Final Exam (reference 1)Close book exam. No cheat sheet. Total 10 short answer questions. Each is 10 points. Question 1:Spot exchange rateS($/) =$2.0000/

360-day forward rateF360($/)= $2.1000/

U.S. discount ratei$ = 5.00%

British discount rate i =4.5%

IS there any arbitrage opportunity? What is your profit if you have $10,000 to invest? Does the forward rate tend to go up or go down due to the arbitrage?Hint: draw the square.

$10,000 ------------------------(invest in US @ 5% interest)------------------- $_______________|^|Convert to GBP @ spot rateConvert back @ forward rate, compare ||V|________ GBP ---------------(invest in UK @ 4.5%) --------------------- ______________ GBP

Or use equation:

Question 2.Assume the following information:Beal BankYardley Bank Bid price of New Zealand dollar$.402$.398Ask price of New Zealand dollar$.404$.399Given 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.

Question 3: Suppose interest rates in the U.S. are 5% when the spot exchange rate is $1.60 = 1 and the interest rate in the euro zone is 8% per year. What must the one-year forward exchange rate be? Hint: use IRP formula:

Question 4: Suppose interest rates in the U.S. are 5% when the spot exchange rate is $1.60 = 1 and the interest rate in the euro zone is 8% per year. If the one year forward rate is 1.59$/, residents in which area can arbitrage to make risk free profits? Explain. If the one year forward rate is 1.50$/, residents in which area can arbitrage to make risk free profits? Shall US investors keep funds in US when the forward rate is 1.50$/? Why or why not? Hint: use IRP formula:, or draw square to compare.

Question 5: What is international fishers effect? What is purchasing power parity? What is interest rate parity?

Question 6: Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 4 percent? How much is the new rate expected to be?

Question 7: What is hedging? What are the pro and con of hedging (name three pros and three cons)?

Question 8: How to hedge payable with forward contract and call option?A U.S.based importer of Italian bicyclesIn one year owes 200,000 to an Italian supplier.The spot exchange rate is $1.18 = 1.00The one year forward rate is $1.20 = 1.00The one-year interest rate in Italy is i = 5%The one-year interest rate in US is i$ = 8%Call option exercise price is $1.2/ with premium of $0.02. If using forward contract to hedge on payable, how much US dollars are needed one year from now to pay off the debt?

If spot rate one year from now is $1.25/, how much US dollars are needed to pay off the debt, including the premium?

Question 9: Forward versus Money Market Hedge on Receivables. Assume the following information:180day U.S. interest rate = 8%180day British interest rate = 9%180day forward rate of British pound = $1.50Spot rate of British pound = $1.48

Assume that Riverside Corp. from the United States will receive 400,000 pounds in 180 days. Would it be better off using a forward hedge or a money market hedge or using a put option hedge if the exercise price is 1GBP = $1.53, with a premium of $0.02 per GBP? Explain.

Question 10: Hedging With Put Options. As treasurer of Tucson Corp. (a U.S. exporter to New Zealand), you must decide how to hedge (if at all) future receivables of 250,000 New Zealand dollars 90 days from now. Put options are available for a premium of $.03 per unit and an exercise price of $.50per New Zealand dollar. The forecasted spot rate of the NZ$ in 90 days follows:

FutureSpotRateProbability$.4430%.4050.3820

Given that you hedge your position with options, create a probability distribution for U.S. dollars to be received in 90 days.Hint: fill up the following table and then calculate the expected value

Possible Spot Rate

Put Option Premium

Exercise Option?Amount per Unit Received Accounting for PremiumTotal Amount Received for NZ$250,000

Probability

$.44$.03 30%

$.40$.03 50%

$.38$.0320%