# Solutions: Sample Exam 2: FINA 5500

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1 Short Questions / Problems Section: (88 points) Solutions: Sample Exam 2: INA 5500 Q1. (8 points) The following are direct quotes from the spot and forward markets for pounds, yens and francs, for two points in time: 2/1/XX and three months latter, 5/1/XX. PLEASE READ AND USE THE QUOTES CAREULLY. I WILL NOT GIVE PARTIAL CREDIT OR ERRORS DUE TO MISREADING OR USING THE WRONG QUOTES. 2/1/XX 5/1/XX a. If you were a currency speculator, based on the information presented, would you rather take a long or a short position in the three-month forward contract for British pounds on 2/1/XX?: Long b. On 2/1/XX, GM sold a three-month forward contract for 250 million yen to CitiCorp. Based on this transaction, indicate whether each statement listed below is either true or false: (5 points) Statements On 5/1/XX, GM will have to pay \$1,875,250 to CitiCorp On 2/1/XX, GM will have to deliver 250 million yen to CitiCorp On 5/1/XX, CitiCorp will have to pay \$2,071,250 to GM On 5/1/XX, CitiCorp will have to deliver 250 million yen to GM On 5/1/XX, CitiCorp will have to pay to \$2,090,000 GM True or false c. Based on the information presented in part (h), what is the total dollar profit or loss in the forward market transaction for GM? Please indicate the dollar amount, and also if it is a profit or a loss. (2 points): ( ) * 250,000,000 = - \$ 196,000 Q2. (4 points) Compared to the orward market, in the oreign Currency utures market: (i) Transaction costs are based on: brokerage fee (ii) Margin is: required (iii) Trading is done via: an exchange (iv) Settlement is done: on a daily basis

4 Q10. (8 points) Please use the exact, not the approximate formula to answer all questions in this section. Current SR of S = \$ ; Expected SR of S, one year from now = \$ ; Current 1-year forward rate for S = \$ ; 1-year interest rate in the U.S. = 7.5% ; 1-year interest rate in the Switzerland = 3.5% a) Calculate the covered rate of return: P h = ; R ch = (1.0405)*(1.035) -1 = 7.69% b) Calculate the uncovered rate of return: % change in SR= ; R u = ( )*(1.035) -1 = 9.543% c) If you could borrow \$10,000,000 in the US, and set up a uncovered interest rate arbitrage, how many dollars will you have at the end of one-year: ( )*10,000,000 = \$204, d) Based on IE, calculate the expected spot price of S one year from now:(1.075/1.035)* = \$ Q11. (4 points) Please fill in the blanks with letter (a, b, c, etc.,) associated with the most appropriate phrases from the phrases listed below: 1. According to the Interest Rate Parity Theory, the difference between the domestic and foreign interest rates has an effect on the forward premium or discount 2. According to the Purchasing Power Parity Theory, the difference between the domestic and foreign inflation rates has an effect on the percentage difference between the current spot exchange rate and future spot exchange rate 3. According to the isher Effect, the sum of the real rate and inflation premium has an effect on the nominal rate of interest 4. According to the International isher Effect, the difference between the domestic and foreign interest rates has an effect on the percentage difference between the current spot exchange rate and future spot exchange rate Q12 (5 points): Assume that Texaco does a large part of its crude petroleum extraction and refining the UK. In both the US and UK markets it has to compete with other US and British firms. Please indicate whether the appreciation of the US dollar will increase, decrease or have no effect on the following factors: actors The dollar value of Texaco's domestic revenue The dollar value of Texaco's sales in the UK, if exports are denominated in US \$ The dollar value of Texaco's sales in the UK, if exports are denominated in BP The dollar value of Texaco's operating costs in the UK, if those payments have to be made inbp The level of Texaco's operating costs in the UK, if those payments have to be made in US \$ No change Q13 (8 points): Assume that a US firm expects to make a payment of S 2,500,000 in 1 year and wants to execute a money market hedge. The following information is available: US interest rate = 5% ; Swiss interest rate = 7% ; 1 year forward rate for S = \$0.60 ; Spot rate for S = \$0.59 a. In what currency should the firm borrow, and how much: (2,500,000/1.07)*0.59 = \$ 1,378,504.67

5 b. In what currency should the firm invest, and how much: (2,500,000 / 1.07) = BP 2,336, c. If the US firm sets up the money market hedge, how many US dollars would it need to cover the payment of S 2,500,000 payable at the end of one year? (2,500,000/1.07)*0.59*(1.05) = \$1,447, d. Based on available information, should the firm use a forward hedge or money market hedge to cover the payment of S 2,500,000 payable at the end of one year? money market hedge Q14 (8 points): The following table projects inflows and outflows in four different currencies for Nemonics.com, a US based firm. Also given are the projected exchange rates for these currencies and their projected ranges. Based on this information, estimate the information required in the last four rows of the table. Euro Japanese Yen Hong Kong \$ Mexican Peso Inflows 500,000 25,000, ,000 Outflows , ,000 Projected exchange rates \$0.90 \$0.01 \$0.75 \$0.10 Projected range of exchange rates \$ \$ \$ \$ \$ \$0.25 Projected \$ NC + 450, ,000 <450,000> <40,000> Projected range of the \$ NC +375, , , ,500 <330,000> <510,000> <8,000> <100,000> Projected overall \$ NC \$210,000 Projected range of the overall \$ NC \$524,500 - <47,500> B. Multiple Choice Section (2 X 7 = 14 points): 1. irm A is a US based MNC with net cash inflows of Japanese Yen and net cash inflows of rench rancs. irm B is also a US based MNC with net cash outflows of Japanese Yen and net cash inflows of rench rancs. These two currencies are positively correlated in their movements against the dollar. Which firm has a higher exposure to exchange rate risk?: irm A 2. irm J is a US based MNC with net cash inflows of Japanese Yen and net cash outflows of rench rancs. irm K is also a US based MNC with net cash inflows of German Marks and net cash outflows of rench rancs. While Japanese Yen and rench rancs are positively correlated, German Marks and rench rancs are negatively correlated in their movements against the dollar. Which firm has a high exposure to exchange rate risk?: irm K 3. Which of the following reflects a hedge of net receivable in British pounds by a US firm? A) purchase a currency put option in British pounds B) sell forward contracts on pounds D) A and B 4. Which of the following reflects a hedge of net payables on British pounds by a US firm: borrow US dollars, convert them to pounds, and invest in a British pound deposit 5. Assume that Parker company will receive S200,000 in 360 days. Interest rates are 6% in the US and 5% in Switzerland. One-year forward rate for Swiss franc is \$.50 and the current spot rate of Swiss franc is \$.48. If Parker Company uses a money market hedge, it will receive \$96,914 in 360 days.

6 6. Your company will receive CD1,200,000 in 90 days. The 90 day forward rate for Canadian dollars is \$0.80 and the current spot rate is \$0.75. If you use a forward hedge, estimate the cost of hedging the receivable if the spot rate for CD 90 days later turns out to be \$0.82: \$ 24, Your company will expected to pay DM 4,000,000 in 6-months. The 6-month forward rate for DM is \$0.40 and the current spot rate is \$0.50. If you use a forward hedge, estimate the cost of hedging the payable if the spot rate for DM 6-months later turns out to be \$0.44: < \$160,000 >

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