Question

INSTRUCTIONS: READ THE QUESTIONS CAREFULLY. ANSWER THE QUESTIONS ON THE SEPARATE ANSWER SHEET THAT CAN BE DOWNLOADED

You are the manager of a U.S. company situated in Los Angeles and manages the import/export division of the company. The company distributes (resells) a variety of consumer products imported to the U.S.A from Australia and also exports goods manufactured in the U.S.A. to Britain.

Therefore, your company is very much dependent on the impact of current and future exchange rates on the performance of the company.

Scenario 1:

You have to estimate the expected exchange rates between your home currency and the other currencies of the major other countries that you deal with in terms of both imports and exports. The reason is that increases in the values of other currencies compared to the U.S. Dollar may impact your imports negatively, whilst it may on the other hand, be good for exports. To do this estimate, you obtain the following spot exchange rate information:

£/$	0.76918
AUD$/$	1.38140

You also obtain the following annual risk free rates applying in the countries:

U.S.A.	2.660%
Britain	0.778%
Australia	1.953%

Your focus is presently to estimate the 3 month forward rates in order to consider the impact that it will have on the import and export sales of the company. Calculate the forward rates of the $ in terms of all the currencies by using simple interest rate parity e.g. 10% annual interest rate = 10/2 = 5% for six months. Do not effective annual interest rate compounding. Show all your workings in table 1 on the separate answer sheet by using the correct formula provided in your formula sheet.

Provide an indication about what will happen to the value of the US$ based on the forward exchange rate calculations by calculating the expected discount/premium of it for each of the currencies in Table 2 on the separate answer sheet. Also show whether the impact will be positive (P) or negative (N) for imports and exports. For example:

Exchange rate	% Discount/Premium	Import	Export
£/$	Workings by you ……………. = 1.93% premium	Positive	Negative

Table 1: Calculation of 3 month forward rates using the simple interest rate parity principle

Exchange rate	Forward rate 3 months from now (provide answer with 5th decimal rounding in this column)	Workings (Use of 6th decimal rounding in workings)
£/$
AUD$/$

Table 2: Discounts/Premium of US$

Exchange rate	% Discount/Premium (Show calculations with answer). Answer must be rounded to 2 decimals. (1 mark each)	State whether positive or negative for imports (1 mark each)	State whether positive or negative for exports (1 mark each)
£/$
AUD$/$

Answer 1

Table 1:

3-month forward rate = spot rate*(1 + 3-month foreign risk-free rate)/(1 + 3-month US risk-free rate)

Table 2:

If the foreign currency becomes costlier then imports are going to be negatively affected (since they will cost more) and exports are going to be positively affected

Discount/premium = (3-month forward rate/spot rate) -1