FINAL PROJECT:

Groups of 4 students.

Value 50%.

Delivery date: April 25th, 2019.

Answer the following questions:

Exercises and question can be located at the end of chapter of the main book
proposed for the class.

1. What is a spot exchange rate contract? When does delivery occur on a spot
contract? 


2. What was the Japanese yen spot price of the U.S.dollar on December 21,
2010? 


3. What was the U.S. dollar spot price of the Swiss franc on December 21, 2010?

4. How large are the bid–ask spreads in the spot market? What is their purpose?

5. What was the euro price of the British pound on December 21, 2010? Why? 


6. If the direct euro price of the British pound is higher than the indirect euro price
of the British pound using the dollar as a vehicle currency, how could you make
a profit by trading these currencies?

7. What is an appreciation of the dollar relative to the pound? What happens to

8. What is a depreciation of the Thai baht relative to the Malaysian ringgit? What
happens to the baht price of the ringgit in this situation?

9. What is a forward exchange rate? When does delivery occur on a 90-day

10. If the yen is selling at a premium relative to the euro in the forward market, is
the forward price of EUR per JPY larger or smaller than the spot price of EUR
per JPY?

11. What do we mean by the expected future spot rate?

13. If you are a U.S. firm and owe someone ¥10,000,000 in 180 days, what is your
transaction exchange risk?
 14. What is a spot–forward swap?

15. What is a forward–forward swap?

16. If interest rate parity is satisfied, there are no opportunities for covered interest
arbitrage. What does this imply about the relationship between spot and
forward exchange rates when the foreign currency money market investment
offers a higher return than the domestic money market investment?

17. It is often said that interest rate parity is satisfied when the differential between
the interest rates denominated in two currencies equals the forward premium or
discount between the two currencies. Explain why this is an imprecise
statement when the interest rates are not continuously compounded.

18. What does it mean for the 90-day forward exchange rate to be an unbiased
predictor of the future spot exchange rate?

19. Why is it true that the hypothesis that the forward exchange rate is an unbiased
predictor of the future spot exchange rate is equivalent to the hypothesis that
the forward premium (or discount) on a foreign currency is an unbiased
predictor of the rate of its appreciation (or depreciation)?

20. It is often argued that forward exchange rates should be unbiased predictors of
future spot exchange rates if the foreign exchange market is efficient. Is this
true or false? Why?

21. What do economists mean by the law of one price? Why might the law of one
price be violated?


22. What is the value of the exchange rate that satisfies absolute PPP?

23. If the actual exchange rate for the euro value of the British pound is less than
the exchange rate that would satisfy absolute PPP, which of the currencies is
overvalued and which is undervalued? Why?

24. What market forces prevent absolute PPP from holding in real economies?
Which of these represent unexploited profit opportunities?

25. As the vice president of finance for a U.S. firm, what do you say to your
production manager when he states, “We shouldn’t’ let foreign exchange risk
interfere with our profitability. Let’s simply invoice all our foreign customers in
dollars and be done with it.”

26. What determines how much a foreign producer allows the dollar price of a
product sold in the United States to be affected by a change in the real
exchange rate?

27. Given that real exchange rates fluctuate, when would be the best time to enter
the market of a foreign country as an exporter to that market?
 28. Why would an entrepreneur find it desirable to hedge his or her foreign
exchange risk?

29. Your CFO thinks that the value of your firm fluctuates enormously with the yen–
dollar exchange rate, but he does not want to hedge because he thinks it is an
impossible risk to hedge. Can you convince him otherwise?


30. What are the differences between foreign currency option contracts and forward
contracts for foreign currency?

31. What are you buying if you purchase a U.S. dollar European put option against
the Mexican peso with a strike price of MXN10.0 > $ and a maturity of July?
(Assume that it is May and the spot rate is MXN10.5 > $.)

32. What are you buying if you purchase a Swiss franc American call option against
the U.S. dollar with a strike price of CHF1.30 > $ and a maturity of January?
(Assume that it is November and the spot rate is CHF1.35>$.)

33. Suppose you go long in a foreign currency futures contract. Under what
circumstances is your cumulative payoff equal to that of buying the currency
forward?

Resolve de following problems.

1. Mississippi Mud Pies, Inc., needs to buy 1,000,000 Swiss francs (CHF) to pay
its Swiss chocolate supplier. Its banker quotes bid–ask rates of CHF1.3990–
1.4000 > USD. What will be the dollar cost of the CHF1,000,000?

2. If the Japanese yen–U.S. dollar exchange rate is ¥104.30 > $, and it takes
25.15 Thai bahts to purchase 1 dollar, what is the yen price of the baht?


3. If the spot exchange rate of the yen relative to the dollar is ¥105.75 > $, and the
90-day forward rate is ¥103.25 > $, is the dollar at a forward premium or
discount? Express the premium or discount as a percentage per annum for a
360-day year.

4. Suppose today is Tuesday, January 18, 2011. If you enter into a 30-day
forward contract to purchase euros, when will you pay your dollars and receive
your euros? (Hints: February 18, 2011, is a Friday, and the following Monday is
a holiday.)

5. As a foreign exchange trader for JPMorgan Chase, you have just called a
trader at UBS to get quotes for the British pound for the spot, 30-day, 60-day,
and 90-day forward rates. Your UBS counterpart stated, “We trade sterling at
$1.7745-50, 47>44, 88> 81, 125 > 115.” What cash flows would you pay and
receive if you do a forward foreign exchange swap in which you swap into
£5,000,000 at the 30-day rate and out of £5,000,000 at the 90-day rate? What
must be the relationship between dollar interest rates and pound sterling
interest rates?
6. Suppose the 5-year interest rate on a dollar denominated pure discount bond is
4.5% p.a. and the interest rate on a similar pure discount euro denominated
bond is 7.5% p.a. If the current spot rate is $1.08 >: what forward exchange
rate prevents covered interest arbitrage?

