INTERNATIONAL FINANCE TEST ANSWERS

Question one:

a)       One piece of STANDARD PARKER PEN costs £ 1 in UK and $ 1.70 in USA. Inflation rate is 10% p.a. in UK and & 7 % in USA. . Assuming the PPT holds good, find the expected foreign exchange rate after one year. (1marks)

WRITE YOUR ANSWER HERE: Assuming PPT: Spot rate: 1£ = 1.70$. Calculation of forward rate: 1£ (1.10) = 1.70$(1.07) Forward rate: 1£ = 1.6536$

b)                                   Spot 1 $ = Rs. 47.00 – 47.20

3         months forward 1 $ = Rs. 47.50 – 47.70

Interest Rates = Rs. 8% p.a.,

Interest Rates= $ 5% p.a.

: Let’s borrow $ 100,000 Is there opportunity for covered interest arbitrage? Is there arbitrage opportunity? (4marks)

WRITE YOUR ANSWER HERE: Covered Interest Arbitrage: Let’s borrow $ 100,000. Convert into Rs. 47,00,000. Invest @ 8 % p.a. for 3 months. Repayment along with interest after 3 months = $ 1,01,250. Enter into forward purchase contract of $ 101,250 @ Rs. 47.70. (i) Receipt after 3 months = 47,00,000 (1.02) = Rs.47,94,000 (ii) Payment after 3 months = 1,01,250 x 47.70 = Rs. 48,29,625 (iii) Loss = Rs. 35,625 There is no opportunity for covered interest arbitrage.

Question two:

On checking the Telerate screen, you see the following exchange rate and interest rate quotes:

Currency	90-days interest rates annualized	Spot rates	90-day forward rates
Dollar	4.99% - 5.03%
Swiss franc	3.14% - 3.19%	$0.711 - 22	$0.726 - 32

a.       Can you find an arbitrage opportunity? (1 marks)

b.       What steps must you take to capitalize on it? (1 marks)

c.        What is the profit per 1,000,000 of any currency arbitraged? (3 marks)

a.       WRITE YOUR ANSWER HERE ANSWER. Yes. There are two possibilities: Borrow dollars and lend in Swiss francs or borrow Swiss francs and lend in dollars. The profitable arbitrage opportunity lies in the former: Lend Swiss francs financed by borrowing U.S. dollars.

b.       WRITE YOUR ANSWER HERE ANSWER. Borrow dollars at 1.2575% for 90 days (5.03%/4), convert these dollars into francs at the ask rate of $0.722, lend the francs at 0.785% for 90 days (3.14%/4), and immediately sell the francs forward for dollars at the buy rate of $0.726.

c.        WRITE YOUR ANSWER HERE ANSWER. The profit is $1,000,000 x [(1.00785/0.722) x 0.726 - 1.012575] = $858.66.

Question three:

 Spot rates (per USD in New York)

Euro 0.7937 - 0.8000

Yens 135-  136

 Pound 1.99 - 2.00

SGD 1.60 - 1.61

Spot rates (per Pound in London )

Euro 1.59 - 1.60

Yen 230 - 234

USD 1.99 - 2.00

SGD 3.20 - 3.21

a)             Calculate how many British pounds a London-based-firm will receive or pay for its following four foreign currency transactions:

(i) The firm receives dividend amounting to Euro 100,000 from its French Associate Company.

(ii) The firm pays interest amounting to 230,000 Yens for its borrowings from a Japanese Bank.

(iii) The firm exported goods to USA and has just received USD 300,000.

(iv) The firm has imported goods from Singapore amounting to Singapore Dollars (SGD) 400,000. (2 marks)

b)            Calculate how many USD a New York based firm will receive or pay for its following four foreign currency transactions: (2 marks)

(i) The firm receives dividend amounting to Euro 120,000 from its French Associate Company.

(ii) The firm pays interest amounting to 270,000 Yens for its borrowings from a Japanese Bank.

(iii) The firm exported goods to UK and has just received £300,000.

(iv) The firm has imported goods from Singapore amounting to Singapore Dollars (SGD) 400,000.

C) Differentiate weak from strong form of purchasing power parity (1 marks)

answers

a)

(i) WRITE YOUR ANSWER HERE Answer (i) FER 1£ = 1.59/1.60 Euro The bank is selling £. Hence, applicable rate is ‘ask’ i.e. 1£ =1.60 The firm receives: 100,000/1.60 i.e.  =  £ 62,500.00

(ii) WRITE YOUR ANSWER HERE Answer (ii) FER 1£ = 230/234 YENS The bank is buying £ . Hence, applicable rate is ‘bid’ i.e. 1£ = 230 Yens The firm pays: 230,000 /230 i.e.  =  £ 1,000.

(iii) WRITE YOUR ANSWER HERE Answer (iii) FER 1£ = $1.99/2.00 The bank is selling £. Hence, applicable rate is ‘ask’ i.e. 1£ = $2.00 The firm receives: 300,000/2.00 i.e. = £ 1,50,000

(iv) WRITE YOUR ANSWER HERE Answer (iv) FER 1£ = 3.20/3.21 SGD The bank is buying £. Hence , applicable rate is ‘bid’ i.e. 1£ = 3.20 SGD. The firm pays: 400,000/3.20 i.e. = £ 125,000.

b)

(i) WRITE YOUR ANSWER HERE applicable rate is ‘ask’ (i) The bank buys Euro 120,000 for 1,20,000 x 1/0.80 = $150,000 The firm receives $150,000.

(ii) WRITE YOUR ANSWER HERE applicable rate is ‘bid’ (ii) The bank sells Yens 270,000 for 270,000 x 1/135 = $ 2,000 The firm pays $2,000.

(iii) WRITE YOUR ANSWER HERE applicable rate is ‘ask’ (iii) The bank buys £ 300,000 for 3,00,000 x 1/2.00 = $1,50,000 The firm receives $150,000.

(iv) WRITE YOUR ANSWER HERE applicable rate is ‘bid’ iv) The bank sells SGD 400,000 for 4,00,000 x 1/1.60 = $ 250,000 The firm pays $250,000.

c)

WRITE YOUR ANSWER HERE          I.            The weak form uses general inflation level will the strong for uses the price index of selected bundle or basket of goods e.g selected for stuffs.        II.            Weak form is called relative PPP while the strong for is called absolute PPP