EBK ESSENTIALS OF INVESTMENTS
10th Edition
ISBN: 8220102800267
Author: Bodie
Publisher: YUZU
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 19, Problem 1CP
Renee Michaels. CFA. plans to invest $1 million in U.S. government cash equivalents for the next 90 days. Michaels’s client has authorized her to use non-U.S. government cash equivalents, but only if the currency risk is hedged to U.S. dollars by using forward currency contracts. (LO 19-2)
- Calculate the U.S.-dollar value of the hedged investment at the end of 90 days for each of the two cash equivalents in the table below. Show all calculations.
- Briefly explain the theory that best accounts for your results.
- Based upon this theory, estimate the implied interest rate for a 90-day U.S. government cash equivalent.
| Interest Rates 90-Day Cash Equivalents |
|
| Japanese government |
7.6% |
| Swiss government |
86 |
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
1. The following Information should be used for Questions 1 and 2.
The treasurer of X wants to hedge an exposure to currency risk. X is a
company whose domestic currency is the euro, and the company must make a payment of US $500 000 to a US supplier in 6 months' time.
The following market rates are available:
Exchange rates: $ per €1
Spot= 1.604 ± 0.002
6 months forward= 1.570 ± 0.004
6 month interest rates:
Euro Borrowing= 4.8%. Euro Deposits= 4.4%
US dollar Borrowing= 2.5%. US dollar Deposits= 2.0%.
What would be the euro cost to X if he hedges through a forward contract?
(a) Euro 326, 495
(b) Euro 319, 285
(c) Euro 313, 525
(d) Euro 333, 295
2. What would be the cost to X if he hedges through the money market?
(a) USD 634, 631
(b) USD 631, 634
(c) Euro 316, 634
(d) Euro 316, 436
Heidi Høi Jensen, a foreign exchange trader at J.P. Morgan Chase, can invest $5 million, or the foreign currency
equivalent of the bank's short term funds, in a covered interest arbitrage with Denmark.
Assumptions
Arbitrage funds available
Spot exchange rate (kr/$)
3-month forward rate (kr/S)
US dollar 3-month interest rate
Danish kroner 3-month interest rate
Value
$5,000,000
6.1720
6.1980
4.000%
a)
5.000% a)
kr Equivalent
kr 30,860,000
Heidi Høi Jensen generates a covered interest arbitrage profit because, although U.S. dollar interest rates are lower,
the U.S. dollar is selling forward at a premium against the Danish krone. What is the amount of that profit?
kr21,102
kr34,750
kr24,250
kr54,150
Heidi Høi Jensen, a foreign exchange trader at J.P. Morgan Chase, can invest $15
million, or the foreign currency equivalent of the bank's short term funds, in a
covered interest arbitrage with Denmark. Heidi plans to use the following quotes to
make a covered interest arbitrage (CIA).
Assumptions
Arbitrage funds available
Spot exchange raté (kr/S)
3-month forward rate (kr/S)
US dollar 3-month interest rate
Danish kroner 3-month interest rate
Value
$15,000,000
5.1197
5.1611
4.4679%
8.0239%
Because for this level of analysis/problems, small differences in % lead to arbitrage
profit/losses, please always use 4 digits in your calculations
For your answer (since this is a dollars answer), round your answer to the nearest
$0.01 (use 2 decimals). DO NOT USE commas to separate thousands. For negative
results, enter the minus (-) symbol in front of the first digit/#. For example, if your
answer is $4,000,287.329; then enter 4000287.33; if your answer is $400 then
enter 400.00
If Heidi makes…
Chapter 19 Solutions
EBK ESSENTIALS OF INVESTMENTS
Ch. 19 - Prob. 1PSCh. 19 - Prob. 2PSCh. 19 - Prob. 3PSCh. 19 - Prob. 4PSCh. 19 - Prob. 5PSCh. 19 - Prob. 6PSCh. 19 - Now suppose the investor in Problem 3 also sells...Ch. 19 - Prob. 8PSCh. 19 - If the current exchange rate is 1.35/ , the...Ch. 19 - If you were to invest 10,000 in the British bills...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- The treasurer of a major U.S. firm has $31 million to invest for three months. The interest rate in the United States is 30 percent per month. The interest rate in Great Britain is.34 percent per month. The spot exchange rate is £.630, and the three-month forward rate is £.632. What would be the value of the investment if the money is invested in the US and Great Britain? (Do not round intermediate calculations and enter your answers in dollars, not in millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) U.S. Great Britainarrow_forwardVicky 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.arrow_forwardThe treasurer of a major U.S. firm has $30 million to invest for three months. The interest rate in the United States is 15 percent per month. The interest rate in Great Britain is .26 percent per month. The spot exchange rate is £.813, and the three-month forward rate is £.827. Ignore transactions costs. a. If the treasurer invested the company's funds in the U.S., how much would the investment be worth after three months? Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, 1,234,567.89. b. If the treasurer invested the company's funds in Great Britain, how much would the investment be worth after three months? Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, 1,234,567.89. a. U.S. investment b. Great Britain investmentarrow_forward
