Financial Management in IB. Exercises 1. I. Foreign Exchange Market
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1 Financial Management in IB Exercises 1 1 I. Foreign Exchange Market Locational Arbitrage Paris Interbank market: EUR/USD 1,2548/1,2552 London Interbank market: EUR/USD 1,2543/1,2546 Is locational arbitrage possible? If so, compute the profit from this arbitrage if you had 10 MEUR to use. Explain price adjusting process. 2 1
2 I. Foreign Exchange Market Triangular Arbitrage EUR/USD 1,3000 EUR/CZK 28,490 USD/CZK 21,900 Is triangular arbitrage possible? If so, compute the profit from this arbitrage if you had 10 MEUR to use. Explain price adjusting process. 3 I. Foreign Exchange Market Triangular Arbitrage EUR/USD 1,2900/1,2980 EUR/CZK 28,150/28,200 USD/CZK 21,900/21,930 Is triangular arbitrage possible? If so, compute the profit from this arbitrage if you had 10 MEUR to use. Explain price adjusting process. 4 2
3 I. Foreign Exchange Market Currency Speculations Assume you expect Euro to appreciate from EUR/USD 1.40 to 1.47 in 60 days. What is your expected profit from the speculation if your borrowing capacity is 10 MEUR or 14 MUSD and annualized interest rates are as follows: EUR 4.00% % USD 3.00% % 5 II. Currency Derivatives FX Forwards Covered Interest Arbitrage Spot rate EUR/USD 1,3500 Interest rate USD 8 % p.a. Interest rate EUR 4 % p.a. 3-month Forward rate 1,3600 Is covered interest arbitrage possible? If so, compute the profit from this arbitrage if you had 10 MEUR or 13,5 MUSD to use. Explain price adjusting process. 6 3
4 II. Currency Derivatives FX Forwards Non Deliverable Forward Contracts Spot rate: EUR/PHP 70,7660 Contracted 6-month rate: EUR/PHP 72,6431 Reference spot rate in 6 months: EUR/PHP 73,7712 Compute a net payment resulting from the contract for the buyer of EUR II. Currency Derivatives: Currency Futures Currency Futures Assume you have bought 10 FDE contracts on the LIFFE at the price 80,00. Suppose you hold the position for 5 days and then you close out the position. Compute the gains and losses on the position if daily settlement prices are as follows: Day D O D 1 D 2 D 3 D 4 D 5 Settlement Price Gain/Loss 80,00 80,30 80,10 80,40 79,90 79,80 Total 8 4
5 II. Currency Derivatives: Currency Options Speculating with Currency Put Options Assume you have purchased a put option on Euros against U. S. Dollars with following parameters: Option premium: 3,00% Spot price: EUR/USD 1,30 Underlying currency: Maturity: 3 months Strike price: EUR/USD 1,30 What is your net profit/loss on the option if the spot rate at the expiration date is: EUR/USD 1,25 EUR/USD 1,28 EUR/USD 1,35 9 II. Currency Derivatives: Currency Options Speculating with Currency Call Options Assume you have sold a call option on Euros against U. S. Dollars with following parameters: Option premium: 2,50% Spot price: EUR/USD 1,25 Underlying currency: Maturity: 3 months Strike price: EUR/USD 1,25 What is your net profit/loss on the option if the spot rate at the expiration date is: EUR/USD 1,20 EUR/USD 1,25 EUR/USD 1,
6 II. Currency Derivatives: Currency Options Speculating with Currency Call Options Assume you have bought a call option on Euros against Czech Crowns. The strike price is 27,000 EUR/CZK and the premium is 0,054 CZK per Euro. What will be your net profit (loss) on the position if the spot rate at the expiration day is 27,150 EUR/CZK? 11 III. Foreign Exchange Exposure Value at Risk 1. Assume that your corporation will receive 2.8 million U. S. dollars in one month. Spot rate equals EUR/USD 1,40. You estimate the standard deviation of monthly percentage changes of the EUR/USD to be 0,5. Assume further that these monthly percentage changes are normally distributed. What is the maximum expected loss on the position at 95% confidence level over 1 month? 12 6
7 III. Foreign Exchange Exposure Value at Risk 2. Assume that your corporation will receive 1.4 million U. S. dollars and 14 million Czech crowns in one month. Spot rates equal EUR/USD 1,40 and EUR/CZK 28,00. You estimate the standard deviation of monthly percentage changes of the EUR/USD and EUR/CZK to be 0,8 and 0,6 respectively. Assume further that these monthly percentage changes are normally distributed and that the correlation coefficient of EUR/USD and EUR/CZK equals 0,5. What is the maximum expected loss on the positions at 95% confidence level over 1 month? 13 III. Foreign Exchange Exposure Hedging with options and forwards Assume you have sold chocolate invoiced at $ Payment for the invoice is due in 30 days. You have following information: 30-day forward rate is EUR/USD 1, day call option on with the strike price EUR/USD 1,40 costs 1,5%. Which strategy would you prefer if you expect the spot rate at the expiration day to be: EUR/USD 1,39 EUR/USD 1,37 EUR/USD 1,
8 III. Foreign Exchange Exposure Hedging with Risk Reversal Assume you sold bicycles invoiced at USD. Payment for the invoice is due in 6 moths. Assume you want to hedge the position at the exchange rate EUR/USD 1,40 without any hedging costs. Spot rate is EUR/USD 1,37. You have following options to chose: 6-Moths Call EUR/USDStrike: 1,40 EUR/USD Option premium: 3,97% 6-Moths Put EUR/USD Strike: 1,35 EUR/USD Option premium: 3,97% What would be the effective exchange rate for the receivables if the spot rate in 6 moths were: o EUR/USD 1,42 o EUR/USD 1,37 o EUR/USD 1,33 15 III. Foreign Exchange Exposure Money Market Hedge Assume you have sold bicycles invoiced at $ Payment for the invoice is due in 90 days. You have following information: Spot rate EUR/USD Annual IR USD 2,00% - 2,40% EUR 1,80% - 2,20% Calculate an effective exchange rate for the receivables using MM hedge. 16 8
9 III. Foreign Exchange Exposure Hedging with futures Assume you have bought chocolate invoiced at USD. Payment for the invoice is due in 20 days. You have following information: Spot rate EUR/USD 1,37 FDE price 72,46 How would you hedge transaction risk with futures? What would be your financial flows if the spot rate and FED price in 20 days were: a) Spot rate EUR/USD 1,41 FDE price 70,85 b) Spot rate EUR/USD 1,35 FDE price 74,02 17 III. Foreign Exchange Exposure Comparing different hedging strategies Assume you plan to pay $ for the bicycles imported from USA in 30 days. You have following information: 30-day forward EUR/USD 1,38 1-Moth Call EUR/USD Strike: 1,40 Option premium: 3,00% 1-Moth Put EUR/USD Strike: 1,35 Option premium: 3,00% Which strategy (forward, plain vanilla option, zero cost strategy ) would you prefer if you have following scenarios of future exchange rate: EUR/USD 1,42 30% EUR/USD 1,35 40% EUR/USD 1,32 30% 18 9
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