7. If the 30-day yen interest rate is 3% p.a., and the 30-day euro interest rate is
5% p.a. What is the magnitude of the forward premium or discount on the yen?

8. Suppose the spot rate is CHF1.4706 > $, and the 180-day forward rate is
CHF1.4295 > $. If the 180- day dollar interest rate is 7% p.a., what is the
annualized 180-day interest rate on Swiss francs that would prevent arbitrage?

9. You are a sales manager for Motorola and export cellular phones from the
United States to other countries. You have just signed a deal to ship phones to
a British distributor, and you will receive £700,000 when the phones arrive in
London in 180 days. Assume that you can borrow and lend at 7% p.a. in U.S.
dollars and at 10% p.a. in British pounds. Both interest rate quotes are for a
360-day year. The spot rate is $1.4945 > £, and the 180-day forward rate is
$1.4802>£.
a. Describe the nature and extent of your transaction foreign exchange
risk.
b. Describe two ways of eliminating the transaction foreign exchange risk.
c. Which of the alternatives in part b is superior? Assume that the dollar
interest rate and the exchange rates are correct.
d. Determine what sterling interest rate would make your firm indifferent
between the two alternative hedges.

10. Suppose that the price level in Canada is CAD16,600, the price level in France
is EUR11,750, and the spot exchange rate is CAD1.35>EUR.
a. What is the internal purchasing power of the Canadian dollar?
b. What is the internal purchasing power of the euro in France?
c. What is the implied exchange rate of CAD> EUR that satisfies absolute
PPP?
d. Is the euro overvalued or undervalued relative to the Canadian dollar?
e. What amount of appreciation or depreciation of the euro would be
required to return the actual exchange rate to its PPP value?

11. Pick a particular brand of appliance, like a Bosch dishwasher with certain
features, and use the Inter- net to compare its prices across countries. Be sure
to have exactly the same style of appliance in each country. How different are
the prices when expressed in a common currency?
12. Suppose that you are trying to decide between two job offers. One consulting
firm offers you $150,000 per year to work out of its New York office. A second
consulting firm wants you to work out of its London office and offers you
£100,000 per year. The current exchange rate is $1.65 > £. Which offer should
you take, and why? Assume that the PPP ex- change rate is $1.40 > £ and that
you are indifferent between working in the two cities if the purchasing power of
your salary is the same.

13. If there is 10% inflation in Brazil, 15% inflation in Argentina, and the Argentine
peso weakens by 21% relative to the Brazilian real, by how much has the peso
strengthened or weakened in real terms? What effect do you expect that this
change in the real ex- change rate would have on trade between the two
countries?

14. Fleur de France has a project that will provide £20 million in revenue in 1 year.
The project has a euro cost of :30 million that will be paid in 1 year. The cost of
the project is certain, but the fuure spot exchange rate is not. Assume that there
are only two possible future spot exchange rates. Either the spot rate in 1 year
will be :1.54 > £ with 55% probability, or it will be :1.48 > £ with 45% probability.
Assume that the French tax rate on positive income is 45%, that a firm’s losses
are immediately refunded at a rate of 35%, and that the forward rate of euros
per pound equals the expected future spot rate.
a. If Fleur de France chooses not to hedge its foreign exchange risk, what
is the expected value of its after-tax income on the unhedged project?
b. If Fleur de France chooses to hedge its foreign exchange risk, what is
the expected value of its after-tax income on the hedged project?
c. How much does Fleur de France gain by hedging?

15. Assume that U.S. Machine Tool has $50 million of debt outstanding that will
mature next year. It currently has cash flows that fluctuate with the dollar–
pound exchange rate. Over the next year, the possible exchange rates are
$1.50>£ and $1.90>£, and each exchange rate is equally likely. The company
thinks that it will generate $30 million of cash flow from its U.S. operations, and
its expected pound cash flow is £12 million.
a. If U.S. Machine Tool does not hedge its foreign exchange risk, what will
be the current market value of its debt and equity, assuming, for
simplicity, that the appropriate discount rates are 0?
b. Suppose that U.S. Machine Tool has access to forward contracts at a
price of $1.70/£. What is the value of the firm’s debt and equity if it
hedges its foreign exchange risk? Would the shareholders want the
management to hedge?
 c. Suppose U.S. Machine Tool could invest $1 million today in a project
that returns £1 million next period. Is this a good project for the firm?
d. Suppose that U.S. Machine Tool is unhedged, that its managers are
trying to maximize the value of the firm’s equity, and that the $1 million
must be raised from current shareholders. Will the managers accept the
project?
e. If U.S. Machine Tool hedges its foreign exchange risk, would the firm
accept the project?

16. Assume that today is March 7, and, as the newest hire for Goldman Sachs, you
must advise a client on the costs and benefits of hedging a transaction with
options. Your client (a small U.S. exporting firm) is scheduled to receive a
payment of :6,250,000 on April 20, 44 days in the future. Assume that your
client can borrow and lend at a 6% p.a. U.S. interest rate.

a. Describe the nature of your client’s transaction exchange risk.

b. Use the appropriate American option with an April maturity and a strike
price of 129¢>: to determine the dollar cost today of hedging the
transaction with an option strategy. The cost of the call option is 3.93¢
>:, and the cost of the put option is 1.58¢>

GENERAL BIBLIOGRAPHY

Geert Bekaert and Robert Hedrick, International Financial Management, Pearson Prentice
Hall, 2nd Edition, 2012.