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LBS8249

SEMESTER 1 2019/20

INTERNATIONAL FINANCE

QUESTION 1

a) Briefly describe the history of the International Monetary System

b) Define the following:

-Bid rate quote

-Ask rate quote

c) Samantha Corp., a corporate treasury in Frankfurt, simultaneously calls J.P. Morgan in Frankfurt and BNP Paribas in Paris. The two banks give the following quotes at the same time on the euro:

J.P. Morgan: $0.8611-21/€

BNP Paribas: $0.8635-45/€

Using $4 million, show whether the corporate treasury could make geographic arbitrage profit with the two different exchange rate quotes. In your answer, consider two alternative arbitrage strategies.

QUESTION 2

The Balance of Payments records of the country Pavlopetri are given as:

In billions	Year 1	Year 2	Year 3

A. Current Account
Goods: exports	661	583	659
Goods: imports	-738	-603	-597
Balance on goods

Services: credit	121	118	123
Services: debit	-232	-221	-230
Balance on services

Income: credit	153	152	186
Income: debit	-338	-339	-374
Balance on income

Current transfers: credit	32	32	32
Current transfers: debit	-14	-13	-16
Balance on current transfers

*Current* *Account* *Balance*

B. Capital Account	4	7	5

C. Financial Account
Direct investment abroad	-93	-69	-36
Direct investment in Pavlopetri	292	960	417
Direct investment in Pavlopetri, net

Portfolio investment assets, net	-76	-80	-50
Portfolio investment liabilities, net	428	-191	-53
Balance on other investment assets and liabilities, net	207	-41	37

*Financial* *Account* *Balance*
D. Net Errors and Omissions
E. Reserves and Related Items	-102	-50	29

On the basis of the above:

a) Calculate the values in gray cells, that is: balance on goods, balance on services, balance on income, balance on current transfers, current account balance, net direct investment, financial account balance and net errors and omissions.

b) Explain what these balances and their components mean.

c) Is Pavlopetri accumulating or decumulating foreign reserves? Explain.

d) What is the 'Impossible Trinity' trilemma?

QUESTION 3

a) You are planning a 15-day vacation in Saint Lucia, in the eastern Caribbean Sea, one year from now. The present charge for a luxury suite plus meals in Eastern Caribbean dollars (XCD) is XCD 800/day. The Eastern Caribbean dollar presently trades at XCD 2.66/US$. The hotel has informed you that any increase in its room charges will be limited to any increase in the Caribbean cost of living. You are basing your budgeting on purchasing power parity (PPP). Caribbean inflation is expected to be 6% per annum, while U.S. inflation is expected to be 2% per annum. How many US dollars might you expect to need one year from now, for your 15-day vacation?

b) What is partial exchange rate pass-through? Can you give an example?

c) Explain the Fisher effect and the International Fisher effect

d) 'Some forecasters believe that forward exchange rates are unbiased predictors of future exchange rates'. Explain the meaning of this sentence.

QUESTION 4

a) Epidaurus Company recently took out a 4-year €3 million loan on a floating rate basis. The company however, is now worried about rising interest costs.

Epidaurus is now considering whether to seek some protection against a rise in euro-LIBOR, and is considering a Forward Rate Agreement (FRA) with an insurance company. According to the agreement, Epidaurus would pay to the insurance company at the end of each year, the difference between its initial interest cost at LIBOR + 1.50% and any fall in interest cost due to a fall in LIBOR. Conversely, the insurance company would pay to Epidaurus Company the difference between Epidauru’s initial interest cost and any increase in interest costs caused by a rise in LIBOR. Purchase of the FRA will cost €50,000, paid at the time of the initial loan, while current LIBOR is 6%.

What are Epidauru's annual total cash flows under the FRA, if LIBOR rises by 100 basis points per year (1.00%) and if LIBOR falls by 50 basis points per year (0.50%)?

b) Explain the concepts of credit risk premium and repricing risk.

c) What do the general categories of investment grade and speculative grade represent?

d) Explain what does the term 'carry trade' mean.

QUESTION 5

On 4th June, Heraclitus, a derivative trader, wants to speculate on the options market and he sees the following quotations:

180-day Options	Strike Price	Premium
Put on Sing $	$0.6500/S$	$0.00003/S$
Call on Sing $	$0.6500/S$	$0.00046/S$

Answer the following questions, knowing that the spot rate on 4th June is $0.6000/S$ and that Heraclitus, after considerable study has concluded that the Singapore dollar will appreciate against the US dollar in the coming 6 months, probably to about $0.7000/S$.

a) Should Heraclitus buy a put on Singapore dollars or a call on Singapore dollars?

b) Using your answer in part a), what is Heraclitus' break-even price?

c) Using your answer in part a), if the spot rate at the end of the 180 days is indeed $0.7000/S$, say whether the option is 'in-the-money' or 'out-of- the-money' and if it is 'in-the-money', then calculate what is Heraclitus' gross profit and net profit.

d) How would your answer to part c) change, if the spot rate at the end of 180 days is $0.5500/S$?

e) The value of an option is stated to be the sum of its intrinsic value and its time value. Explain what is meant by these terms.

f) What is an option delta? How does it change when the option is 'in-the- money', 'at-the-money', or 'out-of-the-money'?

QUESTION 6

a) What is a currency crisis?

b) What are the shortcomings of the first-generation models of currency crises and how are the second-generation models improving on them? Please make also use of equations to answer the question.

c) Calculate the forward premium or discount on the US dollar (the US dollar is the home currency), if the spot rate is €1.3300/$ and the 3-month forward rate is €1.3400/$.

d) Check your calculation of the forward premium or discount in c), by inverting the currency quotes and using the appropriate quotation formula.