Chapter 11, Problem 2SBD

An investor has $10m to invest and has the following options: 1) depositing it in a US bank account paying 3% annually, or 2) depositing it in a German bank, where the annual rate of interest is only 2%. Assume that today the current spot exchange rate for the Euro is given as $1.2750, while the 1-year Dollar-Euro forward rate is posted as 1.2995. a. Based on your knowledge of the relationship between interest rate differentials and the current dollar-euro forward premium or discount, in which country should the investor deposit her money? why?   b. If you had the power to adjust the German interest rate, with all else constant, what rate would you establish, such that the investor is totally indifferent between depositing in either countries? Show your work and the logic behind it.

Assume that the current (indirect for the UK) spot exchange rate of one pound to the dollar is $1.60/£ and that the corresponding three-month forward exchange rate is $1.59/£. Also, assume that the annualised 3-month interest rate on the pound is currently 4.00% and that the corresponding interest rate on the US dollar is 2.50%. Required:(i) Given the information above, will you invest in the pound or borrow the pound? Explain why. (ii) Calculate the amount of profit that you will realise on each pound that you borrow or invest.

ATZ (US Company) expects to receive a 19 million euros in 90 days from a Australia customer. The current spot rate is S$1.836 per AUD, and the 90 day forward rate is S$1.638 per AUD. In addition, the annualized three-month AUD and USD interest rate 2.81% and 4.03%, respectively. What is the hedged value of the AUD receivable using the forward contract? How does that compare to a situation when the exchange rate remains unchanged at the spot rate?

Credible Research sold a microchip to the Vausten Institute in Germany on credit and invoiced €10 million payable within half a year. Currently, the 6-month forward exchange rate is $1.10/€ and the foreign exchange advisor for Credible Research predicts that the spot rate is likely to be $1.05/€ in 6 months. (i) What would be the expected gain or loss from the forward hedging? (ii) As a decision-maker for Credible Research, would you suggest hedging this euro receivable? Please explain why or why not? (iii) what if the foreign exchange advisor anticipates that the future spot rate will be similar to the forward exchange rate quoted today. As the decision-maker would you propose hedging in this case? If yes or no why?

Vicky Gomez, a foreign exchange trader at Wells Fargo, can invest $1M, or the foreign currency equivalent of the bank's short term funds, in an uncovered or covered interest arbitrage with the United Kingdom.   Arbitrage funds available to invest: $1M( or the equivalent in pounds)   Spot rate ($/Ł) : 1.9422   90-day forward exchange rate ($/Ł): 1.9150   Expected 90-day spot exchange rate ($/Ł): 1.8810   U.S. dollar 90-day interest rate: 2.000%   U.K. pound 90-day interest rate: 5.900%   A.Should Vicky make an covered investment in the UK? Show work and give answer. B. Shoudl Vicky make an uncovered investment in the UK? Show work and give answer.

Suppose that the current spot exchange rate is €1.50/₤ and the one-year forward exchange rate is €1.60/₤. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, i.e., ₤666,667, at the current spot exchange rate. Show how you can realize a guaranteed profit from covered interest arbitrage. Assume that you are a euro-based investor. Also determine the size of the arbitrage profit.

The current spot exchange rate is $1.60/€ and the three-month forward rate is $1.55/€. Based on your analysis of the exchange rate, you are confident that the spot exchange rate will be $1.62/€ in three months. Assume that you would like to buy or sell €1,000,000. What actions do you need to take to speculate in the forward market? What is the expected dollar profit from speculation?   A. Sell €1,000,000 forward for $1.60/€, and you expect to gain $20,000.   B. Buy €1,000,000 forward for $1.55/€, and you expect to gain $70,000.   C. Wait three months, if your forecast is correct buy €1,000,000 at $1.62/€.   D. Buy €1,000,000 forward for $1.60/€, and you expect to gain $20,000.

Explain your understanding of currency hedging. Why is hedging necessary? If your company is expected to pay ¥100 million to a company in Japan on September 30, 2021 list two ways that your company can hedge this transaction.

A currency swap has a remaining life of 15 months. It involves exchanging interest at 10% on £20 million for interest at 6% on $30 million once a year. The term structure of risk-free interest rates in the United Kingdom is flat at 7% and the term structure of risk-free rates in the United States is flat at 4% (both with annual compounding). The current exchange rate (dollars per pound sterling) is 1.5500. What is the value of the swap to the party paying sterling? What is the value of the swap to the party paying dollars?