International Economics II1

PROBLEM SET 12

1. (Prob.3) Assume the following exchange rates:

$2 = ￡1 in New York
¥410 = ￡1 in London
¥200 = $1 in Tokyo
Indicate how profitable triangular, or three-point, arbitrage can take place.

2. (Prob. 5) Calculate the forward discount or premium for the following spot and three-month
forward rates:
(a) SR = $2.00/￡1 and FR = $2.01/￡1
(b) SR = $2.00/￡1 and FR = $1.96/￡1

3. (Prob. 7) Assume that SR = $2/￡1 and the three-month FR= $1.96/￡1. How can an importer who
will have to pay ￡10,000 in three months hedge the foreign exchange risk?

4. (Prob. 8) For the given in Problem 7, indicate how an exporter who expects to receive a payment of
￡1 million in three months hedges the foreign exchange risk.

5. (Prob. 9) Assume that the three month FR = $2.00/￡1 and a speculator believes that the spot rate in
three months will be SR = $2.05/￡1. How can a person speculate in the forward market? How
much will the speculator earn if he or she is correct?

6. (Prob. 10) If the speculator of Problem 9 believes that the spot rate in three months will be SR =
$1.95/￡1, how can he or she speculate in the forward market? How much will the speculator earn
if he or she is correct? What will the result be if in three months SR = $2.05/￡1 instead?

7. (Prob. 11) If the positive interest rate differential in favor of a foreign monetary center is 4 percent
per year and the foreign currency is at a forward discount of 2 percent per year, roughly how much
would an interest arbitrageur earn from the purchase of foreign three-month treasury bills if he or
she covered the foreign exchange risk?

8. (Prob. 12) For the given of Problem 11, indicate:

(a) How much would an interest arbitrageur earn if the foreign currency were at a forward
premium of 1 percent per year?
(b) What would happen if the foreign currency were at a forward discount of 6 percent per year?

1
Yıldız Technical University, Faculty of Economics and Administrative Sciences, Department of Economics, 2014-2015
Spring Semester, Lecturer: Assistant Prof. Zeynep Kaplan, Research Assistant: Aslı Özgür Aktay Fidan

2 “International Economics” Dominick Salvatore, 11th edition, 2013, p.458-459