Question

# Foreign Exchange (FOREX) Problem Set 1. You in US have an accounts payable to a German...

Foreign Exchange (FOREX) Problem Set

1. You in US have an accounts payable to a German exporter for 200 Porsche Cayenne SUVs. The seller offers a 2 percent discount for payment within 10 days and full payment due in 30 days (2/10 net 30). Today the exchange rate is \$1.40 per Euro. You notice that the 30 day forward rate for the \$/Euro is \$1.38. What should you do? Pay now with early payment discount or wait until end of 30 days? You owe 100,000 Euros for each of the cars (before any discounts). [show your work!]

2. Calculate the exchange rate for dollars per SDR using exchange rates for the most recent day that you have exchange rate data. Show work.

3. You are changing planes in London for a flight to Paris where you will connect with your flight to Capetown. You are picking up reading material for the flight and are looking at the prices listed on the Economist magazine that conveniently lists prices in several different global currencies. You note that the price in Pounds is 2.40 pounds and the price in Euros is 2 Euros. The exchange rate for the dollar (your credit card was issued in the USA) is \$1.69/pound and \$1.4837/euro. Should you buy reading materials now or wait until you’re in Paris?

Covered Interest Arbitrage Problems

1. Taking advantage of the “carry trade”

Example:         Spot rate = 10.5 pesos/\$                      Forward Rate = 10 pesos/\$

You have \$1,000,000.

Interest Rates:

 One year Govt debt Mexico USA Rate 7% 2%

Can you make money off of this ????

What are the effects of covered interest arbitrage?

When calculating the % premium or discount, premium or discount size should be equal to but opposite in sign to interest rate difference.

[(Fwd – Spot)/Spot] X 12/n X 100 = % premium or discount

Use this formula with direct rates (units of local currency per one unit of foreign)

Indirect rates are units of foreign currency per one unit of local currency. (Be careful this is a common mistake on exams)

2) You have \$1,000,000 to start with. Here are the facts:

Yen Spot Rate = 108 Yen/\$

Yen Fwd Rate = 105.5 Yen/\$

(6 months)

Interest Rates in Japan are 4% per annum (2% for 6 months).

Interest Rates in the USA are 8% per annum (4% for 6 months)for securities of similar risk and maturity.

Should you invest in Japan or US????

#### Homework Answers

Answer #1

2.

 CURRENCY Currency amount Exchange Rate U.S Dollar Equivalent under Rule 0-1 Chinese Yuan 1.0174 6.32895 0.160753 Euro 0.38671 1.24365 0.480932 Japanese Yen 11.9 108.615 0.109561 U.K. Pound Sterling 0.085946 1.4124 0.12139 U.S. Dollar 0.58252 1 0.58252 1.455156 U.S.\$1.00 = SDR 0.687212 SDR1 = US\$ 1.455160

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