INTERNATIONAL

BUSINESS FINANCE FINS3616

Tutorial Week2
Chapters3+5

CONTACT DETAILS
YourTutor&TutorinCharge: PeterAndersen peter.andersen@unsw.edu.au

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CHAPTER 3 PROBLEM 1
Q. Ifthespotexchangerateoftheyenrelativetothedollaris105.75,andthe 90dayforwardrateis103.25/$,isthedollarataforwardpremiumor discount?Expressthepremiumordiscountasapercentageperannumfora 360dayyear? A. Thedollarisatadiscountasone$isworthlessfortradingin90daystimethan attodaysspotrate.
f
f

Fnd/f Sd/f 360 0 100 d/f S0 n

103.25/$ 105.75/$ 360 100 105.75/$ 90

9.46%

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CHAPTER 3 PROBLEM 3
Q. AsaforeignexchangetraderforJPMorganChase,youhavejustcalleda traderatUBStogetquotesfortheBritishpoundforthespot,30day,60day, and90dayforwardrates.YourUBScounterpartstated,Wetradesterlingat $1.774550,47/44,88/81,125/115.Whatcashflowswouldyoupayand receiveifyoudoaforwardforeignexchangeswapinwhichyouswapinto 5,000,000atthe30dayrateandoutof5,000,000atthe90dayrate?What mustbetherelationshipbetweendollarinterestratesandpoundsterling interestrates? A. Becausetheforwardpointsarebigger/smaller,wesubtractthemfromthespot rateinorderforthebidaskspreadtowidenasmaturitylengthens.

S$/ 0 $1.7745-50 /
$/ F30 $1.7698-1.7706 /

Buy5mat$1.7706/ Sell5mat$1.7620/

=Pay$8,853,000in30d =Receive$8,810,000in90d
4

$/ F90 $1.7620-35 /
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CHAPTER 3 PROBLEM 4
Q. Considerthefollowingspotandforwardratesfortheyeneuro(/) exchangerates:
Spot 146.30 30days 145.75 60days 145.15 90days 144.75 180days 143.37 360days 137.85

Istheeuroataforwardpremiumordiscount?Whatarethemagnitudesof theforwardpremiumsordiscountswhenquotedinpercentageperannum fora360dayyear?

i.e.not365days/year

A. Discount!
f
30
/ Fn / S0 360 100 / S0 n

f90

145.75/ 146.30/ 360 100 146.30/ 30 144.75/ 146.30/ 360 100 146.30/ 90 137.85/ 146.30/ 360 100 146.30/ 360

4.51% 4.24%
5.78%
5

f360

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CHAPTER 3 PROBLEM 5
Q. Asacurrencytrader,youseethefollowingquotesonyourcomputerscreen:
Exch.Rate USD/EUR JPY/USD USD/GBP Spot 1.0435/45 98.75/85 1.6623/33 1month 20/25 12/10 30/35 2month 52/62 20/16 62/75 3month 75/90 25/19 95/110 6month 97/115 45/35 120/130

WhataretheoutrightforwardbidandaskquotesfortheUSD/EURatthe3 monthmaturity? A.

S$/ 0 $1.0435-45 /
Forward points = 75/90
BecausethebidpointsareLESSTHANtheaskpoints,weADDthemtothespot rate.

F3$/ $1.0510-35 /
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CHAPTER 3 PROBLEM 5
Q. Asacurrencytrader,youseethefollowingquotesonyourcomputerscreen:
Exch.Rate USD/EUR JPY/USD USD/GBP Spot 1.0435/45 98.75/85 1.6623/33 1month 20/25 12/10 30/35 2month 52/62 20/16 62/75 3month 75/90 25/19 95/110 6month 97/115 45/35 120/130

Ifoneofyourcorporatecustomerscallsyouandwantstobuypoundswith dollarsin6months,whatpricewouldyouquote? A.

