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International Finance – FINC 4521 – Chapter 5 – Sample Problems and Answers

1. Suppose the spot ask exchange rate, S a ($|£), is $2.10 = £1.00 and the spot bid exchange rate, S b ($|£), is $2.07

= £1.00. If you were to buy $5,000,000 worth of British pounds and then sell them five minutes later without the bid or ask changing, how much of your $5,000,000 would be "eaten" by the bid-ask spread?

2. The dollar-euro exchange rate is $1.5968 = €1.00 and the dollar-yen exchange rate is ¥108.0030 = $1.00.

What is the euro-yen (€/¥) cross rate?

3. The dollar-euro exchange rate is $1.5451 = €1.00 and the dollar-pound exchange rate is $2.0975 = £1.00.

What is the euro-pound (€/£) cross rate?

4. The dollar-Swiss Franc exchange rate is $0.8922 = SF1.00 and the dollar-Australian Dollar exchange rate is

$0.7620 = AUD1.00. What is the Swiss Franc to Australian Dollar (SF/AUD) cross rate?

5. The Dollar to Euro spot exchange rate is $1.4909/€1.00, the Dollar to Yen spot exchange rate is

$0.009346/¥1.00, and the Euro to Yen spot exchange rate is €0.006501/¥1.00. Determine the triangular

arbitrage profit that is possible if you have $8,000,000.

6. The Dollar to Swiss Franc spot exchange rate is $0.8918/SF1.00, the Dollar to Pound spot exchange rate is

$1.6302/£1.00, and the SF to Pound spot exchange rate is SF1.7914/£1.00. Determine the triangular arbitrage profit that is possible if you have $8,000,000.

7. The current spot exchange rate is $2.0507/£ and the three-month forward rate is $2.0753/£. You enter into a

short position on £120,000. At maturity, the spot exchange rate is $2.0919/£. How much have you made or lost?

8. The current spot exchange rate is $2.0507/£ and the three-month forward rate is $2.0753/£. You enter into a

long position on £120,000. At maturity, the spot exchange rate is $2.0919/£. How much have you made or lost?

9. The current spot exchange rate is $1.7261/£ and the three-month forward rate is $1.7779/£. You enter into a

short position on £130,000. At maturity, the spot exchange rate is $1.7672/£. How much have you made or lost?

10. The current spot exchange rate is $1.7261/£ and the three-month forward rate is $1.7779/£. You enter into a long position on £130,000. At maturity, the spot exchange rate is $1.7672/£. How much have you made or lost?

ANSWERS:

1.

Convert dollars to pounds:

($5,000,000)/(2.10) = £2,380,952.38 Convert pounds back to dollars:

£2,380,952.38 X 2.07 = $4,928,571.43 Loss due to bid-ask spread:

$5,000,000 - $4,928,571.43 = 71,428.57

2.

€/¥ = (€ /$) X ($/¥) €/¥ = (1/(1.5968)) X (1/(108.0030)) = 0.005798

3.

€/£ = (€/$) X ($/£) €/£ = (1/(1.5451)) X (2.0975) = 1.357517

4.

SF/AUD = (SF/$) X ($/AUD) SF/AUD = (1/(0.8922)) X (0.7620) = 0.854069

5.

Calculate the implied cross rate:

€/¥ = (€ /$) X ($/¥) €/¥ = (1/(1.4909)) X 0.009346 = 0.006269 Note that the implied €/¥ cross rate is smaller than the actual exchange rate. This means that yen are more costly (in terms of euros) using the actual exchange rate. This indicates we should buy yen using dollars and exchange them into euros at the actual exchange rate. (Note: If you purchase the wrong currency first, you will end up with a loss that is equal to the gain you get if you go in the other direction.) Trade dollars for yen:

$8,000,000 x (1/(0.009346)) = ¥855,981,168.41 Trade yen for euros (using actual exchange rate):

¥855,981,168.41 X (0.006501) = €5,564,733.58 Trade euros for dollars:

€5,564,733.58 X 1.4909 = $8,296,461.29 Profit = $8,296,461.29 - $8,000,000 = $296,461.29

6.

Calculate the implied cross rate:

SF/£ = (SF /$) X ($/£) SF/£ = (1/(0.8918)) X 1.6302 = 1.827988 Note that the implied SF/£ cross rate is larger than the actual exchange rate. This means that pounds are less costly (in terms of SF) using the actual exchange rate. This indicates we should buy SF using dollars and exchange them into pounds at the actual exchange rate. (Note: If you purchase the wrong currency first, you will end up with a loss that is equal to the gain you get if you go in the other direction.)

Trade dollars for SF:

$8,000,000 x (1/(0.8918)) = SF8,970,621.22 Trade SF for pounds (using actual exchange rate):

(SF8,970,621.22)/(1.7914) = £5,007,603.67 Trade pounds for dollars:

£5,007,603.67 X 1.6302 = $8,163,395.50 Profit = $8,163,395.50 - $8,000,000 = $163,395.50

7.

You are short, so you must sell at the forward price. At maturity, you buy pounds at the spot rate:

£120,000 X $2.0919 = $251,028 You sell the pounds at the forward rate:

£120,000 X $2.0753 = $249,036 Your profit or loss is the sale value minus the cost:

$249,036 - $251,028 = loss of $1,992

8.

You are long, so you must buy at the forward price. At maturity, you buy pounds at the forward rate:

£120,000 X $2.0753 = $249,036 You sell the pounds at the spot rate:

£120,000 X $2.0919 = $251,028 Your profit or loss is the sale value minus the cost:

$251,028 - $249,036 = gain of $1,992

9.

You are short, so you must sell at the forward price. At maturity, you buy pounds at the spot rate:

£130,000 X $1.7672 = $229,736 You sell the pounds at the forward rate:

£120,000 X $1.7779 = $231,127 Your profit or loss is the sale value minus the cost:

$231,127 - $229,736 = gain of $1,391

10.

You are long, so you must buy at the forward price. At maturity, you buy pounds at the forward rate:

£120,000 X $1.7779 = $231,127 You sell the pounds at the spot rate:

£130,000 X $1.7672 = $229,736 Your profit or loss is the sale value minus the cost:

$229,736 - $231,127 = loss of $1,391