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Walden University

Lidia Escalona Valdes
MMBA-6252V-1 International Finance
Walden University
Professor: Dr. Tim Truitt, PhD
22th of June, 2014

Chapter 5
1. Using the American term quotes from Exhibit 5.4, calculate the one-, three-, and six-
month forward cross-exchange rates between the Canadian dollar and the Swiss franc. State
the forward cross-rates in "Canadian" terms.
The cross-rate formula we want to use is: S(j/k) = S($/k)/S($/j)
F1(CD/SF) = .8485/.8037 = 1.0557
F3(CD/SF) = .8517/.8043 = 1.0589
F6(CD/SF) = .8573/.8057 = 1.0640
Canadian Dollar 0.9629
1 Month 0.9628
3 Month 0.9624
6 Month 0.9614

Switzerland Franc 0.8662
1 Month 0.8671
3 Month 0.8686
6 Month 0.8715

2. Restate the following one-, three-, and six-month outright forward European term bid-ask
quotes in forward points.
Spot 1.3431 1.3436
One Month 1.3432 1.3442
Three Month 1.3448 1.3463
Six Month 1.3488 1.3508
One-Month 01-06
Three-Month 17-27
Six-Month 57-72
The bid and offer prices are the key components of a stock quote. When an investor comes
to the market to buy or sell a stock, quotation tells the minimum price you can buy
(demand) and the maximum price at which you can sell (the supply). The easiest way to
understand it is to look at the operation from the other end: someone is willing to bid for
your action if you want to sell, and someone is suing both the action you want to buy.
3.Given the following information, what are the NZD/SGD currency against cur- rency bid-
ask quotations?

Bid Ask Bid Ask
.7265 .7272 1.3751 1.3765
.6135 .6140 1.6287 1.6300

The text implies:
Sb(NZD/SGD) = Sb($/SGD) x Sb(NZD/$) = .6135 x 1.3765 = .8445.
The reciprocal:
1/Sb(NZD/SGD) = Sa(SGD/NZD) = 1.1841.
Analogously, it is implied that Sa(NZD/SGD) = Sa($/SGD) x Sa(NZD/$) = .6140 x
1.3765 = .8452.
The reciprocal, 1/Sa(NZD/SGD) = Sb(SGD/NZD) = 1.1832.
Thus, the NZD/SGD bid-ask spread is NZD0.8445-NZD0.8452 and the
SGD/NZD spread is SGD1.1832-SGD1.1841.
The dollar is the most commonly used in transactions worldwide currency. The answer is
simple: because the dollar is accepted in all countries as payment. Being the most widely
used currency trading activities, it is commonly accepted business and oil or commodities
that move huge amounts of money, are done primarily in dollars. Change the whole system
would be complicated and expensive, and for this reason the dollar is maintained.
Moreover, as the dollar is supported by a strong economy, it is the currency that the criteria
imposed on prices of products.
4. Doug Bernard specializes in cross-rate arbitrage. He notices the following quotes: Swiss
franc/dollar =SFr1.5971/$ Australian dollar U.S. dollar =A$1.8215/$ Australian
dollar/Swiss franc = A$1.1440/SFr
Ignoring transaction costs, does Doug Bernard have an arbitrage opportunity based on these
quotes? If there is an arbitrage opportunity, what steps would he take to make an arbitrage
profit, and how much would he profit if he has $1,000,000 available for this purpose?
The implicit cross-rate between Australian dollars and Swiss franc is A$/SFr = A$/$ x
$/SFr = (A$/$)/(SFr/$) = 1.8215/1.5971 = 1.1405. But still, the quoted cross-rate is higher
than A$1.1.1440/SFr. So it will be possible a triangular arbitrage.
How much would he profit if he has $1,000,000 available for this purpose?
Sell dollars to get Swiss francs: $1,000,000 to get $1,000,000*SFr1.5971/$ = SFr
Sell Swiss francs to buy Australian dollars: SFr 1,597,100 to buy SFr
1,597,100*A$1.1440/SFr = A$1,827,082.40.
Sell Australian dollars for dollars: Australian dollars $1,827,082.40 for
A$1,827,082.40/A$1.8215/$ = $1,003,064.73.
Thus, your arbitrage profit is $1,003,064.73 - $1,000,000 = $3,064.73.
In economics and finance, arbitrage is the practice of taking advantage of a price difference
between two or more markets: perform a combination of complementary transactions that
capitalize imbalance prices.
Another way to do it would be through arbitration called triangular arbitrage currencies.
Given three currencies, should be given a relationship between their quotes. For example, if
1 = $ 1.2 and once 1 = 0.8 lbs, then $ 1.2 = 0.8 L, or what is the same, $ 1 = 0.6666
Pounds. If at any time this equality is not fulfilled there would be a risk-free arbitrage
opportunity. Here's an example:
At any given time we have these quotes in the FOREX market:
1 = $ 1.2
$ 1 = 0.68 L
1 = 0.8 L
Sell 1000 and give us $ 1200, we sell it for 816 Pounds 1020 moved again. We obtain a
benefit by arbitration 20, or 2% without any risk.
Arbitrations are only possible to market inefficiencies.
Chapter 6
10. After studying Iris Hamson's credit analysis, George Davies is considering whether he
can increase the holding period return on Yucatan Resort's excess cash holdings (which are
held in pesos) by investing those cash holdings in the Mexican bond market. Although
Davies would be investing in a peso-denominated bond, the investment goal is to achieve
the highest holding period return, measured in U.S. dollars, on the investment.
Davies fmds the higher yield on the Mexican one-year bond, which is considered to be free
of credit risk, to be attractive but he is concerned that depreciation of the peso will reduce
the holding period return, measured in U.S. dollars. "ijamson has prepared selected
economic and financial data to help Davies make the decision.

