XLRI,

Jamshedpur
PGCBM9
MID TERM TEST
Duration!hr"#mts Mar$ % "#
P&RT'& &ns(er an) *i+e ,-./ 0 !#1
! 2hat is the pro3ess o* internationisation4
/ 5o( did Go6d Standard 7rin8 a7out e9ui6i7rium in e:3han8e
rate4
" 2hat is 3o+ered interest ar7itra8e4
; 2hat is Pur3hasin8 Po(er Parit) theor)4
- 2hat is s(ap4 5o( is it 9uoted4
< 2hat *a3tors in*6uen3e *or(ard rate o* e:3han8e4
Part = B &ns(er &LL the 9uestions ,;.- 0 /#1
> The spot and 9#'da) *or(ard rates *or the pound are ?!!"><
and ?!!"-#, respe3ti+e6) 2hat is the *or(ard premium or
dis3ount on the pound4
@ Suppose the DM is 9uoted at #/#>;'@# in London, and the
pound ster6in8 is 9uoted at ;>#!#'"/ in Aran$*urt
a Is there a pro*ita76e ar7itra8e situation4
7 Compute B 7id as$ spread *or 7oth 3urren3ies4
9 &ssumin8 the interest rate is !<B on pounds Ster6in8 and > on
Deuts3he mar$s,i* the Deuts3he mar$ is se66in8 at a one')ear
do(n(ard premium o* !#B a8ainst the pound, is there an
ar7itra8e opportunit)4 E:p6ain
!# &ssumin8 the pound ster6in8 is (orth AA 9@# in Paris and SA
-;# in Curi3h,
a Sho( ho( British ar7itra8eurs 3an ma$e pro*its 8i+en that
the S(iss *ran3 is (orth t(o Aren3h *ran3s 2hat (ou6d 7e the
pro*it per pound transa3ted4 and
72hat (ou6d 7e the e+entua6 out3ome on e:3han8e rates in
Paris and Curi3h 8i+en these ar7itra8e a3ti+ities4
T5E EDD
So6ution
! Pro3ess o* interna6iEation is
Domesti3 produ3tion F e:port F6i3ensin8 or esta76ishin8 sa6es
su7sidiaries F pro+idin8 ser+i3e F esta76ishin8 distri7ution s)stem F
esta76ishin8 produ3tion a7road F3easin8 6o3a6 produ3tion
''&n) - sta8es / mar$s
/ Pri3e'spe3ie'*6o( me3hanism ''/ mar$s
" The spot rate o* a 3urren3) on the e:pir) date o* a *or(ard 3ontra3t
and the stri$e pri3e o* *or(ard 3ontra3t shou6d 7e e9ua6 I* not, there
is opportunit) *or ar7itra8e due to di**erentia6 interest rates 7et(een
the 3ountries This is 3o+ered interest ar7itra8e ''/ mar$s
; The e:3han8e rate 7et(een 3urren3ies, in the 6on8 run, (ou6d
depend upon their re6ati+e pur3hasin8 po(er in their o(n 3ountries
''/ mar$s
- S(ap is one (a) o* 9uotin8 the *or(ard rate It depi3ts the B
premium or Bdis3ount o* *or(ard rate *or the 3urren3) It is 3a63u6ated
as under
Aor(ard rate = spot rate G spot rate . !/ G period o* *or(ard 3ontra3t .
!## ''/ mar$s
<The t(o *a3tors that in*6uen3e *or(ard e:3han8e rate are
re6ati+e interest and in*6ation rates
''/ mar$s
> !"-# '!">< G!"><. !/ G " 0 - 7.56 (discount1 '' - mar$s
@London DM to a H 0 #/#>;G ##/#@#
Aran$*urt DM to a H 0 #/!/< G#/!/>
a There is opportunit) *or ar7itra8e ''" mar$s
7Spread *or H 0 #/9B
Aor DM 0 ##;>B ''/ mar$s
9 &ssumin8 Spot Rate H to DM as X,
IBAR 0 !#> G !!< .: 0 #9/ X
Jr
DM shou6d ha+e depre3iated 7) @B
Do(n(ard premium or dis3ount is !#B
There is opportunity for arbitrage '''- mar$s
!# H in Paris 0AA9@#
in Curi3h,S(iss1 0SA -;#
&3tua6 +a6ue 0 ! SA 0 /AA
That is i* in Curi3h SA -;, it shou6d 7e AA!#@# in Paris
Bu) SA in Curi3h *or a pound, 8et SA -;, se66 it in Paris at AA!#@,
ma$e a profit of 1 FF per '';
mar$s
More *6o( o* SA into Paris ti66 e9ui6i7rium restored ''! mar$

XLRI,
Jamshedpur
PGCBM!#
!2hat is Go6d standard4 2hat (as the main 3ause *or its *ai6ure4
/2hat is Ba6an3e o* pa)ment4 2hat are its 3omponents4
"2hat is spread in *orei8n e:3han8e4 5o( do 7an$ers *idd6e (ith
spread to 7a6an3e their position
;2hat is dire3t 9uote4 5o( does it di**er *rom indire3t 9uote4
-2hat is IBAR4 2hat does it si8ni*)4
<2hat is Internationa6 Aisher E**e3t4
> Suppose toda)Ks spot e:3han8e rate is ?#-!%DM ! The si:'
month interest rates on do66ars and DM are !"B and <B,
respe3ti+e6) The si:'month *or(ard rate is ?#-!>#%DM ! & *orei8n
e:3han8e ad+isor) ser+i3e has predi3ted that the DM (i66 appre3iate
to ?#-;%DM ! (ithin si: months
a 5o( (ou6d )ou use *or(ard 3ontra3ts to pro*it in the
a7o+e situations4
75o( (ou6d )ou use 7orro(in8 and 6endin8 transa3tions to pro*it4
@ &ssumin8 no transa3tion 3osts, suppose H! 0 H/#/ in De( Lor$,
?! 0 AA -99> in Paris, and AA ! 0 H#!-@@ in London, ho( 3ou6d one
ta$e pro*ita76e ad+anta8e o* these rates4
9 The spot rate *or the Deuts3hmar$ in De( Lor$ is ?#--
a1 2hat shou6d the spot pri3e *or the IS do66ar in
Aran$*urt4
71 Shou6d the do66ar 7e 9uoted at DM !@- in Aran$*urt, ho(
(ou6d the mar$et rea3t4
!# In*6ation in the IS& and Aran3e are e:pe3ted to 7e ; and 9 per
3ent, respe3ti+e6), in the *orth3omin8 )ear and < and > per 3ent,
respe3ti+e6), in the )ear *o66o(in8 The 3urrent spot rate is ?#!#-#
Based on pur3hasin8 po(er parit), (hat (ou6d 7e the e:pe3ted spot
+a6ue *or the Aren3h *ran3 in t(o )ears4
a1 ?#!!!!
