Solutions: Sample Exam 1: FINA 5500 Q1. (4 points) Assume it is September 2002. The following table provides a forecast of GLM Corp s cash receipt in US Dollars, British Pounds and French Francs for September 2003 and September 2004. Also provided are the exchange rate forecasts for pounds and francs during the same time periods. September 2003 September 2004 Receipt Exchange Rate Dollar Amount Receipt Exchange Rate Dollar Amount US Dollars 2,000,000 NA $2,000,000 2,500,000 NA $2,500,000 British Pounds 2,800,000 $1.45 $4,060,000 3,000,000 $1.55 $4,650,000 French Francs 20,000000 $0.35 $7,000,000 28,000,000 $0.20 $5,600,000 Total $13,060,000 $12,750,000 If GLM Corp s required rate of return is 14%, estimate the how much GLM Corp s total cash receipt is worth now in US dollar terms using the valuation model for an MNC (discussed in Chapter 1). Value = 13,060,000 / (1.14) 1 + $12,750,000 / (1.14) 2 = $ 12,266,851 Q2. (7 points) A typical Australian farmer can produce 8000 lbs of wheat or 500 lbs of potatoes per year. A typical Canadian farmer can produce 5000 lbs of wheat or 400 lbs of potatoes per year. a) Based on the above figures, please calculate: (i) the number of lbs of potatoes it takes to produce 1 lb of wheat in the Australia: 500/8000 = 0.0625 (ii) the number of lbs of wheat it takes to produce 1 lb of potato in Canada: 5000/400 = 12.50 b) Who has the comparative advantage in the production of potatoes (circle one): Canada c) For each of the exchange rates listed below indicate if Canada and Australia will ACCEPT or REJECT it: Exchange Rates Australia: Accept / Reject Canada: Accept/ Reject 1 lb of potato = 11.00 lbs of wheat A R 1 lb of wheat = 0.05 lbs of potatoes R A 1 lb of potato = 18.50 lbs of wheat R A 1 lb of wheat = 0.10 lbs of potatoes A R Australia Canada Wheat: 500/8000 = 0.0625 400/5000 = 0.050 Potatoes: 8000/500 = 16.00 5000/400 = 12.50
Q3. (6 points) Please enter the number associated with each transaction listed below in the proper cells in the following table. Credit Debit Goods / Merchandise 8 (35) 4 (65) Service 3 (10) Net Investment Income 2 (5) Unilateral Transfers 5 (18) Capital Account 6 (8) 1 (15) Official Reserve 7 (6) 2. Based on the transaction amounts, please calculate the following Balance of Payment accounts: Balance of Trade Current Account Balance (35 + 10) - (65) = - $20 million (35 + 10 + 5) - (65 + 18) = - $ 35 million List of transactions 1. A $15 million bond issue in the US by the Japanese Govt 2. Americans receiving $5 million in coupon payments on Japanese Govt bonds. 3. $10 million casino revenue in Atlantic City from Asian tourists. 4. $65 million wheat purchase by US from Canada 5. $18 million US military assistance to Pakistan 6. Sale of $8 million British Govt Bonds by the US Federal Reserve 7. Purchase of $6 million Euros by the US Federal Reserve 8. Sale of $35 million worth of tennis rackets in Asia by Wilson. Q4. (10 points) Please circle the right words or phrases in the statements listed below: a) If inflation rate in the US is 5% while the Japanese inflation rate is 3%, then: (i) US exports to Japan would: decrease (ii) US imports from Japan would: increase (iii) US trade deficit with Japan would: increase b) If inflation rate in the US is 5% while the British inflation rate is 9%, then: (i) US exports to UK would: increase (ii) US imports from UK would: decrease (iii) US Balance of Trade with UK would: increase c) If the US GNP increased while the Japanese GNP did not change, then: (i) US exports to Japan would: not change (ii) US imports from Japan would: increase (iii) US trade deficit with Japan would: increase
d) If the US GNP decreased while the British GNP did not change, then: (i) US exports to UK would: not change (ii) US imports from UK would: decrease (iii) US Balance of Trade with UK would: increase e) If the US Dollar appreciated against the Japanese yen, then: (i) US exports to Japan would: decrease (ii) US imports from Japan would: increase (iii) US trade deficit with Japan would: increase f) If the US Dollar depreciated against the British Pound, then: (i) US exports to UK would: increase (ii) US imports from UK would: decrease (iii) US Balance of Trade with UK would: increase g) If US trade deficit with Japan decreased, then: The US dollar is most likely to: appreciate against the Japanese yen h) If US Balance of Trade with UK decreased, then: The US dollar is most likely to: depreciate against the British pound Q5. (10 points) During a 2-year period, the British Pound (BP) went from $1.4675 to $1.8850, and both the US and British governments agreed to reverse this trend. a) This means that they should