Mid-term I Review Questions

1

1. In December 1994 the government of Mexico officially changed the value of the Mexican peso
from 3.2 pesos per dollar to 5.5 pesos per dollar. What was the percentage change in its value?
Was this a depreciation, devaluation, appreciation, or revaluation? Explain.

2. Many people were surprised when Vietnam became the second largest coffee producing country
in the world in recent years, second only to Brazil. The Vietnamese dong, VND or d, is managed
against the U.S. dollar but is not widely traded. If you were a traveling coffee buyer for the
wholesale market (a "coyote" by industry terminology), which of the following currency rates and
exchange commission fees would be in your best interest if traveling to Vietnam on a buying trip
with an initial $10,000 for exchange?
Currency Exchange Rate Commission
Vietnamese bank rate d19,800 2.50%
Saigon Airport exchange bureau rate d19,500 2.00%
Hotel exchange bureau rate d19,400 1.50%

3. Under the gold standard, the price of an ounce of gold in U.S. dollars was $20.67, while the price
of that same ounce in British pounds was 3.7683. What would the exchange rate between the
dollar and the pound be? What if the U.S. dollar price had been $42.00 per ounce?
4. Since 2009 the IMF's exchange rate regime classification system uses a "de facto classification"
methodology. Under this system, currencies that are predominantly market-driven are considered
to be:
A) soft pegs.
B) hard pegs.
C) floating arrangements.
D) a residual agreement.

5. When categorizing investments for the financial account component of the balance of payments
the ________ is an investment where the investor has no control whereas the ________ is an
investment where the investor has control over the asset.
A) direct investment; portfolio investment
B) direct investment; indirect investment
C) portfolio investment; indirect investment
D) portfolio investment; direct investment


6. Assume the United States has the following import/export volumes and prices. It undertakes a
major "devaluation" of the dollar, say 18% on average, against all major trading partners'
currencies. What is the pre-devaluation and post-devaluation trade balance (in a very short term)?
Assumptions Values
Initial spot exchange rate, $/fc 2.00
Price of exports, dollars ($) 20.0000
Price of imports, foreign currency (fc) 12.0000
Quantity of exports, units 100
Quantity of imports, units 120
Percentage devaluation of the dollar 18.00%
Price elasticity of demand, imports (0.900)
Mid-term I Review Questions
2

7. Classify the following as a transaction reported in a subcomponent of the current account or the
capital and financial accounts of the two countries involved (hint: look from cash flow
perspective, debit=COF, credit=CIF):
a. a U.S. food chain imports grape from Chile.
b. a US resident purchases a euro-denominated bond from a German company
c. a US university gives a tuition grant to a foreign student from Singapore (the student is
already in the United States)
d. a British company imports Spanish oranges, paying with Eurodollars on deposit in
London
e. a German automobile firm pays the salary of its executive working for a subsidiary in
Detroit

8. On your post-graduation celebratory trip you decide to travel from Munich, Germany to Moscow,
Russia. You leave Munich with 15,000 euros in your wallet. Wanting to exchange all of these for
Russian rubles, you obtain the following quotes:
Spot rate on the dollar/euro cross rate $1.3214/
Spot rate on the ruble/dollar cross rate Rbl 30.96/$

a. What is the Russian ruble/euro cross rate?
b. How many rubles will you obtain for your euros?

9. Assume the following quotes:
1) Bank A: $1.5400/pound
2) Bank B: EURO1.6000/pound
3) Bank C: $0.9700/EURO

a) Can a trader make a profit on these quotes?
b) Assume that the trader has $1,000,000 or the equivalent in another currency available for the
transaction. What profit can the trader make?

