FIN 350, International Finance
Problem Set 3, Fall 2014
Due Nov 23rd 2014
Name: _______________________________
1. Assume that Bank X quotes the New Zealand dollar as NZD-USD.3301/51, while Bank Y quotes the New Zealand dollar as NZD-USD .3201/51.
a. Given this information, is it possible for investors to conduct arbitrage?
b. If an investor has a borrowing capacity of $10,000,000, how much profit can she make from the quote discrepancy?
c. What will be the impact of her transaction on the market quotes of the New Zealand dollar at the two banks?
2. Assume the following information: U.S. investors have $10,000,000 to invest
| Lending and borrowing rate in U.S. dollars | = | 6% and 8% respectively |
| Lending and Borrowing rate in Singapore dollars | = | 4% and 6% respectively |
| Forward rate of Singapore dollars | = | $.412-$0.414 |
| Spot rate of Singapore dollar | = | $.400 – $.402 |
(a) Explain any discrepancy an investor can spot in the situation?
(b) How much profit (if any) can be made by an investor who has a borrowing capacity of the equivalent of $10,000,000?
3. Assume the following information for a bank quoting on spot exchange rates:
| Exchange rate of Singapore dollar in USD | = | $.60 – $0.61 |
| Exchange rate of pound in USD | = | $1.51 – $1.515 |
| Exchange rate of pound in Singapore dollars | = | S$2.605 – S$2.61 |
(a) Explain the process of triangular arbitrage.
(b) How much profit can be made by a speculator with a capacity of $10,000,000 from this situation? (c) As arbitrage takes place, what will be the impact on each currency vis-à-vis the others?
4. Assume the following information:
| U.S. deposit rate for 1 year | = | 4% |
| U.S. borrowing rate for 1 year | = | 6% |
| Swiss deposit rate for 1 year | = | 3% |
| Swiss borrowing rate for 1 year | = | 5% |
| Swiss forward rate for 1 year | = | $.4000-$.4020 |
| Swiss franc spot rate | = | $.3905-$0.3922 |
Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and expects to receive SF 600,000 in 1 year. Using the information above, should the exporter hedge her exports using a forward hedge or a money market hedge? Explain.
5. You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. Call options are available for a premium of $0.03 and an exercise price of $0.50. The forecasted spot rate of the Australian dollar in 180 days is:
| Future Spot Rate | Probability |
| $.46 | 20% |
| $.48 | 30% |
| $.52 | 50% |
The 90-day forward rate of the Australian dollar is $.50.
(a) What option strategy can Arizona use to hedge its receivables?
(b) What is the probability that the option will be exercised (assuming Arizona purchased it)?
(c) What will be the net receivables if the option is exercised?
(d) Is the option strategy better than a forward contract?
(e) Would leaving the receivables unhedged have been better than the hedging strategies?