strengthen the dollar b) What action(s) should both central banks take under a policy of non-sterilized intervention: buy dollars + sell BP c) If the central banks in both countries followed a policy of non-sterilized intervention, this is expected to cause: (i) the supply schedule for BP to: increase / (ii) the demand schedule for BP to: not change / (iii) the dollar price for BP to: decrease d) Based on the actions in part (b), please refer to the graphs on the last page of this exam and identify the one (by its letter) that best describes what will happen in the FX market for BP: Graph E e) Based on the actions in part (b), the money supply in US will decrease f) If the central banks in both countries followed a policy of sterilized intervention, the US Treasury should: buy US government securities g) Based on the actions in part (f), the money supply in US will increase. Q6. (5 points) Currently, the spot rate for DM is $0.55. If the German inflation rate remains constant, but the US inflation rate is expected to fall, then in the FX market (please circle one): a) the supply schedule for DM will: increase b) the demand schedule for DM will: decrease c) If the spot rate for DM remains at $0.55, there will be an excess supply of DM d) the dollar price for DM will eventually: decrease e) Please refer to the graphs on the last page of this exam and identify the one (by its letter) that best describes what will happen in the FX market for DM: Graph A Q7. (5 points) Currently, the spot rate for FF is $0.25. If the French GNP level remains constant, but the US GNP level is expected to rise, then in the FX market (please circle one): a) the supply schedule for FF will: increase or not change b) the demand schedule for FF will: increase c) If the spot rate for FF remains at $0.25, there will be an excess demand of DM d) the dollar price for FF will: increase
e) Please refer to the graphs on the last page of this exam and identify the one (by its letter) that best describes what will happen in the FX market for DM: Graph G or Graph C Q8. (3 points) If US and UK were on a fixed exchange rate basis and the unemployment rate in the US rose relative to UK, please complete the statements below by choosing circling the right phrases: a) US demand for British goods would: decrease b) The dollar price of the BP would: not change d) British unemployment rate would eventually: increase Q9. (4 points) If US and UK were on a floating exchange rate basis and the unemployment rate in the US rose relative to UK, please complete the statements below by choosing circling the right phrases: a) US demand for British goods would: decrease b) The dollar price of the BP would: decrease c) British unemployment rate would eventually: not change d) Unemployment rate in the US may increase: even more Q10. (6 points) German mark (DM) and the French franc (FF) have a fixed exchange rate with each other and with the euro, while euro is floating against the US dollar. Suppose, the dollar depreciates against the euro, then: a) FF appreciates against the dollar b) FF does not change against the DM c) French exports to US will increase / decrease / not change d) French imports from US will decrease e) French exports to Germany will decrease f) French imports from Germany will decrease Q11. (5 points) A currency speculator expects the price of Japanese yen (JY) to change from 120 / dollar to 110 / dollar, in three months. Assume the speculator has access to $1,000,000 or an equivalent amount of JY. The JY borrowing & lending rate is 4 percent while the U.S. dollar borrowing & lending rate is 5 percent. a. In order for the speculator to take advantage from the expected rate change: It should borrow in US dollars and invest in JY b. Please calculate the expected profit (in US dollars) the speculator could earn during the three month period, if his forecast turn out be to true: $1,000,000 x 120 = Y 120,000,000 (1.01) = Y 121,200,000 * 110 = $ 1,101,818-1,000,000 (1.0125) = $89,318 c. Suppose everyone in the FX market speculated based on the information presented above. Please consult the graphs on the last page of this exam and identify the one (by its letter) that best describes what will happen in the FX market for JY: Graph G Q12. (6 points) Please use the currency bid-ask quotes to answer this question: Currency Dealer in New York Frankfurt Geneva Bid/Ask Quotes for DM $0.7475-85 $0.7486-96 $0.7478-88 a) If you are a currency speculator with access to $1,000,000 calculate the maximum profit you can make in one round trip transaction.(1,000,000/0.7485)*0.7486 = 1,000,133-1,000,000 = $133
