Finance Review

8 August 2016

Under the gold standard, the price of an ounce of gold in U. S. dollars was $20. 67, while the price of that same ounce in British pounds was ? 3. 7683. What would the exchange rate between the dollar and the pound be? What if the U. S. dollar price had been $42. 00 per ounce? 4. Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, currencies that are predominantly market-driven are considered to be: A) soft pegs. B) hard pegs. C) floating arrangements. D) a residual agreement. 5.

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When categorizing investments for the financial account component of the balance of payments the ________ is an investment where the investor has no control whereas the ________ is an investment where the investor has control over the asset. A) direct investment; portfolio investment B) direct investment; indirect investment C) portfolio investment; indirect investment D) portfolio investment; direct investment 6. Assume the United States has the following import/export volumes and prices. It undertakes a major “devaluation” of the dollar, say 18% on average, against all major trading partners’ currencies.

What is the pre-devaluation and post-devaluation trade balance (in a very short term)? Assumptions Initial spot exchange rate, $/fc Price of exports, dollars ($) Price of imports, foreign currency (fc) Quantity of exports, units Quantity of imports, units Percentage devaluation of the dollar Price elasticity of demand, imports Values 2. 00 20. 0000 12. 0000 100 120 18. 00% (0. 900) 1 Mid-term I Review Questions 7. Classify the following as a transaction reported in a subcomponent of the current account or the capital and financial accounts of the two countries involved (hint: look from cash flow perspective, debit=COF, credit=CIF):a. a U. S. food chain imports grape from Chile. b. a US resident purchases a euro-denominated bond from a German company c. a US university gives a tuition grant to a foreign student from Singapore (the student is already in the United States) d. a British company imports Spanish oranges, paying with Eurodollars on deposit in London e. a German automobile firm pays the salary of its executive working for a subsidiary in Detroit 8. On your post-graduation celebratory trip you decide to travel from Munich, Germany to Moscow, Russia. You leave Munich with 15,000 euros in your wallet.

Wanting to exchange all of these for Russian rubles, you obtain the following quotes: Spot rate on the dollar/euro cross rate Spot rate on the ruble/dollar cross rate $1. 3214/€ Rbl 30. 96/$ a. What is the Russian ruble/euro cross rate? b. How many rubles will you obtain for your euros? 9. Assume the following quotes: 1) Bank A: $1. 5400/pound 2) Bank B: EURO1. 6000/pound 3) Bank C: $0. 9700/EURO a) Can a trader make a profit on these quotes? b) Assume that the trader has $1,000,000 or the equivalent in another currency available for the transaction. What profit can the trader make? 10.

Use the following spot and forward bid-ask rates for the U. S. dollar/Australian dollar (US$/A$) exchange rate from December 10, 2010, to answer the following questions. Period Spot 1 month 2 months 3 months 6 months 12 months 24 months US$/A$ Bid Rate 0. 98510 0. 98131 0. 97745 0. 97397 0. 96241 0. 93960 0. 89770 US$/A$ Ask Rate 0. 98540 0. 98165 0. 97786 0. 97441 0. 96295 0. 94045 0. 89900 a. What is the mid-rate for each maturity? b. What is the annual forward premium (discount) for all maturities based on mid-rates? 2 Mid-term I Review Questions 11. Suppose that the two-months interest rate is 6.0 percent per annum in the United States and 7. 0 percent per annum in Germany, and that the spot exchange rate is $1. 12/€ and the forward exchange rate, with two-months maturity, is $1. 10/€. Assume that you can borrow €1,000,000. a) What kind of arbitrage is possible? b) Determine the arbitrage profit that can be made. c) What would the forward rate have to be so that there would be no arbitrage opportunity? 12. Separated by more than 3,000 nautical miles and five time zones, money and foreign exchange markets in both Germany and USA are very efficient.

The following information has been collected from the respective areas: Assumptions Germany USA Spot exchange rate ($/€) One-year Treasury bill rate Expected inflation rate 1. 3264 3. 900% Unknown 1. 3264 4. 500% 1. 250% a. What do the financial markets suggest for inflation in Germany next year? b. Estimate today’s one-year forward exchange rate between the dollar and the euro. 3 Mid-term I Review Questions AK 1. Calculation of Percentage Change in Value Initial exchange rate (peso/$) New exchange rate (peso/$) Percentage change in peso value(beginning rate – ending rate) / (ending rate) Values 3. 20 5. 50 -41. 82% Anytime a government sets or resets the value of its currency, it is a managed or fixed exchange rate. If that is the case, any change in its official value must be either a “revaluation” or “devaluation. “In this case, it is devaluation. This is evident from the fact that it now takes more pesos per U. S. dollar, so its value is less or devalued. In terms of the percentage change calculation, this is indicated by the negative percentage change. 2. Assumptions Vietnamese bank rate (dong/$) Bank commission (%)

Saigon Airport Exchange Bureau rate (dong/$) Airport comission (%) Hotel Exchange Bureau rate (dong/$) Hotel comission (%) Values 19,800 2. 50% 19,500 2. 00% 19,400 1. 50% Vietnamese dong proceeds 193,050,000 191,100,000 191,090,000 The combined exchange rate and commission offered in the commercial banks in Vietnam is the better rate. In the case of the Hotel Exchange Bureau rate, although its exchange rate is slightly weaker than the airport, its lower commission makes it preferable over the combined airport rate. 3. Assumptions Price of an ounce of gold in US dollars ($/oz)

