Week 2 Class Problems Fin403

2844 Words Jun 16th, 2008 12 Pages
Chapter 4

2. Inflation Effects on Exchange Rates. Assume that the U.S. inflation rate becomes high relative to Canadian inflation. Other things being equal, how should this affect the (a) U.S. demand for Canadian dollars, (b) supply of Canadian dollars for sale, and (c) equilibrium value of the Canadian dollar?

ANSWER: Demand for Canadian dollars should increase, supply of Canadian dollars for sale should decrease, and the Canadian dollar’s value should increase.

3. Interest Rate Effects on Exchange Rates. Assume U.S. interest rates fall relative to British interest rates. Other things being equal, how should this affect the (a) U.S. demand for British pounds, (b) supply of pounds for sale, and (c) equilibrium value of the pound?
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A wider bid/ask spread adversely affects the U.S. firm that does business in Mexico because it increases the transactions costs associated with conversion of dollars to pesos, or pesos to dollars.

21. Speculation. Diamond Bank expects that the Singapore dollar will depreciate against the dollar from its spot rate of $.43 to $.42 in 60 days. The following interbank lending and borrowing rates exist: Lending Rate Borrowing Rate U.S. dollar 7.0% 7.2% Singapore dollar 22.0% 24.0%

Diamond Bank considers borrowing 10 million Singapore dollars in the interbank market and investing the funds in dollars for 60 days. Estimate the profits (or losses) that could be earned from this strategy. Should Diamond Bank pursue this strategy?

ANSWER:
Borrow S$10,000,000 and convert to U.S. $:
S$10,000,000 × $.43 = $4,300,000

Invest funds for 60 days. The rate earned in the U.S. for 60 days is:
7% × (60/360) = 1.17%

Total amount accumulated in 60 days:
$4,300,000 × (1 + .0117) = $4,350,310

Convert U.S. $ back to S$ in 60 days:
$4,350,310/$.42 = S$10,357,881

The rate to be paid on loan is:
.24 × (60/360) = .04

Amount owed on S$ loan is:
S$10,000,000 × (1 + .04) = S$10,400,000

This strategy results in a loss:
S$10,357,881 – S$10,400,000 = –S$42,119

Diamond Bank should not pursue this strategy.

Chapter 5

10. Speculating

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