- Suppose that the treasurer of IBM has an extra cash reserve of $400,000 to invest for six months. The six-month interest rate is 4.3 percent per annum in the United States and 3.2 percent per annum in Germany. Currently, the EUR/USD is 1.2248 and the six-month forward exchange rate is1.2351. The treasurer of IBM does not wish to bear any exchange risk. How much would IBM have if they choose to invest in Europe hedging their risk? (USD, no cents)arrow_forwardPlease answer both subparts. 1. The following Information should be used for Questions 1 and 2. The treasurer of X wants to hedge an exposure to currency risk. X is a company whose domestic currency is the euro, and the company must make a payment of US $500 000 to a US supplier in 6 months' time. The following market rates are available: Exchange rates: $ per €1 Spot= 1.604 ± 0.002 6 months forward= 1.570 ± 0.004 6 month interest rates: Euro Borrowing= 4.8%. Euro Deposits= 4.4% US dollar Borrowing= 2.5%. US dollar Deposits= 2.0%. What would be the euro cost to X if he hedges through a forward contract? (a) Euro 326, 495 (b) Euro 319, 285 (c) Euro 313, 525 (d) Euro 333, 295 2. What would be the cost to X if he hedges through the money market? (a) USD 634, 631 (b) USD 631, 634 (c) Euro 316, 634 (d) Euro 316, 436arrow_forwardXYZ Corporation, located in the United States, has an accounts payable obligation of ¥1500 million payable in six months to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the six month forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. a) What is the future dollar cost of meeting this obligation using the money market hedge a. $92,307. b. $ 19582168.89 c. $13054779.26 d. $ 6589854.111arrow_forward
- Michelle Co. a US firm, plans to use a money market hedge to hedge its payment of $2,000,000 Australian dollars for Australian goods in a year. The U.S Interest rate is 8%, while the Australian Interest rate is 11%. The spot rate of the Australian dollar is $0.77, while the 1 year forward rate is $0.72. Determine the amount of U.S dollars needed in 1 year if a money market hedge is used. $245,765,879.34 $175,834,193 $1,498,378.378 $320,307,372.07arrow_forwardThe treasurer of a major U.S. firm has $31276878 to invest for three months. The annual interest rate in the United States is 0.35% per month. The interest rate in Great Britain is 0.59% per month. The spot exchange rate is £0.72, and the three-month forward rate is £0.74. Ignoring transaction costs, what would be the NPV of investing in Great Britain as opposed to invest in the U.S.? NOTE: Enter the number rounding to four decimal placesarrow_forwardA British firm will receive $1 million from a U.S. customer in three months. The firm is considering two strategies to eliminate its foreign exchange exposure. The first strategy is to pledge the $1 million as collateral for a three month loan from a U.S. bank at 4 percent interest. The U.K. firm will then convert the proceeds of the loan to pounds at the spot rate. When the loan is due, the firm will pay the $1 million balance due by handing its U.S. receivable over to the bank. This strategy allows the U.K. firm to “monetize” its receivable immediately. The spot exchange rate is 0.6550 pounds per dollar. The second strategy is to enter a forward contract at an exchange rate of 0.6450 pounds per dollar. This ensures that the U.K. firm will receive £645,000 in three months. If the firm wanted to monetize this payment immediately, it could take out a three-month loan from a U.K. bank at 8 percent, pledging the proceeds of the forward contract as collateral. Which of…arrow_forward
- I want the answer of (c). I need the answer of all questions 8. As an employee of the foreign exchange department for a commercial bank in USA, you have been provided the following information: Beginning of Year: Initial amount of investment $2,00,000 One-year forward rate of £ = $1.59 One-year U.S interest rate 8.00% One-year British interest rate 9.09% 11 Spot rate of f = $1.625 Spot rate of Australian dollar (A$) = $.70 Cross exchange rate: £1= A$2.35 One-year forward rate of A$ = $0.70 One-year Australian interest rate 10.00% a) Determine whether triangular arbitrage is feasible and, if so, how it should be conducted to make a profit? b) Using the information, determine whether covered interest arbitrage is feasible and, if so, how it should be conducted to make a profit? c) Assume that at the beginning of the year, the pound's value is in equilibrium. Over-the- year, the British inflation rate is 6 percent, while the U.S. inflation rate is 4 percent. Further…arrow_forwardJames Clark is a foreign exchange trader with Citibank. He notices the following quotes. Spot exchange rate Six-month forward exchange rate Six-month $ interest rate Six-month SFr interest rate USD1.2051/SFr USD1.1922/SFr 8% per year 10% per year Is there an arbitrage opportunity? If yes, determine the arbitrage profit in Swiss Francs. Assume that James Clark is authorized to work with $1,000,000. Input your answer without any currency information.arrow_forwardA British company has a USD 1 million payable in two months.How can the British company hedge the foreign currency payable? * A. Buy pounds in the forward market B. Sell pounds in the spot market C. Sell US dollars in the spot market D. Buy US dollars in the forward marketarrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Foreign Exchange Risks; Author: Kaplan UK;https://www.youtube.com/watch?v=ne1dYl3WifM;License: Standard Youtube License