Reference no: EM133065704

Question 1: Kavita Raman-CIA New York. Kavita Raman is a foreign exchange dealer for a bank in New York. She has USD1000 boo (or its Swiss franc equivalent) for a short-term money market investment and wonders whether she should invest in US dollars for three months or make a covered interest arbitrage investment in the Swiss franc. She faces the following rates:

Spot exchange rate:                             SF1.2810/USD

3-month forward rate:                          SF1.2740/USD

3-month US interest rate:                   4.800% p.a. (1.200% per quarter)

3-month Swiss interest rate:                3.200% p.a. (0.800% per quarter)

a Where do you recommend that KaVfta Raman invest and why?
b What is her rate of return, on an annual basis, on this investment?

Question 2: Kavita Raman-WA. Kavita Raman, using the same values and assumptions as in the previous question, now decides to seek the full 4.800% return available in US dollars by not covering her forward dollar receipts-an uncovered interest arbitrage (UIA) transaction. Assess this decision.

Question 3: Kavita Raman-30 days later. One month after the events described in the previous questions, Kavita Raman again has USD1000000 (or its Swiss franc equivalent) to invest for three months. She now faces the following rates. Should she enter into a covered interest arbitrage (CIA) investment?

Spot exchange rate:                             SF1.3392/USD

3-month forward rate:                          SF1.3286/USD

3-month US interest rate:                    4.75% p.a.

3-month Swiss rate:                           3.625% p.a.

Question 4: Langkawi Island resort. You are planning a 30-day holiday on Langkawi Island, Malaysia, one year from now. The present charge for a luxury suite plus meals in Malaysian ringgit (RM) is RM1050/day. The Malaysian ringgit presently trades at RM3.75/A$. Hence, the dollar cost today for a 30-day stay would be A$8400. The hotel has informed you that any increase in its room charges will be limited to any increase in the Malaysian cost of living. Malaysian inflation is expected to be 4% per annum, while Australia's inflation is expected to be only 1%.

a How many dollars might you expect to need one year hence to pay for your 30-day hotel stay?
b By what percentage has the dollar cost gone up? Why?

Question 5: Statoil of Norway's arbitrage. Statoil, the national oil company of Norway, is a large, sophisticated and active participant in both the currency and petrochemical markets. Although it is a Norwegian company, because it operates within the global oil market it considers the US dollar as its functional currency, not the Norwegian krone. Ari Karlsen is a currency trader for Statoil and has immediate use of either USD4 million (or the Norwegian krone equivalent). He is faced with the following market rates and wonders whether he can make some arbitrage profits in the coming 90 days. Can he? How?

Spot rate, Norwegian krone

(Nkr) per dollar:                                             Nkr6.5520/USD

3-month forward rate:                                    Nkr6.5264/USD

US 3-month Treasury bill rate:                         5.625% per annum

Norwegian 3-month Treasury bill rate:              4.250% per annum

Question 6: Frankfurt and Sydney. Money and foreign exchange markets in Frankfurt and Sydney are very efficient. The following information is available:

Frankfurt                                        Australia

Spot exchange rate:                   A$1.2000/€                       A$1.2000/€

One-year Treasury bill rate:          6.50%                            3.20%

Expected inflation rate:                unknown                         2.00%

a What do the financial markets suggest for inflation in Europe next year?

b Estimate today's one-year forward exchange rate between the Australian dollar and the euro.

Question 7: Chamonix chateau rentals. You are planning a ski trip to Mt Blanc in Chamonix, France, one year from now. You are negotiating over the rental of a chateau. The chateau's owner wishes to preserve his real income .against both inflation and exchange rate changes and so the present weekly rent of €8000 (Christmas season) will be adjusted upwards or downwards for any change in the French cost of living between now and then. You are basing your budgeting on purchasing power parity (PPP). French inflation is expected to average 3.5%for the coming year and Australian dollar inflation is expected to be 2.5%. The current spot rate is A$1.1840/€ What should you budget as the Australian dollar cost of the one-week rental?

Question 8: East Asiatic Company-Thailand. The East Asiatic Company (EAC), a Danish company with subsidiaries all over Asia, has been funding its Bangkok subsidiary primarily with US-dollar debt because of the cost and availability of dollar capital as opposed to Thai baht (Bt) funds. The treasurer of EAC Thailand is considering a one-year bank loan for USD350000. The current spot exchange rate is Bt42.84/USD and the USD-based interest is 8.885% for the one-year period.

a Assuming expected inflation rates of 4.50% and 2.20% in Thailand and the United States, respectively, for the coming year, according to purchasing power parity, what would the effective cost of funds be in Thai baht terms?

b If EAC's foreign exchange advisers believe strongly that the Thai government wishes to push the value of the baht down against the dollar by 5% over the coming year (to promote its export competitiveness in dollar markets), what might the effective cost of funds end up being in baht terms?
c If EAC could borrow Thai baht at 14% per annum, would this be cheaper than in either part (a) or part (b)?

Question 9: London money fund. Tim Hogan is the manager of an international money market fund managed out of London. Unlike many money funds, which guarantee their investors a near risk-free investment with variable interest earnings, Tim Hogan's fund is a very aggressive fund that searches out relatively high interest earnings around the globe, but at some risk. The fund is pound-denominated. Tim is currently evaluating a rather interesting opportunity in Malaysia. The Malaysian government has been periodically enforcing substantive currency and capital restrictions since the Asian crisis of 1997 to protect and preserve the value of the Malaysian ringgit (RM). The current spot exchange rate of RM3.800/A$ has been maintained with little deviation since late 1997. Local currency (Malaysian ringgit) time deposits of 180-day maturities are hovering at about 9.600% per annum (A$500 000 minimum deposit). The London eurocurrency market, for pounds, is offering only about 4.200% per annum for the same 180-day maturities. The current spot rate on the British pound is A$1.6382/f and the 180-day forward rate is A$1.6100/f.

What do you recommend that Tim Hogan do about the Malaysian money market opportunity, assuming he is investing £1 million?