International-Financial-Management---Bekaert-2e---Solutions---Ch02.doc

International-Financial-Management---Bekaert-2e---Solutions---Ch02.doc

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Chapter2:

TheForeignExchangeMarket5

Chapter 2

TheForeignExchangeMarket

QUESTIONS

1.Whatisanexchangerate?

Answer:

Anexchangerateistherelativepriceoftwocurrencies,liketheU.S.dollarpriceoftheeuro,theThaibahtpriceoftheMalaysianringgit,ortheMexicanpesopriceoftheCanadiandollar.

2.Whatisthestructureoftheforeignexchangemarket?

IsitliketheNewYorkStockExchange?

Answer:

Theinterbankforeignexchangemarketisaverylarge,diverse,over-the-countermarket,notaphysicaltradingplacewherebuyersandsellersgathertoagreeonapricetoexchangecurrencies.Traders,whoareemployeesoffinancialinstitutionsinthemajorfinancialcitiesaroundtheworld,dealwitheachotherprimarilyoverthephoneorviacomputer,withwrittenorformalelectronicconfirmationsoftransactionsoccurringonlylater.

3.Whatisaspotexchangeratecontract?

Whendoesdeliveryoccuronaspotcontract?

Answer:

Whencurrenciesintheinterbankspotmarketaretraded,certainbusinessconventionsarefollowed.Forexample,whenthetradeinvolvestheU.S.dollar,businessconventiondictatesthatspotcontractsaresettledin2businessdays—thatis,thepaymentofonecurrencyandreceiptoftheothercurrencyoccursin2businessdays.Onebusinessdayisnecessarybecauseoftheback-officepaperworkinvolvedinanyfinancialtransaction.Theseconddayisneededbecauseofthetimezonedifferencesaroundtheworld.

Severalexceptionstothe2-business-dayrulearenoteworthy.First,forexchangesbetweentheU.S.dollarandtheCanadiandollarortheMexicanpeso,theruleis1businessday.Second,ifthetransactioninvolvesthedollarandthefirstofthe2daysisaholidayintheUnitedStatesbutnotintheothersettlementcenter,thefirstdayiscountedasabusinessdayforsettlementpurposes.Third,FridaysarenotpartofthebusinessweekinmostMiddleEasterncountries,althoughSaturdaysandSundaysare.Hence,non–MiddleEasterncurrenciessettleonFridays,andMiddleEasterncurrenciessettleonSaturdays.

4.WhatwastheJapaneseyenspotpriceoftheU.S.dollaronDecember21,2010?

Answer:

ExaminingExhibit2.5forDecember21,2010wefindthattheJapaneseyenspotpriceoftheU.S.dollarwas¥84.12/$.

5.WhatwastheU.S.dollarspotpriceoftheSwissfranconDecember21,2010?

Answer:

ExaminingExhibit2.5forDecember21,2010,wefindthattheU.S.dollarspotpriceoftheSwissfrancwas$1.0289/CHF.

6.Howlargearethebid–askspreadsintheinterbankspotmarket?

Whatistheirpurpose?

Answer:

Thepurposeofthebid-askspreadistoallowtraderstoprofitbybuyingacurrencyatalowbidpriceandsellingthatcurrencyatahigheraskprice.Bid–askspreadsinthespotforeignexchangemarketarequitesmall,oftenonlytwoorthreebasispoints.Forexample,ayen–dollartradermightquoteabidpriceofyenperdollaratwhichsheiswillingtobuydollarsinexchangeforyenof,say,¥83.74/$.Thetraderwouldthenquoteahigheraskpriceatwhichsheiswillingtoselldollarsforyen,say,atanexchangerateof¥83.76/$.Thispercentagebid-askspreadis

7.WhatwastheeuropriceoftheBritishpoundonDecember21,2010?

Why?

Answer:

Wecanfindthisinformationtwoways.Thecross-ratequotefromExhibit2.6is€1.1818/£.TheexchangeratesofeurosperdollaranddollarsperpoundfromExhibit2.5are€0.7636/$and$1.5477/£.Weknowthattherewouldbeatriangulararbitragepossibilityifthecross-ratediffersfromtheindirectrateusingthedollarasanintermediary.Thus,wefindthesamevalueifwecalculate

8.IfthedirecteuropriceoftheBritishpoundishigherthantheindirecteuropriceoftheBritishpoundusingthedollarasavehiclecurrency,howcouldyoumakeaprofitbytradingthesecurrencies?

Answer:

IfthedirecteuropriceoftheBritishpoundishigherthantheindirecteuropriceoftheBritishpoundusingthedollarasavehiclecurrency,therewouldbeatriangulararbitrage.Wewouldwanttobuypoundsattheindirectlowpriceandsellpoundsatthedirecthighprice.SupposeinQuestion7thatthedirectpriceeurosperpoundwere€1.2115/£andtheexchangeratesversusthedollarare€0.7636/$and$1.5477/£.Theindirecteuropriceofthepoundistherefore

Ifwestartwith€10,000,000,wecanconverteurostodollarsandget

€10,000,000/€0.7636/$=$13,095,862

Convertingthesedollarsintopoundsgives

$13,095,862/$1.5477/£=£8,461,499

Convertingthesepoundsintoeurosgives

€1.2115/££8,461,499=€10,251,106

Thus,wemakeaprofitof€251,106or2.51%.

9.Whatisanappreciationofthedollarrelativetothepound?

Whathappenstothedollarpriceofthepoundinthissituation?

Answer:

Anappreciationofthedollarrelativetothepoundmeansthatittakesfewerdollarstobuyapound,sothedollarpriceofthepoundfalls.Thissituationisalsodescribedasthedollarisstrongerintheforeignexchangemarket,thepoundhasdepreciatedversusthedollar,andthepoundisweakerintheforeignexchangemarket.

