FINS3616 International Business Finance - Week 3

A. Conceptual questions

1. What is an exchange rate?

The price of one currency in terms of another currency. Can be either direct or indirect,
ie. Foreign currency in terms of domestic currency, or vice versa.

2. What is the structure of the foreign exchange market? Is it like the New York Stock
Exchange?

Forex market is a non-physical market that faciliates currency exchange. It is also the
largest financial market in the world.

3. What is a spot exchange rate contract?

It is the rules outlined in the exchange of 2 currencies for immediate delivery. Due to
varying business day structure around the world, most spot transactions settle 2 days after
transaction date.

4. What is an appreciation of the dollar relative to the pound? What happens to the dollar
price of the pound in this situation?

An appreciation of the dollar relative to the pound is when the value of the dollar floats
higher than previous exchange rate due to changes in supply and demand in the Forex
market. A stronger dollar means that GBP/USD rises.

5. Mississippi Mud Pies, Inc. needs to buy 1,000,000 Swiss francs (CHF) to pay its Swiss
chocolate supplier. Its banker quotes bidask rates of CHF1.39901.4000/USD. What
will be the dollar cost of the CHF1,000,000?

It will cost M.M.P Inc $1000000/1.3990=$714796 USD to buy 1000000 Swiss Francs
and pay for Swiss chocolate supplier.

1 mil CHF 1.3990 CHF 1 milCHF

= x milUSD= =0.715 milUSD
x mil USD 1USD 1.3990 CHF /USD
6. If the Japanese yenU.S. dollar exchange rate is 104.30/$, and it takes 25.15 Thai bahts
to purchase 1 dollar, what is the yen price of the baht?

104.30/$, 25.15/$, /=?

$/=(25.15)^(-1)

To prevent triangular arbitrage, the direct quote for THB/JPY must be equal to
exchanging through JPY/USD and then USD/THB

/=104.30/$ * $(25.15)^(-1)/ = 4.1471/

7. As a foreign exchange trader, you see the following quotes for Canadian dollars (CAD),
U.S. dollars (USD), and Mexican pesos (MXN):

USD0.7047/CAD MXN6.4390/CAD MXN8.7535/USD

Is there an arbitrage opportunity, and if so, how would you exploit it?

Implied exchanged: USD(8.7535)^-1 /MXN * MXN6.4390/CAD = 0.7356USD/CAD

Direct exchange: USD0.7047/CAD
Yes, there is arbitrage opportunity.
One example can be: exchange 0.7047 USD for 1 CAD directly, then 1 CAD for 0.7356
USD. This gives a 4.38% arbitrage profit.

8. The Mexican peso has weakened considerably relative to the dollar, and you are trying to
decide whether this is a good time to invest in Mexico. Suppose the current exchange rate
of the Mexican peso relative to the U.S. dollar is MXN9.5/USD. Your investment advisor
at Goldman Sachs argues that the peso will lose 15% of its value relative to the dollar
over the next year. What is Goldman Sachss forecast of the exchange rate in 1 year?

Currently, MXN9.5/USD USD0.1053/MXN, which is the USD value of MXN. 1 year

later, MXN will be 0.85 of this value. Thus = 0.1053*0.85= USD0.0895/MXN
Easier: 9.5*1.15= MXN10.9250 /USD
 9. Deutsche Bank quotes bidask rates of $1.3005/ - $1.3007/ and 104.30 - 104.40/$.
What would be Deutsche Banks direct asking price of yen per euro?

Given Deutsche Banks quotes: USD/EUR, and JPY/USD, and that it offers to sell its
JPY for EURO, implies itll buy USD with EUR and then sell USD for JPY. i.e. bid
1.3007USD/EUR then ask JPY104.40/USD.

JPY/EUR (= JPY/USD *USD/EUR)

1.3007*104.40= JPY135.79/EUR

10. Alumina Limited of Australia has called Mitsubishi UFJ Financial Group to get its
opinion about the Japanese yenAustralian dollar exchange rate. The current rate is
67.72/A$, and Mitsubishi thinks the Australian dollar will weaken by 5% over the next
year. What is Mitsubishi UFJs forecast of the future exchange rate?

Cuurently, 67.72/A$. In 1 year, AUD will depreciate by 5%, thus worth less JPY.

67.72*(0.95)=JPY64.334/AUD

B. True or False questions

1. In the spot market, trade is conducted in a single spot or location.

False trade is conducted through a network of financial

2. In the forward currency markets, trades are made for future delivery according to an agreed-
upon delivery date, exchange rate, and amount.
True

3. A bank that is making a market in lira stands ready to buy lira at its offer price and sell lira
at its bid price.
False, buy at bid, sell at offer. Not other way around.

4. A bank offers you the following quote: $0.8841/C$ BID and $0.8852/C$ ASK. The bank
will buy U.S. dollars at $0.8841/C$ or sell U.S. dollars at $0.8852/C$.
False

5. Commercial banks always quote foreign exchange rates with the domestic currency in the
denominator of the quote.
False as domestically currency can be in numerator or denominator.
6. The biggest traders in the foreign exchange markets are corporations
False commercial banks specifically

7. When someone in the currency market can buy a currency at a low price and sell it for a
higher price, it is known as arbitrage
True

8. The currency market is the largest financial market in the world measured in dollar-volume
trade
True

C. MCQ

1. The biggest traders in the foreign exchange markets are ____.

a. commercial banks
b. corporations
c. government agencies
d. governments
e. individual investors

2. Which one of the following features is not part of the interbank foreign exchange market?
a. derivative securities such as foreign currency futures and options
b. trade in swaps and forward contracts
c. immediate exchanges of monies
d. non-strategic loans
e. none of the above

3. S$/ArPeso = $0.35/ArPeso and SArPeso/Rand = ArPeso0.31/Rand. What is SRand/$?

a. Rand0.886/$
b. Rand1.129/$
c. Rand3.226/$
d. Rand3.459/$
e. Rand9.217/$

4. What do the market makers in the currency markets provide?

a. insurance against default by the buyers
 b. solvency
c. stability
d. liquidity
e. collateral

5. Which one of the following firms dominates the foreign exchange markets?
a. No one firm dominates.
b. Deutsche Bank
c. UBS
d. Citigroup
e. Rio Tinto

6. The foreign exchange desks of commercial banks typically make their profits through ____.
a. arbitrage
b. government subsidies
c. investment banking
d. market making
e. speculation

7. The spot rate is $1.00/ and the one-year spot rate is $1.10/. What is percentage change in the dollar?
a. 10%
b. 9.1%
c. 0%
d. -9.1%
e. -10%