Tutorial 5 Solutions: FOREX 2

8. (a) Simply multiply the bids 0.6755*83.65= AUD/Yen bid = 56.51

Simply multiply the offers 0.6760*83.84= AUD/Yen offer = 56.68
The cross rate AUD/Yen is 56.51/68
(b) Here you first need to reverse the quote: GBP/USD 1.5785/90
USD/GBP = 1/1.5785 1/1.5790 = 0.6333/34
Then
Simply multiply the bids 0.9705*0.6333 = AUD/GBP bid = 0.6146
Simply multiply the offers 0.9760*0.6334= AUD/GBP offer = 0.6182
The cross rate AUD/GBP is 0.6146/82

9. If interest rates in the USA are 5.55% for 90 days and interest rates in Australia 4.95% for 90
days, calculate the 90 day forward outright rate given a spot rate AUD/USD of .9755. (Your answer
should show your calculations).





Delivery of the currency will be in 92 days since the spot rate transaction implying that the delivery
of currency will be two day after the transaction take place.

10. The answer is based on the difference between real and nominal interest rates, and on the
assumption that real interest rates are essentially common throughout the world. If they
werent, this would create arbitrage opportunities and the resultant capital flows would tend to
equalise real interest rates. Therefore, if nominal interest rates are higher in Australia than
elsewhere, it must be because the inflation rate is higher in Australia. A high inflation rate will
result in a depreciation of the Australian dollar, because exports become less competitive and
imports become more attractive, leading to a decrease in demand and increase in supply of the
Australian dollar.














A sudden increase in
interest as shown
above will have the opposite effect,
resulting in a short-term
increase in the real
interest and attracting capital inflows, which will lead to an increase in demand for, and
hence an appreciation of, the Australian dollar. This effect, however, is temporary, as the
resultant capital flows will tend to equalise real interest rates.

0.9769
01220 . 1
01368 . 1
9755 .

) 365 / 90 ( 0495 . 1
) 365 / 90 ( 0555 . 1
9755 .
/
=
(

=
=
(

+
+
=
USD AUD
f
11. The theory of purchasing power parity argues that market forces will eventually cause
adjustments in exchange rates under a floating exchange rate system to provide parity of
purchasing power in different countries i.e. comparable goods will sell for comparable
prices. If Australia was to experience higher inflation than its main trading partners the
Australian dollar would depreciate against the currencies of those countries e.g. a 10%
increase in inflation would increase costs of goods and services exported by 10% and cause
a 10% depreciation in the currency.



12. Reasons why an Australian corporation may borrow offshore include:
- Risk management offsetting natural hedging of currencies.
- Availability of funds.
- Establishing a profile in international financial markets.
- Lower cost of borrowing due to a reduction in domestic regulation in some off-
shore markets, such as the Euromarkets, the narrower spreads due the wholesale
nature of off-shore markets, and the greater availability of funds.

13. Since the beginning of 2000, the AUD/USD exchange rate has been quite volatile:

The AUD/USD exchange rate fell from the beginning of 2000 through until late 2001. In
October 2001 the AUD/USD exchange rate was below .50. This fall was due to falling
commodity prices and increasing inflation in Australia making exports less competitive.
Expectations and international speculation also played a role if the market anticipates a
depreciating Australian dollar it will sell off the currency, initiating depreciation. During this
period, international investors did not want to hold AUDs. The value of the AUD was less
than economic fundamentals would have provided.
From late 2001 until early 2004 the AUD/USD exchange rate appreciated considerably. In
February 2004 it rose above .80. This represented an appreciation of the AUD against the
USD of more than 60% in less than 2.5 years. The causes of this included:
- Higher nominal interest rates in Australia combined with low inflation. Thus, high
real interest rates relative to US.
- An increase in commodity prices boosting Australian exports
- International investors changing their views towards investing in the AUD due to
concern over holding USDs and recognition that the AUD was undervalued according
to economic fundamentals
From early 2004 until present the AUD/USD exchange rate has fluctuated in the range
around .75. initially falling to around .70 and then picking up to be over .75 In this period
US interest rates have been steadily increasing and the US economy has been experiencing
relatively high economic growth. Lately, post-GFC, the Australian economy has been
performing better than the USA, leading to an appreciation of the AUD.