Chapter 6
Intervention with Euros Assume that Belgium, one of the European countries that uses the euro as its currency, would prefer that its currency depreciate against the U.S. Dollar. Can it apply central bank intervention to achieve this objective? Explain.
1. Indirect Intervention. Why would the Fed's indirect intervention have a stronger impact on some currencies than others? Why would a central bank's Indirect intervention have a stronger impact than its direct intervention?
2. 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 local banks. Your subsidiary purchases all of this 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 $100,000 in interest each month. Australia has just raised its interest rate in order to boost the value of its currency (Australian dollar, A$). The Australian dollar appreciates against the U. S 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
b) The cost of your subsidiary of purchasing materials (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
4. 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 local banks. Your subsidiary purchases all of this 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 $100,000 in interest each month. Australia has just raised its interest rate in order to boost the value of its currency (Australian dollar, A$). The Australian dollar appreciates against the U. S 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
b) The cost of your subsidiary of purchasing materials (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
Chapter 7:
Assume the following information:
Beal Bank Yardley Bank
Bid price of New Zealand dollar $.401 $.398
Ask price of New Zealand dollar $.404 $.400
Given this information, is 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?
4. Triangular Arbitrage.Assume the following information:
Quoted Price
Value of Canadian dollar in U.S. dollars $.90
Value of New Zealand dollar in U.S. dollars $.30
Value of Canadian dollar in New Zealand dollars NZ $3.02
Given this information, is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy if you had $1,000,000 to use. What market forces would occur to eliminate any further possibilities of triangular arbitrage?
17. Covered Interest Arbitrage in Both Directions. The one year interest rate in New Zealand is 6 percent. The one year U.S. interest rate is 10 percent. The spot rate of the New Zealand dollar (NZ$) is $.50. The forward rate of the New Zealand dollar is $.54. Is covered interest arbitrage feasible for U.S. investors? Is it feasible for New Zealand investors? In each case, explain why covered interest arbitrage is or is not feasible.
35. Assume that the annual U.S. Interest rate is currently 6% and Germany;s annual interest rate is currently 8%. The spot rate of the euro is $1.10 and the 1-year forward rate of the euro is $1.10. Assume that as covered interest arbitrage occurs, the interest rates are not affected, and the spot rate is not affected. Explain how the 1-year forward rate of the euro will change in order to restore interest rate parity, and why it will change. Your explanation should specify which type of investor (German or U.S.) would be engaging in covered interest arbitrage, whether they are buying or selling euros forward, and how that affects the forward rate of the euro.
36. Assume that interest rate parity exists. As of this morning, the 1-month interest rate in Canada was lower than the 1-month interest rate in the United States. Assume that as a result of the Fed's monetary policy this afternoon, the 1-month interest rate in the United States delined this afternoon, but was still higher than the Canadian 1-month interest rate. The 1-month interest rate in Canada remained unchanged. Based on the information,the forward rate of the Canadian dollar exhibited a ____ [discount or premium] this morning that _____[increased or decreased] this afternoon. Explain.
Chapter 8
1. PPP.Explain the theory of purchasing power parity (PPP).Based on this theory, what is a general forecast of the values of currencies in countries with high inflation?
5. Explain why PPP does not hold.
6. Implications of IFE. Explain the international Fisher effect (IFE). What is the rationale for the existence of the IFE? What are the implications of the IFE for firms with excess cash that consis¬tently invest in foreign Treasury bills? Explain why the IFE may not hold.
21. Inflation and Interest Rate Effects. The opening of Russia's market has resulted in a highly volatile Russian currency (the ruble). Russia's inflation has commonly exceeded 20 percent per month. Russian interest rates commonly exceed 150 percent, but this is sometimes less than the annual inflation rate in Russia.
a. Explain why the high Russian inflation has put severe pressure on the value of the Russian ruble.
b. Does the effect of Russian inflation on the decline in the ruble's value support the PPP theory? How might the relationship be distorted by political conditions in Russia?
c. Does it appear that the prices of Russian goods will be equal to the prices of U.S. goods from the perspective of Russian consumers (after considering exchange rates)? Explain.
d. Will the effects of the high Russian inflation and the decline in the ruble offset each other for U.S. importers? That is, how will U.S. importers of Russian goods be affected by the conditions?
26. IRP. The one-year risk-free interest rate in Mexico is 10%. The one-year risk-free rate in the U.S. is 2%. Assume that interest rate parity exists. The spot rate of the Mexican peso is $.14.
a. What is the forward rate premium?
b. What is the one-year forward rate of the peso?
c. Based on the international Fisher effect, what is the expected change in the spot rate over the next year?
d. If the spot rate changes as expected according to the IFE, what will be the spot rate in one year?
e. Compare your answers to (b) and (d) and explain the relationship.
e. The answers are the same. When IRP holds, the forward rate premium and the expected percentage change in the spot rate are derived in the same manner. Thus, the forward premium serves as the forecasted percentage change in the spot rate according to IFE.
31. Applying IRP and IFE. Assume that Mexico has a one-year interest rate that is higher than the U.S. one-year interest rate. Assume that you believe in the international Fisher effect (IFE), and interest rate parity. Assume zero transactions costs.
Ed is based in the U.S. and he attempts to speculate by purchasing Mexican pesos today, investing the pesos in a risk-free asset for a year, and then converting the pesos to dollars at the end of one year. Ed did not cover his position in the forward market.
Maria is based in Mexico and she attempts covered interest arbitrage by purchasing dollars today and simultaneously selling dollars one year forward, investing the dollars in a risk-free asset for a year, and then converting the dollars back to pesos at the end of one year.
Do you think the rate of return on Ed's investment will be higher than, lower than, or the same as the rate of return on Maria's investment? Explain.