MIDTERM EXAM

GLOBAL FINANCIAL MANAGEMENT

FALL 2012

Show your work in order to receive any partial credit. Partial credit will not be given for work that
contains some correct numbers, but is essentially incorrect.

1. A commercial bank quotes a bid rate of $0.784 for the Swiss franc, and an ask rate of $0.80.
a. What is the bid/ask percentage spread? Show your work.

2. A commercial bank quotes a spot rate of $0.190 for the French franc and a 90-day forward rate of
$0.188.
a. Determine the forward premium (or discount) of the French franc on an annualized basis.
Show your work.

3. The bid-ask rates are as follows:

Spot exchange rate: ¥/$ 102.40–48
Interest rates:
1–year interest rate in ¥ 11⁄2–5⁄8
1–year interest rate in $ 91⁄8–1⁄4
a. What is the quotation for the one-year ¥/$ forward exchange rate?

4. A French company knows that it will have to pay 10 million Swiss francs in three months. The
current spot exchange rate is 0.6000 €/SFr. The three-month forward rate is 0.603 €/SFr. The
treasurer is worried that the euro will depreciate in the next few weeks.
a. What action can be taken to hedge against exchange rate risk?
b. Three months later, the spot exchange rate turns out to be 0.620 €/SF; was it a wise
decision? Show calculations to support your conclusion.

5. You are a foreign exchange dealer. You see the following quote on your Reuter's screen:
a. The spot exchange rate of the Swedish krona is equal to 5.7 SKr per U.S. dollar. The 3-
month interest rates are 12% in SKr and 8% in dollars. What is the 3-month forward
exchange that you should quote?
b. Compute the annualized discount or premium on the dollar relative to the krona.
c. After a careful look at your screen, you discover that the spot exchange rate is really
5.7000-5.7015. The 12-month interest rates are 12 1/4-1/2% in SKr and 8 1/4-1/2% in
dollars. What should be the bid-ask quote on the one-year forward SKr/$ rate?
d. A Swedish exporting firm expects to be paid $1 million in 3 months. Please simulate the
SKr value of this payment if in three months, the spot exchange rate is equal to SKr/$=5
and SKr/$=6. What would be the value of this payment if the firm had hedged against
currency movements using the forward rate calculated in a)?

6. Paf is a small country. Its currency is the pif and the exchange rate with the U.S. dollar is 2 pifs
per dollar in 1980. The inflation indexes in 1980 are equal to 100 in the United States and in Paf.
Twenty years later, the inflation indexes are equal to 400 in the United States and 200 in Paf. The
current exchange rate is 0.9 pifs per dollar.
a. What should the current exchange rate be if PPP prevailed?
b. Is the Pif over/undervalued according to PPP?
7. American Airlines is trying to decide how to go about hedging a €70 million ticket sales
receivable in 180 days. Suppose it faces the following exchange and interest rates.
 Spot rate: $0.6433-42/€
 Forward rate (180 days): $0.6578-99/€
 Euro 180-day interest rate (annualized): 4.01% - 3.97%
 U.S. dollar 180-day interest rate (annualized): 8.01% - 7.98%

a. What is the hedged value of American’s ticket sales using a forward market hedge?
b. What is the hedged value of American’s ticket sales using a money-market hedge?
c. Which hedge is less expensive?
d. Is there an arbitrage opportunity here?
e. Suppose the expected spot rate in 180 days is $0.67/€, with a most likely range of $0.64-
$0.70/€. Should American hedge?

8. Spot rate of £ = $1.60

180-day forward rate of £ = $1.56
180-day British interest rate = 4% (8% annual rate)
180-day US interest rate = 3% (6% annual rate)
a. Provide an example demonstrating why covered interest arbitrage is or is not possible.

9. Assume the spot exchange rate of the British pound is $1.73.

a. How would this spot rate adjust according to purchasing power parity if Great Britain
experiences an inflation rate of 7% while the United States experiences an inflation rate
of 2%? Show your work.

10. A U.S. company has an account receivable of 10,000,000 marks from a German company to be
paid in three months. The three-month forward rate for the German mark is $0.50 per mark.
a. What is the approximate value (ignoring time value of money) of the account receivable
in U.S. dollars, if the company makes a forward hedge?

11. Two countries, the United States and England, produce only one good, wheat. Suppose the price
of wheat in the United States is $3.25 and in England it is £1.35.
a. According to the law of one price, what should the $/£ spot exchange rate be?

12. In July, the one-year interest rate is 12% on British pounds and 9% on U.S. dollars. If the current
exchange rate is $1.63/£, what is the expected exchange rate in one year?

13. You have gone to work for Nike in the company's pension department. One morning you walk in
and the new Fund Manager asks, "How much would it cost us to hedge the rand? What's the
forward discount, in percent per annum, on three-month South African rand? There's some kind
of crisis down there, and we may have to hedge our S.A. bonds." Although you cannot find a
quote for 3-month rand, you are able to get the following: Spot: 4.93 rand per dollar Eurodollar 3-
month interest rate: 5.85% Eurorand 3-month deposit rate: 12.77%. These rates are on an
annualized basis.
a. What's the forward discount (estimated to the nearest basis point)?
14. Given the bid-ask quotes for JPY/GBP 160–180, at what rate will:
a. Mr. Smith purchase GBP?
b. Mr. Brown sell GBP?
c. Mrs. Green purchase JPY?
d. Mrs. Jones sell JPY?

15. A Japanese manufacturer has an accounts receivable of USD 1 million due in 90 days. The spot
and forward exchange rates are JPY/USD 110 and 109.8, respectively, and the simple interest rate
for a three-month deposit is 2 percent p.a. in Japan and 3 percent p.a. in the US.
a. If the manufacturer sells the USD 1 million forward for 90 days, how many JPY will she
receive at time T?
b. How could she replicate a forward sale in the spot and money markets?
c. Is the manufacturer indifferent between (a) and (b)?

16. Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X.  
Assume the bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. 
a. Given this information, what would be your gain if you use $1,000,000 and execute
locational arbitrage?  That is, how much will you end up with over and above the
$1,000,000 you started with?
17. A bank is quoting the following exchange rates against the dollar for Swiss franc and Australian
dollar:
SFr
 =1.5960−70
$
A$
 =1.7225−35
$
A$
a. An Australian firm asks the bank for a quote. What cross-rate would the bank
SFr
quote?

18. The current T-bill rate in the U.S. is 4% per annum, while Swiss T-bill rates are 3% per annum.
The spot exchange rate is $0.7598/SF (SF is the symbol for Swiss Francs) and the six-month
forward rate is $0.7763/SF. You can borrow funds in either country for 2 percentage points
above the T-bill rates. That is, you can borrow in Switzerland at 5% and you can borrow in the
U.S. at 6%. Is the forward rate consistent with interest rates, and if not, how can a profit be
made? Assume you can borrow 10,000 units of either currency.
MULTIPLE CHOICE:
19. A large increase in the income level in Europe along with no growth in the U.S. income level is
normally expected to cause a(n)
a. increase in European demand for U.S. goods, and the European euro should appreciate
b. increase in European demand for U.S. goods, and the European euro should depreciate
c. decrease in European demand for U.S. goods, and the European euro should appreciate
d. decrease in European demand for U.S. goods, and the European euro should depreciate
e. no change at all

20. If a country experiences high inflation relative to the U.S., its exports to the U.S. should
_______________, its imports should ___________, and there is __________ pressure on its
currency’s equilibrium value.
a. decrease; increase; upward
b. decrease; decrease; upward
c. increase; decrease; downward
d. decrease; increase; downward
e. increase; decrease; upward