NBS8249 INTERNATIONAL FINANCE 2018/19
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NBS8249
SEMESTER 1 2018/19
INTERNATIONAL FINANCE
QUESTION 1
1.1) Explain the concepts of currency boards, dollarization and free-floating regimes of exchange rates highlighting the advantages and disadvantages associated with each of them.
1.2) Give an example of how to record a transaction in the current account of the Balance of Payments, for both the home country and the foreign country.
1.3) You are given the following spot and forward bid-ask rates for the Australian dollar (US$/A$) exchange rate:
Period |
US$/A$ Bid Rate |
US$/A$ Ask Rate |
spot |
0.91630 |
0.91700 |
1 month |
0.91477 |
0.91551 |
2 months |
0.91313 |
0.91388 |
3 months |
0.91156 |
0.91233 |
6 months |
0.90542 |
0.90621 |
12 months |
0.89155 |
0.89242 |
24 months |
0.86488 |
0.86602 |
Can you tell for which maturities the Australian dollar is at premium (and the US dollar is at discount) and for which maturities the Australian dollar is at discount (hence the US dollar is at premium) without calculating the forward rates? Use
5 decimal points in your calculations.
1.4) Using the mid-rates and using the information in the table from question 1.3) calculate the forward premium or discount for the Australian dollar at 3 months.
QUESTION 2
2.1) Explain the different characteristics of organised markets and over-the-counter markets within the Forex markets and specify which types of exchange rate transactions they deal with.
2.2) Joanne Ferrari, a foreign exchange trader at JPMorgan Chase, can invest $8 million, or the foreign currency equivalent of the bank's short term funds, in a covered interest arbitrage with Denmark. Using the following quotes can Joanne make a covered interest arbitrage (CIA) profit?
Spot exchange rate: kr 6.1720/$
Three-month forward rate: kr 6.1980/$
Three-month dollar interest: 3.0% per year
Three-month krone interest: 4.5.0% per year
In your answer please use also the Arbitrage Rule of Thumb.
2.3) Suppose the following quotations by a bank:
€/$ = 0.8035 - 0.8050
¥/$ = 125.002 -125.113
What are the bid-ask prices of the yen in euro or €/¥ ? Please consider up to six decimal points in your answer.
QUESTION 3
3.1) Construct a numerical example to show how all the international parity conditions hold in equilibrium. Use formulae in approximate form.
3.2) Money and foreign exchange markets in London and New York are very efficient. The following information is available:
London New York
Spot exchange rate ($/€) $1.3860 $1.3860
One-year Treasury bill rate 3.800% 4.200%
Expected inflation rate ? 2.000%
What do the financial markets suggest for inflation in Europe next year?
3.3) Using the information provided in the previous question 3.2) now estimate today’s one-year forward exchange rate between the dollar and the euro.
QUESTION 4
On 25th January Phillip Lord, a derivative trader, wants to speculate on the options market and he sees the following quotations:
180-day Options |
Strike Price |
Premium |
Put on Mexican Peso |
$0.10521/Ps |
$0.00004/Ps |
Call on Mexican Peso |
$0.10521/Ps |
$0.00033/Ps |
Answer the following questions, knowing that the spot rate on 25th January is $0.110/Ps and that Phillip after considerable study has concluded that the Mexican peso will depreciate against the dollar in the coming 6 months, probably to about $0.0920/Ps.
4.1) Should Phillip buy a put on Mexican pesos or a call on Mexican pesos?
4.2) Using your answer to part 4.1) what is Phillip’s break-even price?
4.3) Using your answer to part 4.1), if the spot rate at the end of the 180 days is indeed $0.0920/Ps say whether the option is “in the money” or “out of the money” and if it is in the money then calculate what is Phillip’s gross profit and net profit.
4.4) How would your answer to part 4.3) change if the spot rate at the end of 180 days is $0.10554? If Phillip had known this outcome, should he have bought a different option to what you previously answered in part 4.1)?
4.5) ‘Some forecasters believe that forward exchange rates are unbiased predictors of future spot exchange rates”. Explain the meaning of this sentence.
QUESTION 5
5.1) Explain the concepts of credit risk and repricing risk.
5.2) Explain why companies may want to access swap markets for their financial needs.
5.3) What is the necessary numerical condition for a fixed-for- floating interest rate swap to be possible?
5.4) Alpha and Beta Companies can borrow for a five-year term
at the following rates:
Alpha Beta
Moody’s credit rating AA BAA
Fixed-rate borrowing cost 10.5% 12.0%
Floating-rate borrowing cost LIBOR LIBOR+1%
Design an interest rate swap in which Alpha and Beta share the cost savings in the proportion of 2:1. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap bank is involved in this transaction.
5.5) Consider the information given in part 5.4) and assume now that a swap bank is involved as an intermediary. Briefly describe how this would change the cost savings in the borrowing costs of both Alpha and Beta companies. You can choose in this case whether the two companies have asymmetry in cost saving or whether they save the same cost.
QUESTION 6
6.1) Describe the first-generation models of currency crisis.
6.2) Compare the characteristics of currency futures and forward contracts.
[HINT: comparison in terms of size of contract, maturity, location, liquidity, commissions, settlement, counterparties, etc.]
2022-01-08