Problem 1: Intervention Effects on Corporate Performance. Assume you have a subsidiary in Australia. The Subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from the local banks. Your subsidiary purchases all of its materials from Hong Kong. The Hong Kong dollar is tied to the U.S. dollar. Your Subsidiary borrowed funds from the U.S. parent, and must pay the parent $100,000 in the interest each month. Australia has just raised its interest rate in order to boost the value of its currency (Australian dollar, A$). The Australian dollar appreciates against the dollar as a result. Explain whether these actions would increase, reduce, or have no effect on:
a. The volume of your subsidiary’s sales in Australia (measured in A$)
b. The cost to your subsidiary of making the interest payments to the U.S. parent (measured in A$)
c. The cost to your subsidiary of making the interest payments to the U.S. parent (measured in A$)
Briefly explain each answer.
Problem 2: Locational Arbitrage. Assume the following information:
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Beal Bank
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Yardley Bank
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Bid price of New Zealand dollar
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$.401
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$.398
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Ask price of new Zealand dollar
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$.404
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$.400
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Given this information, is the locational arbitrage possible? If so, explain the steps involved in locational arbitrage and compute the profit from this arbitrage, if you had $1,000,000 to use. What market forces would occur to eliminate any further possibilities of locational arbitrage?
Problem 3: Covered Interest Arbitrage. Assume the following information:
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Spot rate of Mexican peso
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=$.80
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180-day forward rate of Mexican peso
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=$.79
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180-day Mexican interest rate
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=4%
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180-day U.S. interest rate
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=2.5%
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Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer.
Problem 4: Deriving the Forward rate. Assume that annual interest rates in the United Sates are 4 percent, while interest rates in France are 6 percent.
a. According to IRP, what should the forward rate premium or discount of the euro be?
b. If the euro’s spot rate is $1.10, what should the one-year forward rate of the euro be?
Problem 5: Estimating Depreciation Due to PPP. Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to ppp if the United Kingdom experiences an inflation rate of 7 percent while the U.S. experiences an inflation rate of 2 percent?