Suppose you (or you have friends or relatives) work in a financial institution, how you would advise your clients with regard to the following:
(a) A U.S. resident can earn 6% interest on a one-year bank deposit of US$100,000 at home. Alternatively, she can convert the US$100,000 into Euro and earn 4% on a one-year bank deposit in Germany. Suppose the initial exchange rate is 1.5 Euro/US$.
Suppose that she wishes to withdraw her money at the end of the year and the exchange rates changes to 1.45Euro/US$ at the end of the year. Identify and discuss which deposit will give her a higher return, and by how much (measured in U.S. dollars).
(b) At the end of the year, the U.S. investor referred to in (a) wishes to travel to Germany to visit relatives. She sees that the £ /US$ exchange rate is 0.91£/US$, and the £/Euro exchange rate is 0.65£/Euro, and the Euro/US$ conversion is 1.45Euro/US$. Should she convert the US$10,000 she wishes to take to Germany directly from US$ to Euro, or should she first convert to £, and then to Euro? Discuss how much (in Euro) does she make/lose by converting to £ first.
(c) Suppose you have a corporate client IXM which sells computers in Japan and receives revenues in yen. However, IXM's expenses are in US dollars. Explain how you would advise your client to hedge against currency risks.