71 ?#!#/;
31 ?##99/
d1 ?#!#>;
SOLT!O"
!Go6d standard is a internationa6 monetar) s)stem (here
Finternationa6 inde7tedness 7et(een 3ountries are sett6ed 7) trans*er
o* 8o6d
F Curren3) o* the 3ountr) is minted in 8o6d
F Go6d 3an 7e e:3han8ed *or 3urren3) and 3urren3) into 8o6d
F There is no restri3rtion on mo+ement od* 8o6d *rom 3ountr) to
3ountr) &n) / points ''''''!
mar$
Causes o* *ai6ure
ine6asti3it) o* supp6) o* 8o6d *or 3han8e in e3onomi3 a3ti+it)
mem7er 3ountries did not adhere to the ru6es o* the 8ame
8o6d is too pre3ious
6oss o* materia6 in transa3tion''' an) / points '!
mar$
/ Ba6an3e o* pa)ment is the re3ord o* internationa6 mo+ement o*
*unds into and *rom a 3ountr) o+er a period' ''! mar$s
F3urrent a33ount
F3apita6 a33ount and o**i3ia6 reser+es a33ount''''''''''! mar$
" Spread is the di**eren3e 7et(een the 7u) rate and the se66 rate o*
3urren3ies' ''''''''''' !mar$
Ban$ers reduce the spread #hen they are in e$cess buy and
increase the spread #hen they are in e$cess sa%e position
'''!mar$
; Dire3t 9uote,&meri3an 9uote1 is ho( man) units o* home 3urren3)
is e9ui+a6ent to one unit o* *orei8n 3urren3) ''! mar$
Indire3t 9uote,European 9uote1' it is ho( man) units o* *orei8n
3urren3) e9ua6 to one unit o* home 3urren3)'''''''! mar$
-IBAR is the spot rate on e:pir) date o* a *or(ard rate It is the
e9ui6i7rium rate' ''''/ mar$s
< Internationa6 *isher e**e3t is impa3t o* di**erentia6 interest rate and
in*6ation rate on the e:3han8e rate o* a 3urren3)'''/ mar$s
> a
Spot rate per DM ?#-!
< months *or(ard ?#-!>
&d+isorKs e:pe3tation ,IBAR1 ?#-;
Aor(ard rate 7iased
&uy for#ard '( ) *.517 '''''/ mar$s
Jn e:piration date , spot rate (ou6d 7e ?#-;
Se66 DM M ?#-;
+rofit ,*.*-.'''''''! mar$
7
Borro( DM M<B *or < months 0 DM !#"
Con+ert at spot rate into ?#-/>N in+est in IS M!"B *or <
months0#-<!, 3o+er in *or(ard rate M?#-!>0DM !#@-
+rofit *.*551 ''''''/ mar$s
@ De( Lor$ H 0 ?/#/
Paris ? 0 AA -99>
+aris for a /FF1-.110
London AA 0H#!-@@
London- for / FF 6..*
Paris AA is 3heap and London it is dear
Con+ert a H in De( Lor$ into ? 0/#/
Con+ert the ? /#/ in Paris into AA M-99> 0 AA !/!!; Con+ert AA
!/!!; into H in London M#!-@@/ 1.1-0 '''''- mar$s
+rofit *.1-0
9 a IS do66ar in Aran$*urt (ou6d 7e !G-- 0 '( 1.2- '''' / mar$s
7
DM M!@- is 3heap in Aran$*urt 3rbitrageurs #ou%d buy '( in
Fran4furt and se%% it in "e# 5or4. Con+ert a? in Aran$*urt into DM
0!@-, 3on+ert the DM !@- in De( Lor$ M ?-- 0? !#!>- +rofit
,*.*175 ------. 6ar4s
!#
Cumu6ati+e in*6ation
!#/;B in IS a*ter / )ears '''''/ mar$s
!<<"B in Aran3e '''''/ mar$s
E:3han8e rate (ou6d 7e !!#/; G !!<<" . #!#-# 0##99/
c- *.*11- '' ! mar$