THE UNIVERSITY OF THE WEST INDIES, MONA

DEPARTMENT OF ECONOMICS

ECON3007 (EC30P): INTERNATIONAL FINANCE

Tutorial Paper 2 Foreign Exchange Markets and Exchange Rate
Risk

Table 1: Dollar/Franc Exchange Values

IN U.S.$ CURRENCY PER U.S. $
Wed. Tues. Wed. Tues.
Switzerland (franc) .5851 .5846
30-day forward .5853 .5848
90-day forward .5854 .5849
180-day forward .5851 .5847

1. Table 1 gives hypothetical dollar/franc exchange values for Wednesday, May 5, 2008.
a. Fill out the last two columns of the table.
b. On Wednesday, the spot price of the two currencies was ________ dollars per franc, or
_______ francs per dollar.
c. From Tuesday to Wednesday, in the spot market the dollar (appreciated/depreciated) against
the franc; the franc (appreciate/depreciated)against the dollar.
d. In Wednesdays spot market, the cost of buying 100 francs was _______dollars; the cost of
buying 100 dollars was _______francs.
On Wednesday, the 30-day forward franc was at a (premium /discount of _______dollars,
which equalled ______ percent on an annual basis. What about the 90-day forward franc?

2. a) The dollar price of British pounds in Tokyo and Bonn are as shown below:

Tokyo Bonn
R = $/ = 1.45 R = $/ = 1.40

Explain why the above is a disequilibrium situation and what will happen to force the two prices
towards equality.
b) Suppose the exchange rates in three financial centers are as shown below:

New York London Paris

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 R=$/=1.45 R=$/euro=0.20 R=euro/ = 7

If you have dollars and are interested in buying pounds, where would you obtain them?

c) Explain why the situation presented in the table in part b) is a disequilibrium situation and what
will happen to produce equilibrium.

3. Calculate the forward discount or premium for the following spot and three-month forward rates:
a. SR = $2.00/1 and FR = $2.01/1
b. SR = $2.00/1 and FR = $1.96/1

4. What is the cross rate implied by the following quotes:

a. C$/$1.5613,$/ 1.0008
b. /$ 124.84,$/1.5720
c. SF/$ 1.4706,C$/$ 1.5613

5. Assume that the foreign exchange market is initially in equilibrium. What effect will the
following changes have on the dollar value of the yen ($/) if exchange rates are allowed to float
freely? Use foreign exchange supply and demand curves to explain your answer.

a) An increase in interest rates in Japan

b) Lowered incomes in the U.S. (recession)

c) A reduction in import barriers in Japan

d) An increase in inflation in the U.S.

6. Construct an example for the $/ exchange rate where the dollar appreciates relative to the pound.
Carefully label your diagram and have the initial exchange rate equal to 1.60. What might cause
the supply and/or demand curve to move in the manner illustrated (what are the underlying
reasons for exchange rate movements)? Indicate what sort of central bank intervention would be
necessary to prevent the exchange rate from moving away from the initial equilibrium.

7. Describe the forward transaction necessary to hedge the transactions described below:

a) A U.K. firm imports wine from Germany, agreeing to deliver Euros in thirty days

b) A U.S. bank lends dollars to a French bank and agrees to accept Euros in thirty days

c) A Canadian investor buys a one-year U.S. government security

d) A U.S. firm borrows Japanese yen and agrees to repay the yen in ninety days

e) A U.S. importer expects to receive Japanese yen in thirty days and borrows an equivalent
amount of yen in Tokyo today, and converts the yen to dollars today

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 8. Explain three ways to bet on your forecast of an increase in the dollar value of the yen.

9. Suppose IBM sells computers in Japan and receives revenues in yen. IBMs expenses however
are in dollars.
a) Does IBM risk an appreciation or depreciation of the yen?

b) What can IBM do in the forward market to eliminate the risk you described in part a?

c) What can IBM do in the swap market to eliminate the risk of part a?

10. Assume a speculator anticipates that the spot rate of the franc in three months will be lower than
todays three- month forward rate of the franc, $0.50= 1 franc.
a. How can this speculator use $ 1 million to speculate in the forward market?
b. What occurs if the francs spot rate in three months is $0.40; $0.60; $0.50?

11. As treasurer of a large US corporation, you must decide how best to manage the firms cash
flows to maximize profits subject to maintaining an acceptable level of risk. Your firm has an
account payable to a French firm of 2,000,000 due in 180 days. Review the options available for
managing this foreign currency liability. Is there any reason to prefer one course of action over
another?
a. You could rely on the spot market and buy the euros any time in the next 180 days.
b. You could buy the euros today in the forward market.
c. You could establish a margin account and buy a futures contract for the euros.
d. You could buy a call option for the euros

12. When is an option in the money and at the money.

13. Suppose you expect that Singapore dollar will appreciate versus the US$ in the coming 90 days.
The current spot rate is $0.60/S$. You expect an appreciation to $0.70/S$. The following options
are available to you:

Option Strike Price Premium

Put on S$ $0.65/S$ $0.0002/S$
Call on S$ $0.65/S$ $0.045/S$

a. What option would you buy?

b. What is the gross and net profit (i.e. accounting for the premium) if the spot rate at the
end of 90 days is $0.80/S$?

14. Assume an American call option on euros is written w/ a strike price of $0.94/EUR at a
premium of 0.90 cents per EUR and with an expiration date three months from now. The
option is for EUR 100,000. Calculate your profit or loss should you exercise the option
before maturity at a time when the euro is traded spot at

a. $0.94/EUR

b. $1.00/EUR

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