10.WhatisadepreciationoftheThaibahtrelativetotheMalaysianringgit?

Whathappenstothebahtpriceoftheringgitinthissituation?

Answer:

AdepreciationoftheThaibahtrelativetotheMalaysianringgitmeansthatitwilltakemorebahttobuyoneringgit.Thus,thebahtpriceoftheringgitisnowhigherafterthedepreciationofthebaht.

PROBLEMS

1.MississippiMudPies,Inc.needstobuy1,000,000Swissfrancs（CHF）topayitsSwisschocolatesupplier.Itsbankerquotesbid–askratesofCHF1.3990–1.4000/USD.WhatwillbethedollarcostoftheCHF1,000,000?

Answer:

Thebank’sbidrateisCHF1.3990/$.Thatisthepriceatwhichthebankiswillingtobuy$1inreturnforCHF1.3990.ThebanksellsdollarsatitsaskpriceCHF1.4000/$.MississippiMudPiesmustselldollarstothebanktobuyCHF.ThereforeMississippiMudPieswillreceivethebank’sbidrateofCHF1.3990/$.ThedollarcostofCHF1,000,000isconsequently

CHF1,000,000/CHF1.399/$=$714,796

2.IftheJapaneseyen–U.S.dollarexchangerateis¥104.30/$,andittakes25.15Thaibahtstopurchase1dollar,whatistheyenpriceofthebaht?

Answer:

Topreventtriangulararbitrage,thedirectquoteoftheyenpriceofthebaht（¥/THB）mustequaltheyenpriceofthedollartimesthedollarpriceofthebaht（whichisthereciprocalofthebahtpriceofthedollar）:

¥104.30/$1/（THB25.15/$）=¥104.30/$$0.03976/THB=¥4.1471/THB

3.Asaforeignexchangetrader,youseethefollowingquotesforCanadiandollars（CAD）,U.S.dollars（USD）,andMexicanpesos（MXN）:

USD0.7047/CAD MXN6.4390/CAD MXN8.7535/USD

Isthereanarbitrageopportunity,andifso,howwouldyouexploitit?

Answer:

Thedirectquoteforthecross-rateofMXN6.4390/CADshouldequaltheimpliedcross-rateusingthedollarasanintermediarycurrency;otherwisethereexistsatriangulararbitrageopportunity.Theindirectcrossrateis

MXN8.7535/USDUSD0.7047/CAD=MXN6.1686/CAD

Thisindirectcrossrateislessthanthedirectquotesothereisanarbitrageopportunitytoexploitbetweenthethreecurrencies.Inthissituation,buyingtheCADwithMXNbyfirstbuyingUSDwithMXNandthenbuyingtheCADwiththeUSDandfinallysellingthatamountofCADdirectlyforMXNwouldmakeaprofitbecausewewouldbebuyingtheCADatalowMXNpriceandsellingtheCADatahighMXNprice.

4.TheMexicanpesohasweakenedconsiderablyrelativetothedollar,andyouaretryingtodecidewhetherthisisagoodtimetoinvestinMexico.SupposethecurrentexchangerateoftheMexicanpesorelativetotheU.S.dollarisMXN9.5/USD.YourinvestmentadvisoratGoldmanSachsarguesthatthepesowilllose15%ofitsvaluerelativetothedollaroverthenextyear.WhatisGoldmanSachs’sforecastoftheexchangeratein1year?

Answer:

OnewaytothinkofthisistosaythattheinvestmentadvisorisreferringtothefactthattheMexicanpesopriceofthedollarwillbe15%highernextyear.Inthiscase,theforecastoftheMXN/USDexchangerateinyear1

MXN9.5/USD1.15=MXN10.925/USD

A15%lossofvalueoftheMexicanpesoversustheU.S.dollartechnicallymeansthatdollarpriceofthepesois15%lower.WeknowthatthecurrentUSDpriceofthepesois

1/（MXN9.5/USD）=USD0.105263/MXN

Ifthisexchangeratefallsby15%,thenewexchangeratewillbe

0.85USD0.105263/MXN=USD0.089474/MNX

Inthiscasetheforecastforthefutureexchangeratemeasuredinpesosperdollaris

1/（USD0.089474/MXN）=MXN11.1765/USD

Thedifferencearisesbecausethesimplepercentagechangeintheexchangeratedependsonhowtheexchangerateisquoted.

5.DeutscheBankquotesbid–askratesof$1.3005/€-$1.3007/€and¥104.30-104.40/$.WhatwouldbeDeutscheBank’sdirectaskingpriceofyenpereuro?

Answer:

Thedirectaskingpriceofyenpereuro（¥/€）istheamountofyenthatthebankchargessomeonewhoisbuyingeuroswithyen.Thebankwouldwantthistobethesameasthepriceatwhichitsellsdollarsforyen（thebank’saskprice）timesthepriceatwhichitsellseurosfordollars（alsothebank’saskprice）.Thus,theaskingpriceofyenpereuroshouldbe

（¥104.40/$）（$1.3007/€）=¥135.79/€

6.AluminaLimitedofAustraliahascalledMitsubishiUFJFinancialGrouptogetitsopinionabouttheJapaneseyen–Australiandollarexchangerate.Thecurrentrateis¥67.72/A$,andMitsubishithinkstheAustraliandollarwillweakenby5%overthenextyear.WhatisMitsubishiUFJ’sforecastofthefutureexchangerate?

Answer:

IftheAustraliandollarweakensby5%overthenextyear,itwilltake5%fewerJapaneseyentopurchasetheAu