1. The Hong Kong (HK$) is presently pegged to the U.S. dollar and is expected to remain pegged. Some Hong Kong firms export products to Australia that are denominated in Australian dollars and have no other business in Australia. The exports are not hedged. The Australian dollar is presently worth 0.5 U.S. dollar, but you expect that it will be worth 0.45 U.S. dollar by the end of the year. Based on your expectations, will the Hong Kong exporters be affected favorably or unfavourably? Explain with example - 5 Marks

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2. Assume the euro's spot rate is presently equal to $1.00. All of the following firms are based in New York and are the same size. Although these firms concentrate on business in the U.S., their entire foreign operations for this quarter are provided here.

Company A expects its exports to cause cash inflows of 9 million euros and imports to cause cash outflows equal to 3 million euros.

Company B has a subsidiary in Portugal that expects revenue of 5 million euros and has expenses of 1 million euros.

Company C expects exports to cause cash inflows of 9 million euros and imports to cause cash outflows of 3 million euros. It will repay the balance of an existing loan equal to 2 million euros.

Company D expects zero exports and expects imports to cause cash outflows of 11 million euros.

Company E will repay the balance of an existing loan equal to 9 million euros.

Which of the five companies described here has the highest degree of translation exposure? Explain in detail why other companies have lower translation exposure - 5 Marks

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3. As treasurer of Tucson Corp. (a U.S. exporter to New Zealand), you must decide how to hedge (if at all) future receivables of 250,000 New Zealand dollars 90 days from now. Put options are available for a premium of $.03 per unit and an exercise price of $.49 per New Zealand dollar. The forecasted spot rate of the NZ$ in 90 days follows:

FutureSpotRate Probability

$.44 30%

.40 50

.38 20

Given that you hedge your position with options, provide a probability distribution for U.S. dollars to be received in 90 days. - 5 Marks

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4. Since Obisbo Inc. conducts much business in Japan, it is likely to have cash flows in yen that will periodically be remitted by its Japanese subsidiary to the U.S. parent.What are the limitations of hedging these remittances one year in advance over each of the next 20 years?What are the limitations of creating a hedge today that will hedge these remittances over each of the next 20 years? - 5 Marks

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5. You believe that IRP presently exists, whereas the nominal annual interest rate in Mexico is 14%. The nominal annual interest rate in the U.S. is 3%. You expect that annual inflation will be about 4% in Mexico and 5% in the U.S. The spot rate of the Mexican peso is $.10. Put options on pesos are available with a one-year expiration date, an exercise price of $.1008, and a premium of $0.014 per unit.

You will receive 1 million pesos in one year.

1. Determine the amount of dollars that you will receive if you use a forward hedge. - 3 Marks
2. Determine the expected amount of dollars that you will receive if you do not hedge and believe in purchasing power parity (PPP). - 3 Marks
3. Determine the amount of dollars that you will expect to receive if you use a currency put option hedge. Account for the premium you would pay on the put option. - 4 Marks

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6. Beth Miller does not believe that the International Fisher Effect (IFE) holds. Current one-year interest rates in Europe are 5 percent, whereas one-year interest rates in the U.S. are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.10.

a. According to the IFE, what should the spot rate of the euro in one year be- 3 Marks

b. If the spot rate of the euro in one year is $1.00, what is Beth's percentage return from her strategy?- 3 Marks

c. If the spot rate of the euro in one year is $1.08, what is Beth's percentage return from her strategy?- 3 Marks

d. What must the spot rate of the euro be in one year for Beth's strategy to be successful?- 1 Mark

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7. PPP and Real Interest Rates. The nominal (quoted) U.S. one-year interest rate is 6%, whereas the nominal one-year interest rate in Canada is 5%. Assume you believe in purchasing power parity. You believe the real one-year interest rate is 2% in the U.S, and that the real one-year interest rate is 3% in Canada. Today the Canadian dollar spot rate at $.90. What do you think the spot rate of the Canadian dollar will be in one year? - 5 Marks

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8. IFE, Cross Exchange Rates, and Cash Flows. Assume the value of the Hong Kong dollar (HK$) value is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, an Australian dollar (A$) is worth $.50 and HK$3.9. The one-year interest rate on the Australian dollar is 11%, whereas the one-year interest rate on the U.S. dollar is 7%. You believe in the international Fisher effect.

You will receive A$1 million in one year from selling products to Australia and will convert these proceeds into Hong Kong dollars in the spot market at that time to purchase imports from Hong Kong. Forecast the amount of Hong Kong dollars that you will be able to purchase in the spot market one year from now with A$1 million. Show your work. - 5 Marks

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