International-Financial-Management---Bekaert-2e---Solutions---Ch07Word格式.doc

1、Chapter 7Speculation and Risk in the Foreign Exchange MarketQUESTIONS1. What are two ways to speculate in the currency markets without investing any money up front?Answer: To be long in the foreign currency, one can borrow domestic currency, convert to foreign currency in the spot foreign exchange m

2、arket, and invest in the foreign money market while leaving the transaction exchange risk unhedged. The alternative way is to enter into a forward contract to buy the foreign currency forward. To be short in the foreign currency, one can borrow foreign currency, convert to domestic currency in the s

3、pot foreign exchange market, and invest in the domestic money market while leaving the transaction exchange risk unhedged. The alternative way is to enter into a forward contract to sell the foreign currency forward.2. What do financial economists mean when they discuss the conditional expectation o

4、f the future spot exchange rate? The conditional expectation of the future spot exchange rate is the probability weighted average of the future possible exchange rates. It is the mean of the conditional probability distribution of future spot rates.3. What is the main determinant of the variability

5、of forward market returns? The main and only determinant of the variability of forward market returns is the variance of the future exchange rate.4. Describe how you construct the uncertain yen-denominated return from investing 1 yen in the Swiss franc money market. If you invest yen in the Swiss mo

6、ney market, you first must convert from yen into Swiss francs in the spot foreign exchange market. With the Swiss francs that you get, you invest in the Swiss money market, leaving the investment unhedged. At the end of the investment horizon, you convert from Swiss francs back into yen at the futur

7、e spot exchange rate. 5. What is a hedged foreign currency investment? What happens if you hedge your return in Question 4? A hedged foreign currency investment sells the known foreign currency return in the forward market at the time of the investment. This eliminates exposure to foreign exchange r

8、isk, but it also elements possible gains from appreciation of the foreign currency. By interest rate parity, we know that the domestic currency return from the hedged foreign currency investment is just the domestic currency money market return.6. What does it mean for the 90-day forward exchange ra

9、te to be an unbiased predictor of the future spot exchange rate? If the forward exchange rate for 90 days is an unbiased predictor of the future spot rate, the forward rate is equal to the expected future spot rate. While there will be forecast errors that may be large, there will not be systematic

10、errors on one side or the other. Therefore, the expected forward market return is zero.7. Why is it true that the hypothesis that the forward exchange rate is an unbiased predictor of the future spot exchange rate is equivalent to the hypothesis that the forward premium （or discount） on a foreign cu

11、rrency is an unbiased predictor of the rate of its appreciation （or depreciation）? When the forward exchange rate is an unbiased predictor of the future spot exchange rate, we know that the forward rate equals the conditional expectation of the future spot rate. For example, at the 90 day maturity,

12、we haveBecause the current spot rate, S（t）, is in the information set that is used to take the conditional expectation, we can divide by it on both sides of the above equation. Subtracting one from both sides then givesThis equation states that the forward premium on the foreign currency equals the

13、expected rate of appreciation of the foreign currency. 8. It is often claimed that the forward exchange rate is set by arbitrage to satisfy （covered） interest rate parity. Explain how interest rate parity can be satisfied and how the forward exchange rate can be set by speculators in reference to th

14、e expected future spot exchange rate. Interest rate parity is a no arbitrage relation between 4 variables, the spot and forward exchange rates and the interest rates on the two currencies. If the forward exchange rate is set by speculators in reference to the expected future spot exchange rate, the

15、current spot rate or the two interest rates can adjust to satisfy interest rate parity. The speculative dimension of trading must also be satisfied in equilibrium.9. It is sometimes asserted that investors who hedge their foreign currency bond or stock returns remove the foreign exchange risk associ

16、ated with the investment, reduce the volatility of their domestic currency returns, and thus get a “free lunch” because the mean return in domestic currency remains the same as the mean return in the foreign currency. Is this true or false? Why? If forward rates are unbiased predictors of future spo

17、t rates, hedging foreign currency investments does not change their expected returns and effectively removes a source of volatility. Some would say that this provides a “free lunch” because volatility is reduced without a reduction in mean. By hedging foreign investments, you can increase your Sharp

18、e ratio for this particular asset class, which allows you to lever the return to the same volatility and get more return. But, there is no “free lunch” because in this case the foreign exchange risk is not a priced risk. If there is a risk premium in the foreign exchange market, the statement is wro

19、ng. Hedged foreign bond and equity investments would have different expected returns than unhedged investments.10. It is often argued that forward exchange rates should be unbiased predictors of future spot exchange rates if the foreign exchange market is efficient. Is this true or false? Market eff

20、iciency means that asset prices accurately incorporate all available information and expected returns on assets correspond to true sources of risk. If forward rates are biased predictors of future spot exchange rates, the source of the bias could be an equilibrium risk premium. Thus, the claim that

21、forward exchange rates should be unbiased predictors of future spot exchange rates if the foreign exchange market is efficient is wrong.11. What is the prediction of the CAPM for the relationship between the forward exchange rate and the expected future spot exchange rate? The CAPM predicts that the

22、 expected excess return on an asset is the beta of the asset times the expected excess return on the market portfolio. The beta is the covariance of the return on the asset with the return on the market portfolio divided by the variance of the market portfolio. By applying the CAPM to uncovered fore

23、ign money market investments and using interest rate parity, one can demonstrate that the expected return on a forward contract equals the beta of the return on the forward contract times the expected excess return on the market portfolio. The expected return on a forward contract to purchase foreig

24、n currency is the difference between the expected future spot exchange rate and the forward exchange rate scaled by the current spot rate. If the change in the future spot rate is positively correlated with the return on the market portfolio, forward rates would be less than expected future spot rat

25、es, and if the change in the future spot rate is negatively correlated with the return on the market portfolio, forward rates would be greater than expected future spot rates.12. If the CAPM explains deviations of the forward exchange rate from the expected future spot exchange rate, explain why one

26、 party involved in a forward contract would be willing to enter into a contract with an expected loss. If the party that is long in the forward market has an expected profit, the party that is short in the forward market has an expected loss. The CAPM explains this seeming dilemma because the party

27、that is long would have a risky asset. The covariance of the profit on the long position with the return on the market portfolio would be positive, and this positive covariance is what makes the contract risky. The person who is on the short side of the forward contract would have an asset whose cov

28、ariance with the world market portfolio was negative. They would receive profit when the market portfolio was doing poorly, and they would be willing to take an expected loss because of the desirable property of the negative covariance, which is like having portfolio insurance.13. Why is it only the

29、 covariance of an assets return with the return on the world market portfolio that determines whether there is a risk premium associated with the assets expected return? The uncertain part of an assets return can be broken into two components. The non-diversifiable part is determined by the covarian

30、ce of the return on the asset with the return on the market portfolio. This part is the source of risk and the part that gives rise to a risk premium on the asset. The other component of the uncertain part of an assets return is the part that is diversifiable and therefore does not contribute to the

31、 variance of a large, well-diversified portfolio. This latter part is therefore not a source of risk to an investor who holds a large, well-diversified portfolio.14. What is the rational expectations hypothesis, and how is it applied to tests of hypotheses about expected returns in financial markets

32、? The rational expectations hypothesis states that we can break the realization of a return into an expected return that depends on the current information set and an unexpected component that depends only on new information and consequently does not depend in any way on the current information set. Theories of risk premiums generate hypotheses that relate unob