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Answers To End of Chapter 7's Questions: SPD4205: Multinational Business Finance 1

This document provides answers to questions from the end of Chapter 7. It discusses covered interest arbitrage opportunities between currencies when interest rates differ between countries. It also provides examples of how covered interest arbitrage works and the factors that need to be considered when determining if it can be profitably employed.

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Wan MP William
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50 views

Answers To End of Chapter 7's Questions: SPD4205: Multinational Business Finance 1

This document provides answers to questions from the end of Chapter 7. It discusses covered interest arbitrage opportunities between currencies when interest rates differ between countries. It also provides examples of how covered interest arbitrage works and the factors that need to be considered when determining if it can be profitably employed.

Uploaded by

Wan MP William
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Answers to End of Chapter 7s Questions

2. Yes! One could purchase New Zealand dollars at Yardley Bank for $.40 and sell them to Beal Bank for $.401. W th $1 m ll on a!a la"le# $.% m ll on New Zealand dollars could "e purchased &nternat onal 'r" tra(e and &nterest )ate *ar ty at Yardley Bank. +hese New Zealand dollars could then "e sold to Beal Bank for $1#00$#%00# there"y (enerat n( a prof t of $$#%00. +he lar(e demand for New Zealand dollars at Yardley Bank w ll force th s "ank,s ask pr ce on New Zealand dollars to ncrease. +he lar(e sales of New Zealand dollars to Beal Bank w ll force ts " d pr ce down. Once the ask pr ce of Yardley Bank s no lon(er less than the " d pr ce of Beal Bank# locat onal ar" tra(e w ll no lon(er "e "enef c al. 4. Yes. +he appropr ate cross e-chan(e rate should "e 1 .anad an dollar / 0 New Zealand dollars. +hus# the actual !alue of the .anad an dollars n terms of New Zealand dollars s more than what t should "e. One could o"ta n .anad an dollars w th 1.2. dollars# sell the .anad an dollars for New Zealand dollars and then e-chan(e New Zealand dollars for 1.2. dollars. W th $1#000#000# th s strate(y would (enerate $1#003#334 there"y represent n( a prof t of $3#334. 5$1#000#0006$.70 / .$1#111#111 8 0.0$ / NZ$0#0%%#%%3 8 $.00 / $1#003#3349 +he !alue of the .anad an dollar w th respect to the 1.2. dollar would r se. +he !alue of the .anad an dollar w th respect to the New Zealand dollar would decl ne. +he !alue of the New Zealand dollar w th respect to the 1.2. dollar would fall. 8. +he e-pectat ons of a weaker 1.2. economy resulted n a decl ne of short:term nterest rates ; n fact# the <ed e-ped ted the mo!ement "y ncreas n( l =u d ty n the "ank n( system>. +he 1.2. nterest rate was reduced wh le fore (n nterest rates were not. +herefore# the forward prem um on fore (n currenc es decreased# or the forward d scount "ecame more pronounced. 11. +he .anad an dollar,s forward rate should e-h " t a d scount "ecause ts nterest rate e-ceeds the 1.2. nterest rate. 1.2. n!estors would earn a return of 10 percent us n( co!ered nterest ar" tra(e# the same as what they would earn n the 1.2. .anad an n!estors would earn a return of 11 percent us n( co!ered nterest ar" tra(e# the same as they would earn n .anada. 13. a. +rue ". +rue

2*?4$0%@ Ault nat onal Bus ness < nance

18. .o!ered nterest ar" tra(e would "e worth cons der n( s nce the return would "e $1.B percent# wh ch s much h (her than the 1.2. nterest rate. 'ssum n( a $1#000#000 n t al n!estment# $1#000#000 8 ;1.40> 8 .B4 / $1#$1B#000 Y eld / ;$1#$1B#000 C $1#000#000>6$1#000#000 / $1.BD Eowe!er# the funds would "e n!ested n Aalays a# wh ch could cause some concern a"out default r sk or (o!ernment restr ct ons on con!ert " l ty of the currency "ack to dollars. 21. a. ;1.04 6 1.03> / C0.01B7 / F1.B7D ". < / $1.10 ;1 C 0.01B7> / $1.047 22. a. .o!ered nterest ar" tra(e would n!ol!e the follow n( steps@ 1. .on!ert dollars to Aoroccan d rham@ $%00#0006$.11 / A?4#%4%#4%4.%% $. ?epos t the d rham n a Aoroccan "ank for 30 days. You w ll ha!e A?4#%4%#4%4.%% 8 ;1.0$> / A?4#303#030.34 n 30 days. 0. &n 30 days# con!ert the d rham "ack to dollars at the forward rate and rece !e A?4#303#030.34 8 $.10B / $%00#4$4.$4 +he y eld to the 1.2. n!estor s $%00#4$4.$46$%00#000 C 1 / .1%D. .o!ered nterest ar" tra(e d d not work for the n!estor n th s case. +he lower Aoroccan forward rate more than offsets the h (her nterest rate n Aorocco. ". Yes# co!ered nterest ar" tra(e would "e poss "le for a Aoroccan n!estor. +he n!estor would con!ert d rham to dollars# n!est the dollars at a 1 percent nterest rate n the 1.2.# and sell the dollars forward 30 days. G!en thou(h the Aoroccan n!estor would earn an nterest rate that s 1 percent lower n the 1.2.# the forward rate d scount of the d rham more than offsets that d fferent al. 29. &f 1.2. nterest rates ncrease# then the forward rate of the yen w ll e-h " t a prem um. +herefore# f you hed(e your rece !a"les at the end of th s month# the dollar amount to "e rece !ed would "e h (her. 47. $100#0006$.44/'$10%#10% '$10%#10% - .3B / 71#B7$ euros. 71#B7$ euros6.71 / $100#7B0 Ha n / $100#7B0 : $100#000 / $7B0

2*?4$0%@ Ault nat onal Bus ness < nance

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