Foreign Exchange Arithmetic Worksheet For purposes of this worksheet, assume the following exchange rates. S$/bid = 1.

20 S$/ask= 1.205 S$/c$bid=.650 S$/c$bid=.651 Are these direct (American) or indirect (European) ?

American, since they describe the dollars per unit of the foreign currency Suppose an American exporter has just received a payment of 100,000, how many dollars will result upon conversion?

The exporter will receive the bid price when the euro are sold. This will yield $120,000= S$/bidx100,000=1.20x100,000 . Suppose an American restaurant budgets $10,000 to restock its wine cellar with French wine. How many euros does it have to spend.

The restaurant will pay the ask price when it buys the euros. With the $10,000, it can obtain $8,298.76= 10,000/ S$/ask=10,000/1.205. [Another way of thinking about this is to say that the American is selling dollars and so will receive the European bid price. The European bid is the reciprocal of the American ask, S/$bid=1/ S/ffask =1/1.205=.829876. When the American sells the dollars, the result is 10,000x S/$bid.] Suppose a Canadian investor wants to purchase $100,000 worth of U.S. Treasury bonds. What is the c$ cost of this investment?

The Canadian will be selling C$ to get US dollars and so will receive the bid. It will require C$153,846 = 100,000/ S$/C$bid=100,000/.650. [Here again, you could work this by finding the European ask for US dollars.] For the following problems assume that there are no bid/ask spreads and that S$/ =1.20 and S$/C$=.60. What is the quote, in Canadian dollars for euros?

Sc$/=S$//S$/c$=1.20/.60= 2.0 What is the quote in euros for Canadian dollars?

S/c$=1/Sc$/=1/2.0=.50

Suppose that you are a currency trader and you see the quotes described above, but you also notice that in London they are giving quote of S/c$=.505. Does this present an arbitrage opportunity, and if so, how much money can you make with an initial investment of $1,000,000?

Yes, this is an arbitrage opportunity since the rate implied by the cross rate condition, . 50, is different than the rate offered in London. To figure out how to exploit this opportunity, think about the London trader as offering a premium number of euros for the Canadian dollars. The trick will be to get Canadian dollars into that market in order to sell them for the premium number of euros. Here are the steps: o Buy Canadian dollars in the US: $1,000,000 = 1,000,000/S$/c$=1,000,000/.6=C$ 1,666,667 o Sell these Canadian dollars in London for 1,166,667xS/c$=1,166,667x.505=841,667 o Sell euros in the US for 841,667xS$/=841,667x.1.20=$1,010,000

Profit of $10,000

For this problem assume that there are no bid/ask spreads and that the following annual interest rates and exchange rates are available: r$=6%, r=10%, S$/=1.60. What should the one-year forward rate be? o Fd/f=Sd/f(1+rd)/(1+rf) = 1.6(1.06)/(1.10)=1.5418 If your bank offered a forward contract at F$/=1.5500 with no other charges or fees, calculate the arbitrage profits on a deal that involved borrowing or lending $1,000,000.

The key to this arbitrage is to take advantage of the fact that the bank is offering to pay $0.0082 more for a British Pound to be delivered in one year than is required (1.5500-1.5418). This means you need to be in a position to deliver pounds one year in the future. Here are the steps o Borrow $1,000,000 in the U.S. (obligating you to repay $1,060,000) in one year.

o Use the proceeds from the loan to raise 1,000,000/1.60=625,000.

o Loan the 625,000 at 10% (that loan will generate 687,500 in one year) o Sell the amount expected in the forward market for 687,500x1.55=$1,065,625. Profit = $5,625

Gulfstream Aircraft has entered into a contract to sell a private jet to a European corporation. The sales price of 20 million will be paid when the aircraft is delivered in one year. The firm is considering a forward market hedge, a money market hedge and hedging with a currency option. The following rates apply. S0$/ = 1.3 F1$/ = 1.2 P (cost of put option) = .02 X (exercise price of put option) = 1.2 Rb$ (dollar bid rate of interest) = 8.0% Ra$ (dollar asking rate of interest) = 8.5% Rb (euro bid rate of interest) = 10.0% Ra (euro asking rate of interest) = 10.8%

In order to compare each of these hedges prepare a table showing the cash position in one year if the euro is selling for 1.1, 1.20, 1.3, 1.4 and 1.5 Forward Hedge Spot Receivab Forward Net le Contract 1.1 $22.00 $2.00 $24.00 1.2 $24.00 $0.00 $24.00 1.3 $26.00 ($2.00) $24.00 1.4 $28.00 ($4.00) $24.00 1.5 $30.00 ($6.00) $24.00

Spot

Put Receivab Put Net le Option 1 20 $3.60 $23.60 1.1 $22.00 $1.60 $23.60 1.2 $24.00 $0.00 $24.00 1.3 $26.00 $0.00 $26.00 1.4 $28.00 $0.00 $28.00 1.5 $30.00 $0.00 $30.00

Money Market Spot 1.1 1.2 1.3 1.4 1.5 Euros Borrowed 18.0505 18.0505 18.0505 18.0505 18.0505 Dollars Loaned $ 23.4657 $ 23.4657 $ 23.4657 $ 23.4657 $ 23.4657 Net Dollars Realized $ 25.3430 $ 25.3430 $ 25.3430 $ 25.3430 $ 25.3430 Implicit Forward Rate 1.2671 1.2671 1.2671 1.2671 1.2671