S$/ 0 $1.6623-33 /

F6$/ $1.6743-63 /

Asthecustomerwishestopurchasepoundsandthequotesaregiveninterms of$priceperpound,youwouldquotethehigheraskrateof $1.6763/

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CHAPTER 3 PROBLEM 6
Q. Intelisscheduledtoreceiveapaymentof100,000,000in90daysfromSony inconnectionwithashipmentofcomputerchipsthatSonyispurchasing fromIntel.Supposethatthecurrentexchangerateis103/$,thatanalysts areforecastingthatthedollarwillweakenby1%overthenext90days,and thatthestandarddeviationof90dayforecastsofthepercentagerateof depreciationofthedollarrelativetotheyenis4%. ProvideaqualitativedescriptionofIntelstransactionexchangerisk. A. IntelisaU.S.company,anditisscheduledtoreceiveyeninthefuture.A weakeningoftheyenversusthedollarcausesagivenamountofyento converttofewerdollarsinthefuture. Thislossofvaluecouldbesevereiftheyendepreciatesbyasignificant amount.
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CHAPTER 3 PROBLEM 6
Q. IfInteldoesnothedge,whatistherangeofpossibledollarrevenuesthat incorporates95.45%ofthepossibilities? A. Wearetoldthatthestandarddeviationoftherateofdepreciationofthe dollaris4%.Thestandarddeviationofthefuturespotrateistherefore4%of thecurrentspotrateor0.04 x103/$=4.12/$.Thus,plusorminus2 standarddeviationsaroundtheconditionalexpectedfuturespotrateis 101.97/$+8.24/$=110.21/$ 101.97/$ 8.24/$=93.73/$
REMEMBER!!! Calculatethestandarddeviationbymultiplying the%bytheCURRENTspotrate. ButthenADD/SUBTRACTthemultipleofthat fromtheEXPECTED/FORECASTspotrate

Therangethatencompasses95.45%ofpossiblefuturevaluesforIntels receivableistherefore 100,000,000/110.21/$=$907,359 100,000,000/93.73/$=$1,066,894

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CHAPTER 5 QUESTION 1
Q. Howcanyouquantifycurrencyriskinafloatingexchangeratesystem? A. Tocharacterizetheriskofacurrencyposition,youmusttrytocharacterizethe conditionaldistributionofthefutureexchangeratechanges. Withfloatingexchangerates,historicalinformationonstandarddeviations providesusefulinformationaboutthisdistribution. Thehigherthisvolatility,theriskierarepositionsinthiscurrency. Finally,weshouldpointoutthatvolatilityisanadequateindicatorofriskwhen exchangeratechangesareapproximatelynormallydistributed. Inreality,thedistributionofexchangeratechangesdisplaysfattails,evenin floatingexchangeratesystems,andthisincreasestheriskofcurrency positions.

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CHAPTER 5 QUESTION 2
Q. Whymightitbehardtoquantifycurrencyriskinatargetzonesystemora peggedexchangeratesystem? A. Ifthepegortargetzoneholdsforalongtime,historicalvolatilityappearstobe zeroorverylimited,butthismaynotaccuratelyreflectunderlyingtensions thatmayultimatelyresultinadevaluationorrevaluationofthecurrency. Hence,thetruecurrencyriskdoesnotshowupindaytodayfluctuationsof theexchangerate.Itishardtoquantifythislatentvolatility.

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CHAPTER 5 QUESTION 7
Q. Whatistheeffectofaforeignexchangeinterventiononthemoneysupply? Howcanacentralbankoffsetthiseffectandstillhopetoinfluencethe exchangerate? A. Whenacentralbankbuys(sells)foreigncurrency,itsinternationalreserves increase(decrease),andthemoneysupplyincreases(decreases) simultaneously. Tooffsettheeffectonthemoneysupply,theforeignexchangeinterventioncan besterilized;thatis,thecentralbankcanperformanopenmarketoperation thatcounteractstheeffectonthemoneysupplyoftheoriginalforeign exchangeintervention.

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CHAPTER 5 QUESTION 7
Q. Whatistheeffectofaforeignexchangeinterventiononthemoneysupply? Howcanacentralbankoffsetthiseffectandstillhopetoinfluencethe exchangerate? A. Continued.. Thedirecteffectsofasterilizedinterventionaretwofold:
First,itforcesaportfolioshiftonprivateinvestors,byreplacingforeignbonds withdomesticbonds(orviceversa).Thismayaffectexpectationsandprices. Second,theactionsofthecentralbankintheforeignexchangemarkets,while verysmallrelativetothenominaltradingvolumes,maystillmanagetosqueeze foreignexchangeinventoriesatdealerbanksandgeneratepricingeffects.