b) Indicate how the prices will adjust, if all traders try to maximize profits. The ask price for the New York dealer will increase The bid price for the Frankfurt dealer will decrease The bid / ask price for the Geneva dealer will not change c) Suppose the bid/ask quotes for BP in London is $1.4735-98 while the bid-ask quotes for SF in New York is $0.7475-85. Please calculate the cross bid/ask quotes for SF in terms of BP: Ask: 0.7485/1.4735 = BP 0.5080 Bid: 0.7475/1.4798 = BP 0.5051 Q13. (8 points) The table below presents quotes and cross-quotes on DM and SF. Price for FF in New York (in $) Price for DM in London (in $) Price for DM in Paris (in FF) $ 0.30 for 1 FF $ 0.75 for 1 DM FF 2.45 for 1 DM a) Please identify correctly the three steps which will create triangular arbitrage profit: First step, convert: $ to FF ; Second step, convert: FF to DM ; Third step, convert: DM to $ b) If the speculator has access to $10,000,000, calculate the maximum profit in one triangular transaction. $10,000,000 / 0.30 = FF 33,333,333.33 ; FF 33,333,333.33 / 2.45 = DM 13,606,442 ; DM 13,606,442 * 0.75 = $ 10,204,082; Profit = 10,204,082 = 10,000,000 = $204,082 c) How will the prices of each dealer adjust (circle the appropriate words): The dollar price of FF for the New York dealer will increase The FF price of DM for the Paris dealer will increase The dollar price of DM for the London dealer will decrease Q14. (11 points) Using the quotes provided in the table below, try to answer to the following questions: Currency Quotes : 1/1/01 Quotes : 1/1/02 Australian Dollar (AD) $1.9472 for AD1.00 $1.7528 for AD1.00 Canadian Dollar (CD) CD1.5988 for $1.00 CD 1.4545 for $1.00 Singapore Dollar (SD) $ 0.55179 for SD1.00 $ 0.4429 for SD1.00 a) Based on the 1/1/02 quote, convert AD 2,000,000 into CD: $2,000,000 x 1.7528 = $3,505,600 ; $3,505,600 x 1.4545 = CD5,098,895 b) Based on the 1/1/02 quote, convert CD 5,000,000 into SD: CD5,000,000 / 1.4545 = $3,437,607 ; $3,437,607 / 0.4429 = SD7,761,588 c) Based on the 1/1/02 quote, convert SD 3,000,000 into AD: SD3,000,000 x 0.4429 = $1,328,700 ; $1,328,700 / 1.7528 = AD758,044 d) Based on the 1/1/02 quote, how many SDs does it take to buy one AD? 1 AD = 1.7528 / 0.4429 = SD 3.9579
e) During the 1/1/01 to 1/1/02 period, estimate the percentage appreciation/depreciation of the US dollar from the Australian point of view. 1/1.9472 = 0.51356 ; 1/1.7528 = 0.570515; [(0.570515-0.51356) / 0.51356]*100 = 11.09% f) During the 1/1/01 to 1/1/02 period, estimate the percentage appreciation/depreciation of the Singapore dollar from the US point of view. [(0.4429 0.55179) / 0.55179]*100 = - 19.73% Please circle the right answer for each of the next five question. Two points each. Q15. Based on the BOP statistics reviewed in class, for each year during the 1980's and the 1990's: - the US Balance of Trade was always negative, and the US Current Account Balance was mostly negative Q16.. SuperZone is a US company which manufactures and sells skateboards. It neither imports nor exports, but competes in the US with skateboard makers from Australia. If the US dollar depreciates against the Australian dollar, SuperZone s revenues will: increase Q17. Which one of the factors is not likely to be associated with the large US trade deficit: Low investment opportunity in the US Please answer the next two questions based on the assumption that Lucent primarily exports, Abbot Labs primarily imports, and Walmart exports AND imports from Mexico. Q18. If the US dollar depreciates against the Mexican peso, and everything else remain constant, which one of the following conditions is likely to hold: - Lucent s net cashflow will increase, Abbot s net cashflow will decrease, and Walmart s net cashflow will not change Q19. If the US dollar appreciates against the Mexican peso, and everything else remain constant, which one of the following conditions is likely to hold: - Lucent s net cashflow will decrease, Abbot s net cashflow will increase, and Walmart s net cashflow will not change
List of Graphs: Supply / Demand Curve Shifts in the Foreign Exchange (FX) Market In each graph, the vertical axis represents the price of FX in US dollars and the horizontal axis represents the quantity of FX demanded / supplied. D 0 and S 0 refer to the initial supply and demand schedules while D 1 and S 1 refer to the initial supply and demand schedules after they shift. The arrows indicate the direction of the shift. Please choose the graph (A through H) which provides the best answer to the question. (A) (B) (C) S 0 S 1 S 0 S 1 S 0 S 1 D 0 D 1 D 1 D 1 D 0 D 0 (D) (E) (F) S 1 S 0 S 1 S 0 S 1 S 0 D 0 D 1 D 0 D 0 (G) (H) S 0 S 0 D 1 D 0 D 0 D 1