You played a fierce game of H-O-R-S-E against Dr. Van Weaver and lost $100,000. Thank goodness you won $100,000 from Dr. Li betting on UEFA Champions League matches. Dr. VW has given you 90 days to pay and Dr. Li will pay you later today in U.S. dollars. Your F/X broker gives you following exchange and interest rate quotes.
Spot exchange rate (NOK/USD) 6.0312
3-month forward rate (NOK/USD) 6.0186
U.S. dollar 3-month money market interest rate 5.000%
Norwegian krone 3-month money market interest rate 4.450%
a. What is the 90 day forward premium/discount on the Norwegian krones?
b. Obtain a forecast of the krone-dollar 3 month ahead spot exchange rate. What is the basis of your forecast? Briefly explain the rationale.
Taking Dr. Li’s payment, you decide to play the F/X or the U.S. money market to see if you can make some $$ before you have to pay Dr. VW.
c. First, carefully describe the steps you would take to make some profits with Dr. Li’s money before you have to pay Dr. VW. (No calculations needed.)
d. Now, calculate the actual profits you might earn using your investment strategy outlined in part c. (Hint: You should construct a chart to help guide you with calculations. For full credit, show all your formula and calculations.)
e. Given the above, describe how the F/X and the money markets in the two currencies will adjust. Why do you think the markets will adjust in this way? (Hint: You need not be exact – saying “up” or “down” will be sufficient.)