10. Use the following spot and forward bid-ask rates for the U.S. dollar/Australian dollar (US$/A$)
exchange rate from December 10, 2010, to answer the following questions.
US$/A$ US$/A$
Period Bid Rate Ask Rate
Spot 0.98510 0.98540
1 month 0.98131 0.98165
2 months 0.97745 0.97786
3 months 0.97397 0.97441
6 months 0.96241 0.96295
12 months 0.93960 0.94045
24 months 0.89770 0.89900

a. What is the mid-rate for each maturity?
b. What is the annual forward premium (discount) for all maturities based on mid-rates?
Mid-term I Review Questions
3

11. Suppose that the two-months interest rate is 6.0 percent per annum in the United States and 7.0
percent per annum in Germany, and that the spot exchange rate is $1.12/ and the forward
exchange rate, with two-months maturity, is $1.10/. Assume that you can borrow 1,000,000.

a) What kind of arbitrage is possible?
b) Determine the arbitrage profit that can be made.
c) What would the forward rate have to be so that there would be no arbitrage opportunity?

12. Separated by more than 3,000 nautical miles and five time zones, money and foreign exchange
markets in both Germany and USA are very efficient. The following information has been
collected from the respective areas:
Assumptions Germany USA
Spot exchange rate ($/)

1.3264

1.3264
One-year Treasury bill rate 3.900% 4.500%
Expected inflation rate Unknown 1.250%

a. What do the financial markets suggest for inflation in Germany next year?
b. Estimate today's one-year forward exchange rate between the dollar and the euro.















Mid-term I Review Questions
4

AK
1.
Calculation of Percentage Change in Value Values

Initial exchange rate (peso/$) 3.20
New exchange rate (peso/$) 5.50
Percentage change in peso value -41.82%
(beginning rate - ending rate) / (ending rate)

Anytime a government sets or resets the value of its currency, it is a managed or fixed exchange rate. If
that is the case, any change in its official value must be either a "revaluation" or "devaluation."In this
case, it is devaluation. This is evident from the fact that it now takes more pesos per U.S. dollar, so its
value is less or devalued. In terms of the percentage change calculation, this is indicated by the negative
percentage change.
2.
Vietnamese
Assumptions Values dong proceeds
Vietnamese bank rate (dong/$) 19,800
Bank commission (%) 2.50% 193,050,000
Saigon Airport Exchange Bureau rate (dong/$) 19,500
Airport comission (%) 2.00% 191,100,000
Hotel Exchange Bureau rate (dong/$) 19,400
Hotel comission (%) 1.50% 191,090,000

The combined exchange rate and commission offered in the commercial banks in Vietnam is the better
rate. In the case of the Hotel Exchange Bureau rate, although its exchange rate is slightly weaker than the
airport, its lower commission makes it preferable over the combined airport rate.
3.
Gold Standard
Assumptions Values What If
Price of an ounce of gold in US dollars ($/oz) $20.67 $42.00
Price of an ounce of gold in British pounds (/oz) 3.7683 3.7683
What is the implied $/ exchange rate? $5.4852 $11.1456
(dollar price of an ounce / pound price of an ounce)

4. C
5. D





Mid-term I Review Questions
5

6.
a. What is the pre-devaluation trade balance?
Revenues from exports, $ $2,000
Expenditures on imports, fc 1,440
Expenditures on imports, $ $2,880
Pre-devaluation trade balance ($880)

b. Resulting trade balance immediately after devaluation?
Revenues from exports, $ $2,000
Expenditures on imports, fc 1,440
New spot exchange rate, after devaluation 2.36
Expenditures on imports, $ $3,398
Post-devaluation trade balance (currency contract period) ($1,398)

7.
a. A U.S. food chain imports grape from Chile. Debit to U.S. goods part of current account,
credit to Chilean goods part of current account.
b. A U.S. resident purchases a euro-denominated bond from a German company. Debit to
U.S. portfolio part of financial account; credit to German portfolio of financial account.
c. A U.S. university gives a tuition grant to a foreign student from Singapore. If the student
is already in the United States, no entry will appear in the balance of payments because
payment is between U.S. residents. (A student already in the U.S. becomes a resident for
balance of payments purposes.)
d. A British Company imports Spanish oranges, paying with eurodollars on deposit in
London. A debit to the goods part of Britains current account; a credit to the goods part
of Spains current account.
e. A German automobile firm pays the salary of its executive working for a subsidiary in
Detroit. Germany would record a debit in the income payments/receipts in its current
account; the U.S. would record a credit in the income payments/receipts in its current
account.
8.
Assumptions Values
Beginning your trip with euros 15,000.00
Spot rate ($/) 1.3214
Spot rate (Rubles/$) 30.96

a) What is the Russian ruble/euro cross rate?
Cross rate (Rubles/) 40.91

Rubles/ = Rubles/$ x $/

b) How many rubles will you obtain for your
euros?
Converting your euros into Rubles 613,658


