FINA 351 – Managerial Finance, Chapter 18, (Ref. 18b)
Answer the following questions:
1. Refer to the instructor notes for this chapter:
(A) Why do we prefer to have a medium of exchange instead of using the bartering system?
(B) T or F: Paper money has no innate value in and of itself but is only as good as the government that backs
it up and has promised to redeem it for face value.
(C) Why have nations traditionally used gold as a reserve to back up their currency? In other words, what is
so special about gold?
(D) How does the story of Baker Boyer Mercantile and its receipts/notes illustrate the value of Federal
Reserve notes under the gold standard?
(E) What is the main advantage and disadvantage of being on the gold standard (with fixed exchange rates
pegged in terms of gold)?
(F) Why do some famous people call for return to a form of the gold standard?
(G) Even though the U.S. is not currently on the gold standard, does the government still hold gold? Why?
2. A Washington wheat farmer is very interested in learning more about the subject of foreign currency,
especially the Japanese yen (JPY), because it affects the prices of the soft white wheat that he exports to Japan
(which uses it to make noodles). Because you have taken a course in finance, he asks you three important
questions, which he expects you will answer intelligently.
(A) What are five major macroeconomic factors that might cause the U.S. dollar (USD) to strengthen or
weaken relative to the JPY?
(B) From a U.S. macroeconomic perspective, what are the major advantages of a strong USD relative to
JPY?
(C) From a U.S. macroeconomic perspective, what are the major disadvantages of a strong USD relative to
JPY?
(D) Would the wheat farmer prefer a strengthening or weakening USD in relation to the JPY? Why?
(E) Go to the link below, which should create a graph showing the value of the JPY over the last two years.
Would these value changes make the wheat farmer happy or sad? Why?
http://finance.yahoo.com/echarts?s=JPYUSD=X&t=5d&l=on&z=m&q=l&c=#{"range":"2y","showPrePost":false}
3. Determine whether each of the following would make U.S. exporters or importers happy . The first one has
been done for you.
Scenario
(A) Officials in the U.S. administration announced that they are comfortable with a rising
Mexican peso value, relative to the U.S. dollar.
(B) British authorities announced that the pound has been driven too low by currency
speculators, relative to the dollar, so they will take actions to strengthen the pound.
(C) The Brazilian government announced that it will print billions of new reals and inject
them into the economy to reduce the country’s high unemployment rate.
(D) The European Union authorities begin to undertake an expansionary monetary policy
(print Euro’s) in an attempt to jumpstart Europe’s lagging economy.
Importer
Sad
Exporter
Happy
4. (A) What is the difference between the spot and forward exchange rates?
(B) How does the forward market provide a way to reduce currency risk?
5. Suppose the exchange rate for the Swiss franc is quoted in the spot market as SF 1.50 = $1 USD and in the
90-day forward market as SF 1.53 = $1 USD.
(A) Is the forward U.S. dollar selling at a premium or a discount relative to the Swiss franc?
(B) Would you anticipate inflation and interest rates to move higher or lower in Switzerland as compared to
in the U.S.?
6. Suppose that today the spot exchange rate for the Canadian dollar (CDN) is currently CDN$1.10 = $1 USD
and the six-month forward rate is CDN$1.25 = $1 USD.
(A) Which is worth more today, a CDN or a USD?
(B) If a bottle of mountain spring water costs CDN$1.10, how much would the same bottle cost in USDs
today? Why might the bottle actually sell at a different price in the U.S.?
(C) Which currency is expected to strengthen over the next six-months?
(D) Which currency is selling at a discount?
(E) In light of the info above, suppose that in six months a WWU student from Canada needs to pay U.S.
$8,000 for a quarter of WWU tuition. Review each of the following alternatives and state which you think is
best and why. (1) The student should buy USDs now at the spot rate and hold on to them until the tuition is
due. (2) The student should enter a six-month forward contract today by agreeing to buy USDs in six-months
at the current six-month forward rate. (3) The student should just risk it by waiting until the tuition is due
and converting his CDN dollars into USD at whatever the exchange rate is at that time.
7. (A) What is the purpose of cross rates?
(B) What is triangular arbitrage?
(C) Go to http://finance.yahoo.com/currency-investing and click on European Cross Rates. What is the
current cross rate between the Euro and Australian Dollar (EUR/AUD). See price column. Suppose this
cross-rate was slightly mispriced. How could a Forex investor take advantage of a temporarily mispriced
cross-rate?