NATIONAL UNIVERSITY OF SCIENCES AND TECHNOLOGY NUST Business School Course International Financial Management

Assignment No.1

Submitted by: Hafiz Ummar Muhammad Bilal Shafaat Gilani Suleman Zaffar

Submitted to: Mr. Tariq Abbassi

Q1 Case 1 Invest in USA Amount = $100,000,000 Investment period =9 month Investment Rate = 10% per annum Rate for 9 month = (10/12)*9 = 7.5% Amount received after 9 month = 100,000,000*1.075 = $107500000 Case 2 Invest in Germany Amount = $100,000,000 Investment period = 6month Investment Rate = 9 % per annum Rate for 9 month = (9/12)*6 = 4.5% Convert $ 100,000,000 in to German at spot rate $1= 1.01 $100,000,000 = 1.01 * 100,000,000 = 101000000 Invest 101000000 @ 4.5% Amount received after six month 101000000 * 1.045= 105545000 Convert 105545000 in to $ at forward Rate .99 = $1 1=1.01$ 105545000 = $106600450 Invest $106600450 in USA for 3 month Investment rate = (10/12)*3 = 2.5% Amount received after investment = 106600450 *1.025 = $109265461.3 Difference $109265461.3 -$107500000 = $1765461.25 So investing in Germany get $ 1765461.25 more so it must invest in Germany

Q2 Payable amount in Six month = 40000 USA investment Rate = .35%/month compounded monthly Spot Rate = $1.45/ Forward Rate = $ 1.40/ Money market interest rate in Lancaster 3% for three month

Case 1 Keep the funds at your bank in the U.S. and buy 40,000 forward. Dollar required to meet 40000 obligation after Six month = 40000*1.40 = $ 56000 Present value of $56000 @.35% /month, compounded monthly = $56000/(1.0035)^6 = $ 54838 Case 2 (b) Buy a certain pound amount spot today and invest the amount in the U.K. for three months so that the maturity value becomes equal to 40,000. Three month present value of 40000 = 40000/(1.03)^2 = 37703 Dollar required to purchase 37703 @ $1.45/ Difference = $54700-$ 54838 = $169 Keep the funds at your bank in the U.S. and buy 40,000 forward is preferable because it save $168 = 37703*1.45 = $54700

Q3: Covered Interest Arbitrage. a) In this instance, the firm is borrowing in USD and investing in France. The data available: Amount to be borrowed: US interest rate: US three-month interest rate: French interest rate: French 3-month interest rate: Spot rate: Future rate:

$ 1000,000 5.6 % p.a. 1.4% (5.6/4) 5.4% p.a. 1.35% (5.4/3) 0.8/ $1 0.7813/ $1

Hence, the following series of steps shall be undertaken given the data above. Step 1: Borrow $1000,000 for 3 months @ 1.4% for 3 months. Total Obligation: $ 1000,000 + $ 14,000 (3-month interest) $ 1014,000 Step 2: Purchase Euros at the Spot rate, i.e. 0.8/ $1 and invest in France. Total Receivable: 800,000 + 10,800 (3-month interest) $ 810,800

Step 3: Get into the Forwards contract of 0.7813/ $1. After 3 months, convert the Receivables (in Step 2) to USD. 1 810,800 * 1.279918 = $1.279918 (1/ 0.7813) = $ 1037,757.584

Arbitrage Profit= Receivables Obligation

This arbitrage profit has been made, even though there was a difference in the spot and forward rate. It arose as a consequence of the depreciation in the exchange rate of USD in relation to the Euro (a 2.5% decline in exchange rate), thus the invested Euros could buy more USD after the three month period, despite the -2 percentage point difference in interest rate. Another way of judging the possibility of arbitrage is comparing the yield. The yield to be gained out of this investment is: ( )

3.7757% is higher than the three-month US interest rate of 1.4%, hence arbitrage is possible.

b) In this instance, the firm is borrowing in Euros and investing in USA. The data available: Amount to be borrowed: 800,000 The rest of the data is as in Part a.

