Chapter 6
18. Intervention Effects on Corporate Performance. Assume you have a subsidiary in Australia. The subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from local banks. Your subsidiary purchases all of its materials from Hong Kong. The Hong Kong dollar is tied to the U.S. dollar. Your subsidiary borrowed funds from the U.S. parent, and must pay the parent $100,000 in interest each month. Australia has just raised its interest rate in order to boost the value of its currency (Australian dollar, A$). The Australian dollar appreciates against the dollar as a result. Explain whether these actions would increase, reduce, or have no effect on:
a. The volume of your subsidiary’s sales in Australia (measured in A$),
b. The cost to your subsidiary of purchasing materials (measured in A$)
c. The cost to your subsidiary of making the interest payments to the U.S. parent (measured in A$).
Briefly explain each answer.
ANSWER:
Since there shall be a rise in the interest rates, the volume of sales should decline since the cost of the product for the consumers is expected to reduce.
Determination of the cost of subsidiary is based on the effect of certain cost parameters, and as such the purchasing cost for materials should be subjected to a decline. This statement is valid since the appreciation in A$ in correspondence with HK$ leads to an appreciation against the value of the U.S. dollar.
c. Generally, there should be a decline in the interest expenses since it would be less costly to make a payment of $100,000 on a monthly stipulated period as just a few A$ shall be used.
24. Implications of a Revised Peg. The country of Zapakar has much international trade with the
U.S. and other countries, as it has no significant barriers on trade or capital flows. Many firms in Zapakar export common products (denominated in zaps) that serve as substitutes for products produced in the U.S. and many other countries. Zapakar’s currency (called the zap) has been pegged at 8 zaps =$1 for the last several years. Yesterday, the government of Zapakar reset the zap’s currency value so that is now pegged at 7 zaps=$1.
How should this adjustment in the pegged rate against the dollar affect the volume of exports by Zapakar firms to the U.S.?
b. Will this adjustment in the pegged rate against the dollar affect the volume of exports by Zapakar firms to non-U.S. countries? If so, explain.
c. Assume that the Federal Reserve significantly raises U.S. interest rates today. Do you think Zapakar’s interest rate would increase, decrease, or remain the same?
ANSWER:
a. There will be a reduced demand for the Zapakar’s exports value due the predisposed high value associated with Zap’s products.
b. There will be a decline in the Zapakar’s exports by the non-USA countries due to higher value for Zap compared to other currencies.
c. From my own perspective, there shall be a rise in the Zapakar’S interest rates due to a rise in the U.S. interest rate
Chapter 7
6. Covered Interest Arbitrage. Assume the following information:
Quoted Price
Spot rate of Canadian dollar $.80
90day forward rate of Canadian dollar $.79
90day Canadian interest rate 4%
90day U.S. interest rate 2.5%
Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1,000,000.) What market forces would occur to eliminate any further possibilities of covered interest arbitrage?
ANSWER
The calculation is determined as belowTotal spot rate is given by $1,000,0000.80
Given the Canadian interest rate of 4%; the spot rate becomes $C1, 250,000X104100
Which gives Spot Rate = C$1,300,000 × $.79
= $1,027,000
The total yield is a percentage enumerated by the following computations: (1,027,000-1,000,000)1,000,000=2.7%
This yield is thus higher than the yield rate of the U.S dollar over a 90-day period.
Based on these calculations, it is apparent that there should be a decline in the forward rate for the Canadian dollar in its spot rate has to rise, and at the same time there might be a fall in the Canadian Interest rate, while the U.S dollar interest rate could shoot.
17. Covered Interest Arbitrage in Both Directions. The oneyear interest rate in New Zealand is 6 percent. The oneyear U.S. interest rate is 10 percent. The spot rate of the New Zealand dollar (NZ$) is $.50. The forward rate of the New Zealand dollar is $.54. Is covered interest arbitrage feasible for U.S. investors? Is it feasible for New Zealand investors? In each case, explain why covered interest arbitrage is or is not feasible.
ANSWER:
The determination of the yield covered from the interest arbitrage, and by the U.S investors requires us to begin with an initial investment that we will assume to be $1,000,000.
Therefore 1,000,0000.5$
And becomes NZ$2,000,000 × 106100
Thus the NZ$2,120,000 × $.54
= $1,144,800
The yield could be given by (1,144,800-1,000,000)1,000,000
And it is equivalent to 14.48%
We could also determine the yield from covered arbitrage attributed to the New Zealand Investors by assuming an initial value of NZ$1,000,000:
This becomes NZ$1,000,000 × $.50 =
$500,000 × (110/100)
$550,000/$.54 =
NZ$1,018,519
Thus, the yield is given by = (NZ$1,018,519 – NZ$1,000,000)/NZ$1,000,000
= 1.85%F
45. IRP Relationship. Assume that interest rate parity (IRP) exists. Assume this information is
provided by today’s Wall Street Journal.
Spot rate of Swiss franc = $.80
6-month forward rate of Swiss franc = $.78
12-month forward rate of Swiss franc = $.81
Assume that the annualized U.S. interest rate is 7% for a six-month maturity and a 12-month maturity. Do you think the Swiss interest rate for a 6-month maturity is greater than, equal to, or less than the U.S. interest rate for a 6-month maturity? Explain.