9. a)



b)
F

S

T

Pr

T

10. S
pr
F
Perio
Spot
1 month
2 month
3 month
6 month
12 mont
24 mont

The forwa
spot rate.
forward a
11.
a)
b)
B
E
In
E
R
Pr

c)
) Yes, the cro
)
irst transactio
econd transac
Third transacti
rofit: $7,792.
This type of ar
ince the exch
remium calcu
orward premi
d F

h
hs
hs
hs
ths
ths
ard rates prog
Therefore the
at a discount.
) Covered inte
)
Borrow Euro 1
Exchange spot
nvest at 1 perc
Exchange forw
Repay loan Eu
rofit: Euro 16
) F = 1.12*(1
oss-rate and th
on: buy pound
ction: buy EU
ion: buy dolla
2
rbitrage is cal
hange rate quo
ulation is:
ium = ( Forw
Days
orward

30
60
90
180
360
720
gressively req
e US dollar is
erest rate arbi
1,000,000
t at $1.12/euro
cent to get $1
ward at $1.10/
uro 1,011,666
6,696.9
.01/1.01167)
Mid-term I
he quote at De

d at Bank A:
URO at Bank B
ar at Bank C:
led: triangula
otes are direct
ward - Spot ) /
US$/A$
Bid Rate
0.98510
0.98131
0.97745
0.97397
0.96241
0.93960
0.89770
quire fewer an
s selling forwa
itrage (CIA);
o to get $1,12
,131,200
/euro, to get E
.7
= $1.1182/eu
I Review Que
eutsche Bank
1,000,000/1.5
B: 649,350.6
1,038,961.04
ar arbitrage.
t quotes on th
(Spot) x (360
US$
e Ask
0.98
0.98
0.97
0.97
0.96
0.94
0.89
nd fewer US d
ard at a prem
20,000
Euro 1,028,36
uro
estions
k are not the sa
54 = pound 64
5*1.6 = 1,038
4 *0.97 = 1,00
he dollar (US$
0 / days)
$/A$
k Rate
8540
8165
7786
7441
6295
4045
9900
dollars per Au
mium and the A
63.6
ame.
49,350.65
8,961.04
07,792.2
$/A$), the pro
a.
Calculated
Mid-Rate
0.98525
0.98148
0.97766
0.97419
0.96268
0.94003
0.89835
ustralian dolla
Australian do
oper forward
b.
Forwa
Premiu
(discou
-4.5917
-4.6252
-4.4902
-4.5816
-4.5902
-4.4100
ar than the cu
ollar is selling
6
ard
um
unt)
7%
2%
2%
6%
2%
0%
urrent
g
Mid-term I Review Questions
7


12.
a. According to the Fisher effect, real interest rates should be the same in both Europe and
the US.

Since the nominal rate = [ (1+real) x (1+expected inflation) ] - 1:

1 + real rate = (1 + nominal) / (1 + expected inflation)
1 + nominal rate 103.900% 104.500%
1 + expected inflation ? 101.250%
So 1 + real = 103.210% 103.210%
and therefore the real rate in the US is: 3.210%

The expected rate of inflation in Europe is then: 0.669%

b. From IRP, we know:
(1 + i

) = S
$
(1 + i
$
)
1
F
$

Or F
$
= S
$

(1+
$
)
(1+

)

Then,

Spot exchange rate ($/) 1.3264
US dollar one-year Treasury bill rate 4.500%
European euro one-year Treasury bill rate 3.900%
One year forward rate ($/) 1.3341