Multinational Finance (BSc) - WS 2015/16
Problems Part II
Multinational Finance (BSc)
WS 2015/16
Dr. Volker Seiler
Problems Part II: Foreign Exchange Theory
I. Paris to St. Petersburg
On your post-graduation trip you are leaving Paris for St. Petersburg, Russia.
You leave Paris with 10,000 euros (EUR) in your money pouch. Wanting to
exchange all of these for Russian rubles (Rbl), you obtain the following quotes:
Currencies
Spot rate
USD/EUR cross rate
Rbl/USD cross rate
1.4260
24.7500
Table 1: Spot rate quotes
1. What is the Russian ruble/euro cross rate?
2. How many rubles will you obtain for your euros?
II. Forward premiums on the Japanese yen
Use the following spot and foward bid-ask rates for the yen/dollar (JPN/USD)
exchange rate to answer the following questions:
Period
Spot
1 month
2 months
3 months
6 months
12 months
24 months
JPN/USD
Bid Rate
JPN/USD
Ask Rate
85.41
85.02
84.86
84.37
83.17
82.87
81.79
85.46
85.05
84.90
84.42
83.20
82.91
81.82
Table 2: Bid and Ask Rates for JPN/USD Exchange Rate
1. Calculate the mid-rates for each maturity.
2. Based on the mid-rates, calculate the annual forward premium for all
maturities.
3. Which maturities have the smallest and largest forward premiums?
III. Starbucks in Croatia
Starbucks opened its first store in Zagreb, Croatia, in October 2010. In Zagreb,
the price of a tall vanilla latte is kn 25.50. In New York City, the price of a
tall vanilla latte is USD 2.65. The exchange rate between Croation kunas (kn)
and U.S. dollars is kn 5.6288/USD. According to purchasing power parity, is
the Croation kuna overvalued or undervalued?
Dr. Volker Seiler
1
Multinational Finance (BSc) - WS 2015/16
Problems Part II
IV. Covered Interest Arbitrage (CIA)
Joun Duell, a foreign exchange trader at J.P. Morgan Chase, can invest USD
1 million or the foreign currency equivalent for a short-term money market
investment and wonders if he should invest in U.S. dollars for three months or
make a covered interest arbitrage (CIA) investment in Swiss franc. He faces
the following rates:
Rate
Spot rate
3-months forward rate
3-months U.S. interest
3-months Swiss interest
1.2810 CHF/USD
1.2740 CHF/USD
4.8000% p.a.
3.2000% p.a.
Table 3: Exchange Rate and Interest Rate Quotes for Covered Interest Arbitrage
V. Uncovered Interest Arbitrage (UIA)
Brynja Johannsdottir is Icelandic by birth, but is working for Magma Capital, a
currency hedge fund run out of New York. The high money market rates offered
in Iceland have been supporting the carry-trade, as investors borrow in cheaper
currencies (nearly any currency at this point) and invest for the short term in
Icelandic krona. But they do so on an uncovered basis. Brynja believes that at least for the coming three- to six-months period - the krona will continue to
stay strong, sticking at 70 kr./USD. Her bank requires that any position she
takes yields at least 4.0% for the period in question (16% annually). Using
the assumptions in the preceding table, she wishes to evaluate the uncovered
interest arbitrage (UIA) potential of a USD 2 million investment, using the
3-months forward rate as an estimator for the spot rate in 3 months.
Rate
Spot rate
3-months forward rate
3-months dollar interest
3-months krona interest
71.6350 kr./USD
72.9127 kr./USD
4.800% p.a.
12.020% p.a.
Table 4: Exchange Rate and Interest Rate Quotes for Uncovered Interest Arbitrage
VI. Japanese/United States Parity Conditions
Derek Tosh is attempting to determine whether U.S./Japanese financial conditions are at parity. The current spot rate is a flat JPY 89.00/USD while
the 360-day forward rate is JPY 84.90/USD. Forecast inflation is 1.10% for
Japan and 5.90% for the United States. The 360-day euro yen deposit rate is
4.70% and the 360-day euro dollar deposit rate is 9.50%. Find the forecasted
change in the Japanese yen/U.S. dollar (JPY/USD) exchange rate one year
from now.
VII. Corolla Exports and Pass-Through
Assume that the export price of a Toyota Corolla from Osaka, Japan, is JPY
2,150,000. The exchange rate is JPY 87.60/USD. The forecast rate of inflation
in the United States is 2.2% per year and in Japan 0.0% per year. Use this
data to answer the following questions on exchange rate pass-through.
Dr. Volker Seiler
2
Multinational Finance (BSc) - WS 2015/16
Problems Part II
1. What was the export price of the Corolla at the beginning of the year
expressed in U.S. dollars?
2. Assuming purchasing power parity holds, what should be the exchange
rate at the end of the year?
3. Assuming 100% pass-through of exchange rate, what will be the dollar
price of a Corolla at the end of the year?
4. Assuming 75% pass-through, what will be the dollar price of a Corolla at
the end of the year?
VIII. Speculating with Foreign Currency Futures
Jennifer Magnussen, a currency trader for Chicago-based Black River Investments, uses the futures quotes shown in the table below on the British pound
to speculate on its value:
Maturity
Mar
June
Open
High
Low
Settle
Change
High
Low
1.4246
1.4164
1.4268
1.4188
1.4214
1.4146
1.4228
1.4162
0.0032
0.0030
1.4700
1.4550
1.3810
1.3910
Open Interest
25,605
809
All contracts are for 62,500 pounds. Open means the opening price on the day. High means the high price on
the day. Low indicates the lowest price on the day. Settle is the closing price on the day. Change indicates
the change in the settle price from the previous day’s close. High and Low to the right of Change indicate
the highest and lowest prices this specific contract (as defined by its maturity) has experienced over its
trading history. Open Interest indicates the number of contracts outstanding.
Table 5: British Pound Futures, USD/GBP (CME)
1. If Jennifer buys 5 June pound futures, and the spot rate at maturity is
1.3980 USD/GBP, what is the value of her position?
2. If Jennifer sells 12 March pound futures, and the spot rate at maturity
is 1.4560 USD/GPB, what is the value of her position?
3. If Jennivery buys 3 March pund futures, and the spot rate at maturity is
1.4560 USD/GBP, what is the value of her position?
4. If Jenniver sells 12 June pound futures, and the spot rate at maturity is
1.3980 USD/GBP, what is the value of her position?
Dr. Volker Seiler
3