a) Suppose the following exchange rate quotations are available:
Citibank quotes U.S. dollars per Euro: $1.2223/€
Barclays Bank quotes U.S. dollars per pound sterling: $1.8410/£
Dresdner Bank quotes Euros per pound sterling: €1.5100/£
You are a market trader with $1,000,000. Will you be able to make an arbitrage profit using these quotes? If yes, what will be the profit? Show your calculations.
b) Forward contracts are not as liquid as Futures contracts. Why is this so?
c) ABC enjoys a different credit rating than XYZ in the debt market. It can either borrow at a fixed interest rate of 9% or at a floating rate which equals LIBOR + 2%. XYZ can borrow at 10.5% fixed rate or at a floating rate of LIBOR + 1.5%.
ABC wishes to borrow on a floating rate basis and XYZ wishes to borrow on a fixed rate basis. The quality spread differential is 2%.
Because ABC is more better in borrowing at a fixed rate basis than XYZ is at borrowing on a floating rate basis, it is agreed that 1.5% of the potential gain is to go to ABC and the remaining 0.5% belongs to XYZ.
Fortunately, they come in contact with each other, doing away with the need of a swap dealer.
Construct an interest rate swap between ABC and XYZ which will be mutually beneficial.
d) A Put option with a maturity of 5 months sells for $8.10. A call with the same expiration sells for $6.12. If the exercise price is $70 and the stock is currently priced at $66.81, what is the annual continuously compounded interest rate?
e) Let us say that a put and a call have the same maturity and strike price. If they have the same price, what will be the value of the stock?