Question 1

What is the Law of One Price?

The official currency exchange rate is 8.60 Mexican peso per US dollar. The price of the Big Mac in the US is $3.75, and 35 pesos in Mexico. Other things being equal, is the Big Mac overpriced or underpriced in Mexico?

(9 marks)

Question 2

A foreign exchange trader at Credit Suisse is exploring covered interest arbitrage opportunities. She wants to invest $4,000,000 or its yen equivalent, in a covered interest arbitrage between US dollars and Japanese yen. The /$ spot rate is 115.60 and the /$ 180-day forward rate is 114.80. In addition, the 180-day US dollar interest rate is 4.8%, while 180-day Japanese yen interest rate is 3.3%. What should the trader do to generate profit?

(11 marks)

Question 3

What is the difference between credit risk and repricing risk? In a plain-vanilla interest rate swap, why do firms with low credit quality prefer to swap floating-rate interest rate payments for fixed interest rate payments?

(9 marks)

Question 4

Why would a company always strive to achieve investment grade status, as opposed to speculative grade status?

(7 marks)

Question 5

Maxima Oil is a Canadian oil company. Its current cost of debt is 7.60%, and the 10-year Canada Government Bond yield, the proxy for the risk-free rate of interest, is 3.50%. The expected return on the market portfolio is 8.10%. The company's effective tax rate is 38%. Its optimal capital structure is 30% debt and 70% equity.

1. If Maxima's domestic beta is estimated at 1.50, what is Maxima's weighted average cost of capital?

2. If Maxima's global beta is estimated at 1.20, what is Maxima's weighted average cost of capital?

3. Briefly explain why Maximas WACC has fallen once Maxima entered the global energy market.

(14 marks)

Question 6

Discuss the main causes of market segmentation.

(10 marks)

Question 7

Outline the difference between a confirmed and an unconfirmed Letter of Credit. In which case would an exporter insist on a confirmed Letter of Credit?

(10 marks)