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Disadvantages of fixed versus floating exchange rates

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Reference no: EM131992578

1- The current spot exchange rate is $1.20/£ and the three-month forward rate is $1.18/£. Based on your research, you expect the exchange rate to be $1.19/£ in three months. Assume you have £1,000,000 available to you.

a. What is the current forward premium/discount on the £?

b. What action do you need to take to speculate on your expectation about the exchange rate? What is your profit/loss if your expectation is correct?

c. What is your profit/loss if the exchange rate is $1.175/£ three months later?

2- While you were visiting Turin, Italy, you purchased a Ferrari for €135,000, payable in three months. You have enough cash at your bank in New York, which pays .35 per month compounding monthly. Currently the spot exchange rate is $1.15/€ and the three month forward exchange rate is $1.14/€. In Turin, the money market investment rate is 2.0% for a cumulative three month investment. There are two ways for you to pay for your Ferrari:

a. Keep your funds in the bank in the US and buy €135,000 forward

b. Buy a certain € amount spot today and invest the amount in Turin for three months so that the maturity value becomes equal to €135,000. Which method do you prefer?

3- Assume that December 2016 Mexican Peso futures contract has a price of $.90975 per 10MXN. You believe the spot price in December will be $.9700 per10MXN. The size of 1 MXN futures contract is MXN500,000. What position do you need to enter into to benefit from your anticipation? If you use three futures contracts, what is your profit/loss if you end up correct in your belief?

4- A speculator is considering the purchase of five three-month Euro call options (size €100,000 each) with a striking price of $.869/€. The premium is 1.35 cents per €. The spot price is $.84/€ and the 90-day forward rate is $.85/€. The speculator believes the euro will appreciate to $.91/€ over the next three months. As the speculator’s assistant, you have been asked to prepare the following:

a. Determine the speculator’s profit if the euro appreciates to $.91/€.

b. Determine the speculator’s profit if the euro appreciates only to the forward rate

c. Determine the future spot rate at which the speculator will only break even.

5- Currently the spot exchange rate is $1.50/£ and the three month forward exchange rate is $1.52/£. The three month interest rate is 8.0% per annum in the US and 5.8% per annum in the UK. Assume that you can borrow as much as $1M. or £1M.

a. Is there a covered interest arbitrage opportunity for a US multinational? What is the payoff if they conducted CIA?

b. Is there a covered interest arbitrage opportunity for a UK multinational? What would be their payoff if they conducted CIA?

c. How will the covered interest rate parity be restored?

d. What should have been the “correct” forward exchange rate?

6- Suppose the current spot exchange rates are $1.15/€, and $1.25/£. Suppose also that a dealer quotes you €1.18/. Is there a triangular arbitrage opportunity? Calculate your profit for $1M. starting amount.

7- Briefly discuss advantages and disadvantages of fixed versus floating exchange rates.

8- “If a country employs a currency board, all monetary policy is on autopilot”. Explain this statement

9- What are the macroeconomic impacts of exchange rate appreciations/depreciations?

10- What is the main difference between direct and indirect interventions in foreign exchange markets?

Reference no: EM131992578

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