Reference no: EM131429448

IF Practice Questions

1. JrHeadcon is hydro-construction firm with a government contract to install salt water purification plants in a number of Chile's northern coastal desert settlements. The work is to be completed in one year at which time the final payment of 25B(billion) Chilean Pesos (CLPs) will be wired to JrHeadcon's NY bank. At the current spot exchange rate of .002USDs per CLP, the contract payment would be worth 50M USDs. The chief financial officer (CFO) of JrHeadcon calls you, his NY banker, and requests a one-year forward exchange rate quote from the bank to sell the CLPs.

Before canine the CFO back, you look up the current interbank: lending/borrowing rates for CLPs and USDs. The one one-year interbank interest rates are i(CLP) = 6% and i(USD) = 2%.

A. Design a set of lending/borrowing positions in the interbank money market that will generate a risk-free one-year-ahead forward rate quote stated in term of USDs per CLP. Explain why this is a risk-free quote.

B. How much will the USD value of the 25B CLP ore-year-ahead contract payment be if JrHeadcon accepts the offered forward rate from your bank? Hint: See the money market hedge setup in Note Set 7.

2. You work for a bond trader who is thinking of taking uncovered positions in foreign bonds to boost his investment returns. He has never invested in foreign bonds before but is about to buy 100M Lower Slobovian dollars' (the anonym is LSD) worth of one-yen-maturity Lower Slobovian treasury bills.

Lower Slobovia has for years been on a fixed exchange rate relative to the USD at par (that is, one LSD for one USD.)

Your boss wants to buy the Lower Slobosian treasury bills because they pay 10% in LSDs while one-year US Treasuries pay only 2% in USDs. It's a risk-free 8% spread! The fixed exchange rate policy of the Lower Slobovian government guarantees our profit by keeping the LSD-USD exchange rate fixed at par!" your boss exclaims, actually drooling at the prospect of an easy, risk-free profit.

Afterwards, back in your office, second thoughts about this deal start to arise as you remember some important lessons from your Into national Finance class that directly apply here. Critique your bosses belief that he will make an easy profit from the LSD bonds.

3. Explain what the Cray Trade is and how Carry Traders expect to make money. Use the UIP equation in log approximation ken to explain.

4. When are Expected Relative PPP and UIP the same?

5. In developing a forecast for a fixed exchange rate, what two factors are critical in a government's decision to maintain its promise of a fixed exchange rate?

6. Why does the Efficient Markets Hypothesis, as applied to the FX markets, imply that movements in exchanges rates are inherently very hard to predict acutely?

7. A US company must make a payment of 100M AUDs in 90 days for goods bought. It is concerned that the AUD will appreciate relative to the USD and is looking for possible protection against this outcome. Using the information in Exhibit 1 set up a MMH that will protect the company from loss due to an unexpected appreciation in the AUD.

Exhibit 1

The current spot rate is 1.000 USD per AUD.

The current 90-day loan rate for AUDs is 5% and for USDs is 1%. Interest rates are quoted on an annualized basis.

8. Using the LIBOR data in Exhibit 1 calculate the forward exchange rates for the Brazilian Real (BRL) and the South African Rand (ZAR) relative to the USD in units of foreign currency per USD.  Insert these numbers in the appropriate boxes in Exhibit 2 below.

9. Explain why both international capital flows and international trade flows sum to zero at the planetary level.

10. Show and explain why every country's BOP equalszero (ignoring errors and omissions in the data).

Attachment:- Assignment File.rar