Hence, the following series of steps shall be undertaken given the data above. Step 1: Borrow 800,000 for 3 months @ 1.35% for 3 months. Total Obligation: 800,000 + 10,800 (@ 1.35% 3-month interest) 810,800 Step 2: Purchase USD at the Spot rate, i.e. 0.8/ $1 and invest in USA. Total Receivable: $ 1,000,000 + $ 14,000 (@ 1.4% 3-month interest) $ 1,014,000

Step 3: Get into the Forwards contract of 0.7813/ $1. After 3 months, convert the Receivables (in Step 2) to Euros. $1,014,000*0.7813 = 792238 5

Arbitrage Profit (Loss) =

Receivables Obligation

There is no arbitrage here as the appreciation of the exchange rate, i.e. 2.5%, is more than the 2 percentage point increase in interest to be received. Hence, the investment buys fewer dollars than would have been the prior case. Another way of judging the possibility of arbitrage is comparing the yield. The yield to be gained out of this investment is: ( )

-2.289% is the yield that would be received, whereas, the interest that could be achieved by investing within France would be at a rate of 1.35% for the three months.

Q4 In order to avoid its exposure to the exchange rate risk and to hedge its position, Honda can either: (1) Sell Euros Future contract for U.S. dollars. (2) Buy U.S dollars Future contract for Euros.

Honda can lock in Dollar price for its imported parts From USA by buying dollars futures contracts from market at the March futures price of 1=0.9002$. On march 4th, we need 7million/0.9002= 7776050 1 US $ contract = 125420 units. No of future contracts to buy = (7million $/125420) = 55 contracts of US dollar.

Honda can also hedge its position by selling euro futures contracts. At that futures price, Honda will sell 7776050 for $7 million. 1 uro contract = 125420 units. No of future contracts to sell = (7776050/125420) = 62 contracts of Euro.

(b) On March 4, the spot rate turns out to be $0.8952/, Calculate Honda's net euro gain or loss on its futures position. If Honda had not hedged its position by future contracts, it could have bought the $7 million on March 4 at a cost of 7819481 @ (7,000,000/0.8952) So Net profit on its future position is 7819481-7776050 = 43431 By not hedging, Honda would have paid an extra 43431 for the $7,000,000 to satisfy its dollar.

Q5 a) Yes, there is an opportunity for covered interest arbitrage because the Spot rates are $0.711 22 whereas 90 days Forward rates are $0.726 32. This clearly shows an appreciation in Swiss Franc as compared to Dollar. So an arbitrage is created and if we borrow in dollar and lend it in Swiss franc, we can capitalize this situation of arbitrage. b) Steps: 1) Borrow US Dollars and convert it into Swiss Franc at todays Spot Rate i.e. $0.722. 2) The Swiss Franc will be lent in Switzerland at 3.14 % (annual rate will be converted into 3 months rate) for three months. 3) At the same time enter into a Forward contract to sell Swiss Franc after 3 months at a Forward rate of $0.726. 4) After 3 months, you will get back your money which will consist of Principal amount plus interest. 5) Again convert the Swiss Franc into US dollar at $0.0726. 6) Pay the interest to your lender on your borrowed money. 7) Remaining Dollar amount will be your interest.

C) Lets suppose today we borrow $1000, 000 @ 5.03% Interest amount = 1000000 * (.0503/12) *3 = $ 12575 Today we have = $ 1000, 000 Spot Rate = Sr = $0.711 22 Forward Rate = Fr = $0.726 32 Convert Us $ into Swiss Franc = 1000000/ .722 = 1385041.55 SF Now we lend this money in Switzerland

Annual Rate = 3.14% 3 Months Rate = (3.14/12)*3 = .785% Interest Amount after 3 Months = .785% * 1385041.55 SF = 10872.57 SF

Total Principal and Interest amount = 10872.57 SF + 1385041.55 SF = 1395914.126 SF

Now convert it into US $ at Forward Rate = 1395914.126 SF * .726 = $ 1013433.656

Profit = $ 1013433.656 - $ 1000, 000 = $ 13433.6556 Pay the interest to lender on borrowed money and we will get Net Profit. Net Profit = $ 13433.6556 - $ 12575 = $ 858.6556