Price of an ounce of gold in British pounds (? /oz) What is the implied $/? exchange rate? (dollar price of an ounce / pound price of an ounce) Gold Standard Values $20. 67 ?3. 7683 $5. 4852 What If $42. 00 ?3. 7683 $11. 1456 4. C 5. D 4 Mid-term I Review Questions 6. a. What is the pre-devaluation trade balance? Revenues from exports, $ Expenditures on imports, fc Expenditures on imports, $ Pre-devaluation trade balance $2,000 1,440 $2,880 ($880) b. Resulting trade balance immediately after devaluation? Revenues from exports, $ Expenditures on imports, fc

New spot exchange rate, after devaluation Expenditures on imports, $ Post-devaluation trade balance (currency contract period) $2,000 1,440 2. 36 $3,398 ($1,398) 7. a. A U. S. food chain imports grape from Chile. Debit to U. S. goods part of current account, credit to Chilean goods part of current account. b. A U. S. resident purchases a euro-denominated bond from a German company. Debit to U. S. portfolio part of financial account; credit to German portfolio of financial account. c. A U. S. university gives a tuition grant to a foreign student from Singapore.

If the student is already in the United States, no entry will appear in the balance of payments because payment is between U. S. residents. (A student already in the U. S. becomes a resident for balance of payments purposes. ) d. A British Company imports Spanish oranges, paying with eurodollars on deposit in London. A debit to the goods part of Britain’s current account; a credit to the goods part of Spain’s current account. e. A German automobile firm pays the salary of its executive working for a subsidiary in Detroit. Germany would record a debit in the income payments/receipts in its current account; the U.S. would record a credit in the income payments/receipts in its current account.

8. Assumptions Beginning your trip with euros Spot rate ($/€) Spot rate (Rubles/$) a) What is the Russian ruble/euro cross rate? Cross rate (Rubles/€) Values 15,000. 00 1. 3214 30. 96 40. 91 Rubles/€ = Rubles/$ x $/€ b) How many rubles will you obtain for your euros? Converting your euros into Rubles 613,658 5 Mid-term I Review Que estions 9. a) Yes, the cro ) oss-rate and th quote at De he eutsche Bank are not the sa k ame. b) ) First transactio buy pound at Bank A: 1,000,000/1.5 = pound 64 on: d 54 49,350. 65 ction: buy EU URO at Bank B: 649,350. 65*1. 6 = 1,038 B 8,961. 04 Second transac Third transacti T ion: buy dolla at Bank C: 1,038,961. 04 *0. 97 = 1,00 ar 4 07,792. 2 Pr rofit: $7,792. 2 This type of ar T rbitrage is called: triangula arbitrage. ar hange rate quo are direct quotes on th dollar (US$ otes t he $/A$), the pro oper forward 10. Since the exch remium calcu ulation is: pr Forward premi ium = ( Forw ward – Spot ) / (Spot) x (360 / days) 0 US$/A$ Period Spot 1 month h 2 month hs 3 month hs 6 month hs 12 mont ths 24 mont ths Days

Forward 30 60 90 180 360 720 US$ $/A$ a. Calculated Bid Rate e 0. 98510 0. 98131 0. 97745 0. 97397 0. 96241 0. 93960 0. 89770 Ask Rate k 0. 98 8540 0. 98 8165 0. 97 7786 0. 97 7441 0. 96 6295 0. 94 4045 0. 89 9900 Mid-Rate 0. 98525 0. 98148 0. 97766 0. 97419 0. 96268 0. 94003 0. 89835 b. Forwa ard Premiu um (discou unt) -4. 5917 7% -4. 6252 2% -4. 4902 2% -4. 5816 6% -4. 5902 2% -4. 4100 0% ard gressively req quire fewer an fewer US d nd dollars per Au ustralian dolla than the cu ar urrent The forwa rates prog spot rate. Therefore the US dollar is selling forwa at a prem es ard mium and the A Australian do ollar is selling g forward at a discount. a 11. ) erest rate arbi itrage (CIA); a) Covered inte b) )Borrow Euro 1,000,000 B 1 Exchange spot at $1. 12/euro to get $1,12 E t o 20,000 In nvest at 1 perc to get $1,131,200 cent Exchange forw E ward at $1. 10/ /euro, to get Euro 1,028,36 E 63. 6 Repay loan Eu 1,011,666. 7 R uro Pr rofit: Euro 16 6,696. 9 ) uro c) F = 1. 12*(1. 01/1. 01167) = $1. 1182/eu 6 Mid-term I Review Questions 12. a. According to the Fisher effect, real interest rates should be the same in both Europe and the US.

Since the nominal rate = [ (1+real) x (1+expected inflation) ] – 1: 1 + real rate = (1 + nominal) / (1 + expected inflation) 1 + nominal rate 1 + expected inflation So 1 + real = and therefore the real rate in the US is: 103. 900% 104. 500% ? 101. 250% 103. 210% < 103. 210% 3. 210% The expected rate of inflation in Europe is then: b. From IRP, we know: 1+ Or € = $/€ ? (1 + $/€ = $ )? $/€ ? 0. 669% 1 $/€ ( $) ( €) Then, Spot exchange rate ($/€) US dollar one-year Treasury bill rate European euro one-year Treasury bill rate One year forward rate ($/€) 1. 3264 4. 500% 3. 900% 1. 3341 7

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