Thereisnoconsensusonhoweffectivesterilizedinterventionsareinaffecting thelevelandvolatilityofexchangerates.

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CHAPTER 5 QUESTION 9
Q. Describetwochannelsthroughwhichforeignexchangeinterventionsmayaffect thevalueoftheexchangerate. A. Thereisadirectandanindirectchannel. Thedirecteffectofforex purchasesorsalesislikelysmall,becausetradingvolumes aresolargeintheforex market. Theindirectchannelreferstothefactthataninterventioncanalterpeoples expectationsandaffecttheirinvestments,thushelpingtopushtheexchangerate inthedirectionthecentralbankdesires. Aninterventionmaybeasignaltothepublicofthecentralbanksmonetarypolicy intentions,oritmaysignalthecentralbanksinsideinformationaboutfuture marketfundamentals,oritmaysignaltoinvestorsthatacurrencysexchangerateis deviatingtoofarfromitslongrunequilibriumvalue. Thesignaliscostlyandthereforepotentiallymorecredible,becauseifthecentral bankiswrongand,forexample,buysanundervaluedcurrency,whichkeeps depreciating,theinterventionwilllosemoney.
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CHAPTER 5 QUESTION 11
Q. Howdodevelopingcountriestypicallymanagetokeepcurrenciespeggedat valuesthataretoohigh?Whobenefitsfromsuchanovervaluedcurrency?Who ishurtbyanovervaluedcurrency? A. Suchasituationisdifficulttomaintain,becauseiftheexchangerateovervaluesthe localcurrencyontheforeignexchangemarkets,therewillbeanexcesssupplyof thelocalcurrencyeverybodywillwanttoturninlocalcurrencytothecentral bank,receiveforeigncurrencies,andinvestthemabroad. Ifthissituationpersists,thecentralbanksforeignreserveswilldwindlequitefast. Theonlywaytosustainsuchasystemistoimposeexchangecontrols. Thecentralbankofthedevelopingcountrymustrationtheuseofforeign exchange,managewhogetsaccesstoit,andrestrictcapitalflows;inshort,itmust strictlycontrolfinancialtransactionsinvolvingforeigncurrencies. Thatcurrenciesofdevelopingcountriesareprimarilytradedbythecentralbankof thecountryorbyanumberoffinancialinstitutionswithstrictcontrolsontheiruse offoreigncurrency(i.e.thecurrenciesareinconvertible),ishelpfultomaintain suchasystem.
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CHAPTER 5 QUESTION 11
Q. Howdodevelopingcountriestypicallymanagetokeepcurrenciespeggedat valuesthataretoohigh?Whobenefitsfromsuchanovervaluedcurrency? Whoishurtbyanovervaluedcurrency? A. Itisclearwhobenefitsandwholosesfromthissituation. Thefixedexchangerateundervaluestheforeigncurrencyandovervaluesthe domesticcurrency,therebysubsidizingbuyersofforeigncurrency(suchas importersandthoseinvestingabroad)andtaxingsellersofforeignexchange (suchasexportersandforeignbuyersofdomesticassets). Notsurprisingly,onemainreasonforthepopularityofovervaluedexchange ratesisthatsuchsituationsincreasetheexternalpurchasingpowerofthe politicalelite.

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CHAPTER 5 QUESTION 13
Q. Describetwodifferentcurrencysystemsthathavebeenintroducedin countriessuchasHongKongandEcuadortoimprovethecredibilityof peggedexchangeratesystems. A. HongKonghasacurrencyboardsystem. Acurrencyboardisamonetaryinstitutionthatissuesbasemoney(notesand coins,andrequiredreservesoffinancialinstitutions)thatisfullybackedbya foreignreservecurrencyandfullyconvertibleintothereservecurrencyata fixedrateandondemand. Hence,thedomesticcurrencymonetarybaseis100%backedbyassetspayable inthereservecurrency.Inpracticalterms,thisrequirementbarsthecurrency boardfromextendingcredittoeitherthegovernmentorthebankingsector. EcuadorinsteadhasofficiallyadoptedtheU.S.dollarasitscurrency.Thisisan exampleof(Official)dollarization,whichoccurswhenaforeigncurrencyhas exclusiveorpredominantstatusasfulllegaltenderinaparticularcountry.
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