ANSWER:
Chapter 8
20. Deriving Forecasts of the Future Spot Rate. As of today, assume the following information is available:
U.S. Mexico
Real rate of interest required
Nominal interest rate 11% 15%
Spot rate — $.20
Oneyear forward rate — $.19
a. Use the forward rate to forecast the percentage change in the Mexican peso over the next year.
The forward rate calculation would be given by One-year forward rate for mexico-spot rate for mexicospot rate for mexico
0.19-0.20.2= -0.05 or -5%
b. Use the differential in expected inflation to forecast the percentage change in the Mexican peso over the next year.
The inflation forecast rate is given by 1.091.13 – 1 = -.0353
Or -3.53%;
The negative sign associated with the final forecast rate is a representation of depreciation to the peso
c. Use the spot rate to forecast the percentage change in the Mexican peso over the next year.
The answer is zero since there is no percentage change in the interest rate for the Mexican peso
24. IFE. Beth Miller does not believe that the international Fisher effect (IFE) holds. Current one-year interest rates in Europe are 5 percent, while one-year interest rates in the U.S. are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.10.
a. According to the IFE, what should the spot rate of the euro in one year be?
b. If the spot rate of the euro in one year is $1.00, what is Beth’s percentage return from her strategy?
c. If the spot rate of the euro in one year is $1.08, what is Beth’s percentage return from her strategy?
d. What must the spot rate of the euro be in one year for Beth’s strategy to be successful?
The spot rate in euro could be given by the following formula
Spot rate: $1.10 × (1 – 1.90%)
$1.079
b.
Beth’s percentage return from this strategy could be obtained by considering the following presumptions:
In the first case, we shall convert dollars into euros: $100,000/$1.10 = €90,909.09, followed by investing these proceeds for one year in order to obtain the following:
Investment in one year leads to a return of €90,909.09 × 1.05
= €95,454.55
Finally, we shall convert out resultant euros into dollars before determining her percentage benefits:
This is equivalent to €95,454.55 × $1.00 = $95,454.55
While her percentage returns on this investment is calculated as
$95, 454.55100,000 – 1
–4.55% (this is a negative percentage returns implying a loss)
C.
Here, we shall follow similar steps of section b; convert dollars to euros, invest and reconvert the returns to dollars, but for this case we shall use a new rate of 1.08, and it becomes €95,454.55 × $1.08 =$103,090.91
Thus, the percentage returns $103,090.91100,000– 1 = 3.09%.
This strategy will now be successful since Beth will achieve positive returns from her investment, and indeed this strategy will be a success since the spot rate is higher than $1.079.
34. IRP, PPP, and Speculating in Currency Derivatives. The U.S. three-month interest rate (unannualized) is 1%. The Canadian three-month interest rate (unannualized) is 4%. Interest rate parity exists. The expected inflation over this period is 5% in the U.S. and 2% in Canada. A call option with a three-month expiration date on Canadian dollars is available for a premium of $.02 and a strike price of $.64. The spot rate of the Canadian dollar is $.65. Assume that you believe in purchasing power parity.
a. Determine the dollar amount of your profit or loss from buying a call option contract specifying C$100,000.
ANSWER:
1.051.02 – 1
= 2.94%.
Thus, the3-months projected spot rate is given as $.65 × (1.0294) = $.66911.
The net profit per unit with regards to the call option is calculated as $.66911 – $.64 – $.02
= $.00911.
Thus, this contract yields a net profit of $.00911 × 100,000 = $911.
b. Determine the dollar amount of your profit or loss from buying a futures contract specifying C$100,000.
ANSWER:
Based on the IRP standards, the rates for the future premiums out to be 1.011.04 – 1 = –2.88%
This, thus unfolds the future rate to be $.65 × (1 – .0288) = $.6313.
Considering that the expected spot rate for this contact over a 3-month period is $$.65 × (1.0294) = $.66911; then from this calculation we obtain the net profit per unit buying as $.66911 – $.6313 = $.03781.
The actual value for the net profit is $.03781 × 100,000 = $4,341.
Chapter 10
2. Assessing Transaction Exposure. Your employer, a large MNC, has asked you to assess its transaction exposure. Its projected cash flows are as follows for the next year:
Assume that the movements in the Danish krone and the pound are highly correlated. Provide your assessment as to your firm’s degree of transaction exposure (as to whether the exposure is high or low). Substantiate your answer.
ANSWER: the degree of the transaction exposure is given by the following projections in the table:
This is a very high exposure considering the overall value of exposure.
17. Impact of Exchange Rates on Earnings. Cieplak, Inc., is a U.S.-based MNC that has expanded into Asia. Its U.S. parent exports to some Asian countries, with its exports denominated in the Asian currencies. It also has a large subsidiary in Malaysia that serves that market. Offer at least two reasons related to exposure to exchange rates why Cieplak's earnings were reduced during the Asian crisis.
ANSWER:
Considering this scenario, the depreciation of the Asian currencies led to a conversion of fewer dollars on its exports. In the second scenario, the Malaysian subsidiary was converted to fewer dollars due to this spiral effect, and thus lower earnings reflected on the consolidated income statement.
