT hold.

D. none of the above

Q-19

Darwin Industries, based in BC, Canada, has a production division in Ohio, US that sources its required aluminum material from Montreal, Canada. Because of promising economic conditions in US, the US dollar has appreciated significantly against Canadian dollar. Examine the possible conversion and competitive effect of such significant appreciation of US dollar on Darwin Industries

12

Linda tries to take advantage of using option market on exchange rate to make some profit. Here is the information she currently sees in the market.

The current exchange rate today: $1.33/euro

European Call option expires in 55 days, Strike price: $1.28/euro Option Premium: $0.09/euro

European Put option expires in 55 days, Strike price: $1.26/euro Option Premium: $0.03/euro

Lindas prediction on exchange rate in 55 days: $1.19/euro

13

Which combination of the following statements is true about the risks that a swap dealer confronts: (i) interest rate risk, (ii) hedge risk, (iii) exchange rate risk, (iv) mismatch risk, (v) investment risk A. (i), (ii), (iii), and (v) B. (i), (iii), and (iv) C. (ii), (iii), (iv) D. (i), (iii), (iv), and (v)

Linda wants to make profit from speculating the exchange rate movement in the option market. Show the best strategy that Linda should take using these available options that would give her the Highest payoff if she truly believes that her prediction on exchange rate will prove to be correct? (Show calculations to support your answer).

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