Transaction Exposure Management

2- Parity Conditions
3- Forex Market

23- Henri Jacque is an arbitrager with Bank of Montreal, Montreal, Canada. The bank”s home currency is the Canadian dollar (CAD or C$). He is authorized to engage in transactions subject to a maximum of C$20,000,000. His bank expects him to earn his profits in Canadian dollars (C$). He is studying the market data as shown below:

Spot rate    C$ 1.4900/$
6-month forward rate      C$1.5100/$
6-month interest for C$    7.5000% p.a
6-month interest for $    5.0000% p.a

Assume that the interest rates reported are for both borrowing and investing. Ascertain arbitrage profits, if any.

25- You start working for a US company based in Cleveland. Your company has export-import transactions with a few businesses in Switzerland and you handle all such international transactions. Your company is a valued client of a major local bank and the bank sends the exchange rates daily to your office via email. You pull out the bills due for collection (accounts receivable) and payment (accounts payable) today and start reading the following outright quotes for Swiss Francs against the dollar (CHF/$) from your bank.
Bid    Ask
Spot    1.6075    1.6085
1 M Fwd    1.6085    1.6100
3 M Fwd    1.6089    1.6107
6 M Fwd    1.6095    1.6115

1-    Is the Swiss franc (CHF) poised to become strong or weak against the dollar between now and future?
2-    What would you receive if you sold CHF 1 million spot?
3-     Are you an exporter or importer in this transaction?
4-    What would it cost for you to purchase CHF 500,000 three-months forward?
5-    Are you an exporter or importer in this transaction?
6-    Using mid-rates, calculate the annualized premium or discount for Swiss Francs against the dollar for all given maturities.

22- Your family is planning a ski vacation to Mt. Blanc in Chamonix, France, one year from now. Your family is based in the U.S and your home currency is the US dollar. Since this is a foreign currency expenditure, your parents have entrusted the budgeting in your expert hands. The chateau”s owner wishes to preserve his real income against both inflation and exchange rate changes. So, the present monthly rent of €8,000 will be adjusted upwards or downwards for any change in the French cost of living between now and then. You are basing your budgeting on purchasing power parity (PPP). French inflation is expected to average at 3.5000% for the coming year, while the inflation in the U.S. is expected to be at 2.5000%. The current spot rate is $1.1840/€.
1-    How many dollars will you need for your family”s month-long vacation if your family were departing now?
2-    What is the expected exchange rate between the dollar and the euro one year hence?
3-    How many euros you will need one year hence for your month-long vacation?
4-    What will be the cost of your vacation in US dollars as per the estimated exchange rate next year?
5-    By what percent will the dollar cost go up between now and next year? Show with calculation.
6-    Why will your dollar cost go up?

24- An average US household spent $30,000 on consumption goods in 2012 and a similar household incurred an annual expenditure of £20,000 during the same period in the UK. The average exchange rate during the year was £0.714286/$ in the UK and the same in the US was $1.4000/ £.

1-    Did the purchase power parity theorem prevail in 2012? Answer Yes or No.
2-    Justify (explain) your answer with calculations.

26- You are about to leave for an assignment in the United Kingdom. Your employer covers all travel related expenses. When you incur any loss in currency conversion(s), your office covers the loss in as much as it is entitled to your profits too. Most of your bills (air-ticket and hotel) are already paid by your office. You are permitted to carry $1,000 worth of foreign currency denominated debit card with a microchip to cover your daily incidental expenses in the UK. Your office has given you $1,000 in cash. When you enter the bank, there is a display board that shows bank rates for foreign currency denominated debit cards. Here is a snapshot of the display board:

Direct Quotes in the US ($ per unit of foreign currency)
Currency    Bid    Ask
Japanese Yen (¥)    0.010037    0.010080
Euro (€)    1.3500    1.4000
Swiss Franc (CHF)    0.8600    0.8850
Pound Sterling (£)    1.5200    1.6000
Canadian Dollar (C$)    0.8100    0.8300
Singapore Dollar (S$)    0.6580    0.6930
Chinese Yuan Renminbi    0.1300    0.1500

1-    What is the currency that you need to buy for your use in the UK?
2-    What is the amount you will get in the foreign currency denominated debit card? (Ignore cents/decimals as debit cards may be issued in whole units only)
3-    When you are ready to leave the bank, you get a text message that your proposed assignment is cancelled because of the recent storm in Europe. Therefore, you are compelled to cancel your proposed trip. You hurry back to the bank and return the debit card to get your dollars back. What is the amount that you will get from the bank upon returning the card?
4-    What is the amount that you gained or lost in the combined pair of transactions as shown in (2) and (3)?
5-    What is the amount that you must return to your office?

21- Data for the money market and forex market in the US and UK are as follows:

Money Market and Forex Market Rates in the US and UK
London    New York
Spot Exchange Rate    $1.6000/£    £0.6250/$
One-year T-Bill rate    5.0000%    6.0000%

1-    Is the forex market in equilibrium now? Support your answer with a calculation.
2-    Estimate the forward rate between the two currencies in both markets.

27- Tektronics is a manufacturer of scientific instruments and is a US based MNC. The company”s treasurer, Dr. Robert Grosse, needs to choose an instrument to hedge a €2 million sale to Siemens, Germany and the payment is due in sex months. His bank has given him the following quotes:
Market Rates and Internal Data
Spot Rate    $1.0538/€
Six-month forward rate    $1.0687/€
Six-month euro interest rate    3.1250%
Six-month US dollar interest rate    6.0000%
Tektronics” weighted average cost of capital    12.0000%
Premium on Six-month call option on euros at strike price $1.1200/€    1.2000 cents of USD / €
Premium on Six-month put option on euros at strike price $1.1200/€    6.1000 cents of USD / €

He needs your assistance in hedging this transaction exposure. His firm does not permit remaining unhedged.
Calculate the following:
1-    Forward Market Hedge
2-    Money Market Hedge at Market Rates
3-    Money Market Hedge at the firm”s weighted average cost of capital (WACC)
4-    Options Market Hedge
5-    Which hedging strategy is the best according to your calculations?

23- Henri Jacque is an arbitrager with Bank of Montreal, Montreal, Canada. The bank”s home currency is the Canadian dollar (CAD or C$). He is authorized to engage in transactions subject to a maximum of C$20,000,000. His bank expects him to earn his profits in Canadian dollars (C$). He is studying the market data as shown below:

Spot rate    C$ 1.4900/$
6-month forward rate      C$1.5100/$
6-month interest for C$    7.5000% p.a
6-month interest for $    5.0000% p.a

Assume that the interest rates reported are for both borrowing and investing. Ascertain arbitrage profits, if any.