A currency dealer, Nancy Wood, working for a U.S. bank took a 5,000,000 British pound short position
Question:
A currency dealer, Nancy Wood, working for a U.S. bank took a 5,000,000 British pound short position when the exchange rate for the dollar/£ was $1.5500. The exchange rate then changed to $1.6100. a. Was the subsequent change in the exchange rate from the perspective of the positon taken by Nancy, that is, what has happened to the exchange rate? b. How much has Nancy’s positon changed as a result of the subsequent change in the exchange rate? Did it result in a gain or loss? How much? c. What is the percentage change in the dollar? What is the percentage change in the pound? d. In retrospect, what position should Nancy have taken? Compute how much would be the result if Nancy had taken this positon? (10 points)
2. A New Zealand fashion retailer recently attended a fashion show in Milan, Italy and decided to purchase a set of clothing line for €350,000 with payment due in 3 months. The New Zealand retailer has sufficient funds in its bank account to pay for the clothing line in a New Zealand bank, which compounds monthly, paying 0.35% per month. The current spot rate is NZ$1.4500/€ and the 3-month forward rate is NZ$1.4000/€. The short-term interest rate in Italy is 2.0% for a 3-month investment. The NZ retailer has two alternatives to pay for the clothing line: 1. Let the funds remain in the bank account in New Zealand and go into a €350,000 forward buy. 2. Buy a certain amount of euros today at the spot and invest it in Italy for 3 months and when it matures it will be equal to the €350,000. Determine the cost of each alternative payment methods. Which alternative is preferable? Why (10 points)
3. Ronald Sterns is an investor in the U.S. He is considering $1,000,000 to begin with denominated in his own currency. Ronald is considering if covered interest arbitrage is feasible looking at the currency quotations. The following quotations are available to him: Spot rate of £ = $1.6100 180-day forward rate of £1 = $1.5700 180-day British interest rate = 5% (for 6 months) 180-day U.S. interest rate = 4% (for 6 months) 2 a. If Ronald was to begin his first arbitrage transaction with the $1,000,000 in the international money market immediately, is arbitrage possible? If so, what is the gain or a loss? b. Is the international money market and foreign exchange market in equilibrium and is arbitrage possible if Ronald starts with £1,000,000. Determine if it is a gain or a loss. (10 points)
4. Benjamin Hess is looking at currency rates and wondering if arbitrage is possible. Assume a bank quotes an ask price for the forward rate for May 21th on Swiss francs is $0.9137. The price quoted at the same time by the CME on the Swiss francs futures for the same day delivery on May 21th is $0.9155. (Contract size per futures contract is SFr 125,000). a. Is there an opportunity for an arbitrage? What will be Benjamin’s profit for one futures contract? b. Assume that Benjamin also purchases Swiss francs using Swiss franc futures contract at a price of $0.8400 for July 16th delivery. On July 16th settlement date the spot rate for the Swiss franc is SFr 1 = $0.8350, what is Benjamin’s gain or loss on this contract? (10 points)
5. Chicago Mercantile Exchange sells 4 call option contracts on Swiss francs at a premium of $0.0400 per SF to their client, a multinational company. The exercise price is $0.9200 and the spot price of the Swiss franc at date of expiration is $0.9400. (Contract size per option is SF125,000) a. What is CME's profit (loss), as the option writer, on the call option? b. What is the multinational company’s profit (loss) on the call option? Should the multinational company exercise its option on expiration date? (18 points)
6. Aima Company has to pay its Australian supplier A$1 million and the bill is due in three months. The company is considering buying 20 Australian dollar call options (contract size of A$50,000) to hedge against the appreciating Australian dollar at an exercise price of $0.8000. The premium is $0.015 per A$. Aima also has an alternative to buy one three-month Australian futures contracts (contract size of A$1,000,000) at a futures contract rate of $0.7940 per A$. The current spot rate is A$1 = $0.7823. Assuming Aima’s financial manager believes that the Australian dollar will be $0.7900 in 90 days, and that the Australian dollar can appreciate to $0.8400 or depreciate to $0.7500: a. Determine the gain or loss from hedging in call options by Aima Company and when Aima will exercise the options? b. What is Aima's break-even price on the option contract? 3 c. Draw a diagram of Aima's gains or losses on the call option position, if it is exercised. Ignore transaction costs and margins. d. Determine the gain or loss of Aima’s futures contract hedging if the Australian dollar settled at its likely value? e. What is Aima's break-even price on the futures contract? f. Which is a better alternative for Aima to hedge it’s a $1,000,000 payable? Explain.
Advanced Accounting
ISBN: 9781260247824
14th Edition
Authors: Joe Ben Hoyle, Thomas Schaefer, Timothy Doupnik