Hamson recommends buying the Mexican one-year bond and hedging the for- eign
currency exposure using the one-year forward exchange rate. She concludes: "This
transaction will result in a U.S. dollar holding period return that is equal to the holding
period return of the U.S. one-year bond."
a. Calculate the U.S. dollar holding period return that would result from the transaction
recommended by Hamson. Show your calculations. State whether Hamson's conclusion
about the U.S. dollar holding period return resulting from the transaction is correct or
After conducting his own analysis of the U.S. and Mexican economies, Davies expects that
both the U.S. inflation rate and the real exchange rate will remain constant over the coming
year. Because of favorable political developments in Mexico, however, he expects that the
Mexican inflation rate (in annual terms) will fall from 6.0 percent to 3.0 percent before the
end of the year. As a result, Davies decides to invest Yucatan Resort's cash holdings in the
Mexican one-year bond but not to hedge the currency exposure.
b. Calculate the expected exchange rate (pesos per dollar) one year from now. Show your
calculations. Note: Your calculations should assume that Davies is correct in his
expectations about the real exchange rate and the Mexican and U.S. inflation rates.
The expected exchange rate one year from now is 9.5931. The rate can be calculated if we
use this formula:
(1 + % RUS) = (1 + % SUS) [(1 + % PUS) / (1 + % PMEX)] =(S1
1.0000 = (X/ 9.5000) 0.9903
1.0098 = X / 9.5000
X = 9.5931
When an investor or a fund manager buying an obligation, the performance they get comes
from two sources. First, the coupons regularly pay this obligation throughout his life and,
moreover, the principal received at maturity.
The payment of interest compensates the investor for the fact that, for example, 100 EUR
offered as a bonus in 2001 will not be worth those 100 EUR suppose when returned in
2006. Inflation is responsible for the loss of purchasing power.
Indeed, over time, prices rise so investors want to recover not only the 100 but something
to offset the effect of inflation and also get a certain return. For example, if inflation is
2.5%, the investor who wants to get a return of 4.5% will invest in an obligation to pay a
coupon of 7%.
c. Calculate the expected U.S. dollar holding period return on the Mexican one-year bond.
Show your calculations. Note: Your calculations should assume that Davies is correct in his
expectations about the real exchange rate and the Mexican and U.S. inflation rates.
Holding period return (X)
X = [(1 + YMEX) (1 + % pesos value)] 1
X = [(1 + YMEX) (S0 / S1)] 1
X = [(1 + 0.065) (9.5000 / 9.5931)] 1
X = (1.065 0.9903) 1
X = 5.47%
Chapter 7
1. Using the market data in Exhibit 7.6, show the net terminal value of a long position in
one 108.5 Sep Japanese yen European call contract at the following terminal spot prices,
cents per yen: 106, 108, 108.5, 110, and 112. Ignore any time value of money effect.
2. Assume the spot Swiss franc is $0.7000 and the six-month forward rate is $0.6950. What
is the minimum price that a six-month American call option with a striking price of
$0.6800 should sell for in a rational market? Assume the annualized six- month Eurodollar
rate is 3.5 percent.
Ca Max [(70 - 68), (69.50 - 68)/(1.0175), 0] Max [2, 1.47, 0] = 2 cents
3. Problem 9 again assuming an American put option instead of a call option?
Pa Max [(68 - 70), (68 - 69.50)/(1.0175), 0] Max [-2, -1.47, 0] = 0 cents
The direct consequence of the dollar's rise is that U.S. exports suffer big falls because
countries that buy products from U.S. may acquire less the same money because a rising
dollar means that your currency is worth less. If, however, the dollar loses value, foreign
countries with different currency can buy more dollars with the same amount of its
currency. Thus, import more because they can buy more goods with the same amount of
money. Therefore, when the dollar suffers devaluation U.S. exports level increases
As we have seen, changes in the valuation of the dollar, with its ups and downs, impact in a
very direct effect on the prices of the products. If, as often happens, USA exported to
Europe products made with foreign labor (made in China, for example) and the value of the
dollar rises, but buy less merchandise because Europe has raised the value of the dollar,
also the low price of raw materials and goods, reducing and exports and raising the price of
products. Lowering the value of the dollar, increase exports, and is also true that the
development of products with foreign raw materials will be more expensive.