Foreign Exchange (FOREX) Problem Set
1. You have an accounts payable to a German exporter for 100 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? You owe 70,000 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 which 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 $1.59/pound and $1.3837/euro. Should you buy reading materials now or wait until you're in Paris?
Covered Interest Arbitrage Problems
1) Taking advantage of the "carry trade"
Example: Spot rate = 9.5 pesos/$ Forward Rate = 10 pesos/$
You have $1,000,000.
Interest Rates:
|
One year Govt debt
|
Rate
|
|
Mexico
|
7%
|
|
USA
|
1%
|
Can you make money off of this?
What are the effects of covered interest arbitrage?
Calculation of % 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 $1,000,000 to start with. Here are the facts:
Yen Spot Rate = 106 Yen/$
Yen Fwd Rate = 103.5 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.
What should you do?