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					                           International finance - exercises
                                         Vasja Rant

                Problem set 4 – parity conditions in international finance

1. Arbitrageur at Bank of Aukland has the following data about the NZ$ and USD markets:

   spot rate                        NZ$ 1,4393/$
   6-month forward rate             NZ$ 1,4637/$
   NZ$ 6-month interest rate        8,00 % (annualized)
   $ 6-month interest rate          5,50 % (annualized)

   Assume that the arbitrageur can borrow or invest at the above interest rates. He has NZ$
   20 million or the USD equivalent of this amount at his disposal. Transaction costs are $
   2700 and have to be paid at the end of the 6-month period. Potential profit from the
   transaction should be made in NZ$. How would he perform a covered arbitrage and what
   would his profit be?

2. An English company needs to pay in 3 months USD 1 million. The USD are already at
   disposal in the company, therefore they decide how to invest them in the given period.
   You have the following data:

   $ 3-month deposit rate: 8% (annualized)
   £ 3-month deposit rate: 10% (annualized)
   Spot rate:                $1,80/£
   3-month forward rate: $1,78/£
       a. Where should the company invest?
       b. Assume the interest rates and the spot rate stay the same. What forward rate would
           cause indifference between decisions (equilibrium position)?
       c. Assume the U.S. interest rates, spot rate, and the forward rate stay the same.
           Where would you invest if annual interest rates in pounds were 14%?
       d. What interest rates for pound deposits would cause equilibrium position if all the
           other data remained unchanged

3. The USA and France both produce Cabernet Sauvignon wine. A bottle of this wine costs
   USD 18 in the USA and FRF 100 in France.
      a. What should be the exchange rate between USD and FRF (FRF/USD) according to
         purchasing power parity theory?
      b. Let’s assume that the price of a Cabernet Sauvignon bottle in the USA is expected
         to rise to USD 20 in the following year, and to FRF 118 in France. What should
         the 1-year forward exchange rate (FRF/USD) be?
      c. What are the expected interest rates in France, if you take in consideration the
         above calculations and the fact that the 1-year interest rate in the USA is 6%?

4. You’re planning for the next year to go on a 1-month luxury vacation to Bali. Price for the
   all-inclusive package today is 28.000 rupias or USD 800 according to the current spot rate
   Rps 36/USD. At the hotel they told you that their prices will increase according to the
   inflation on Bali, for which you expect to be 16% next year. American inflation is
   expected to be 4%. When you were introduced to different theories of explaining future

   exchange rates at the International finance course, you preferred the PPP theory. How
   many USD will you need next year to pay the planned vacation?

5. The money and foreign exchange markets in      London and New York are very efficient.
   You have the following information:
                                  London          New Yor
      Spot rate:                  1,6220 $/£      0,6165 £/$
      Expected rate of inflation: unknown         3% p. a.
      Yield on 12 month T-bills: 6,25% p. a.      5,50% p. a.

       a. Estimate the rate of inflation in UK in the next year.
       b. Estimate the one year forward rate between the british pound and the dollar.

6. January 1st an American company borrows 5 million Swiss franks (CHF) from a Swiss
   bank at 3% interest rate.The company wants to exchange the CHF for USD, as it needs
   funds for financing a project in the USA. Spot rate on January 1st is CHF 1,4515/$.
   Expected rate of inflation for the USA is 4% and 1% for Switzerland. The company
   expects that the future spot rate – after 1 year (when the company needs to exchange USD
   back to CHF in order to repay the loan) will be formed according to PPP. What is the real
   cost of borrowing the fund for the American company (what should the yield of the
   project be in order to allow the company to repay its debt)?

7. American company wants issue 10-year bonds and assume that if it issues them in
   Denmark it needs to offer a 10% yield or 7% yield if it issues them in Holland.
      a. Where do you think the expected rate of inflation should be higher?
      b. Should Denmark Kroner be getting stronger or weaker in comparison to the Dutch

8. Exchange rate between Czech Krona an USD a year ago was CZK 30,00 / USD. In one
   year USD apreciated against CZK by 12 %. The price level in the USA remained the same
   and in Czech Republic increased by 8%.
      a. What is today’s spot exchange rate between CZK and USD (CZK/USD)?
      b. What should the exchange rate be according to the PPP condition?
      c. Has Czech Krona depreciated or appreciated against the USD in real terms?

9. American dollar appreciated against argentine peso by 50%. By what percentage did
   argentine peso depreciat against USD?

10. Price of the £ in Paris is 8,3347 FF and 2,0556 CHF in Zürich. In Frankfurt we can come
    across with the exchange rate FF 4,1519 / CHF. Is it possible for an arbitrageur from
    London to realize profit?


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