Gmmi Chap 5 Eun with Answers

Global Money Markets and Institutions

Chapter 5

Assignment #1

Fall 2017

1. Spot = BRL 3.00/$.

F6m = BRL 3.25/$.

Find the discount or premium on the BRL and the $.

Forward premium or discount on the BRL:  -15.38%.

Forward premium or discount on the $.  +16.67%.

1. Spot = $1.30/€.

F2y = $1.40/€.

Find the discount or premium on the € and the $.  €.

Forward premium or discount on the €:  +3.85%.

Forward premium or discount on the $.  -3.57%.

1. You are a portfolio manager in New York with $1,000,000 to invest on behalf of your clients for
   1 year.

Spot = $1.600/£.

F12m = $1.648/£.

i$ = 8.15%.

i£ = 5.00%.

There are two investment strategies.  Invest in dollars for one year, or convert the dollars to pounds, invest in pounds, and sell pounds forward.  Which strategy is better?

1. Invest only in US.

$1,000,000 x 1.0815 = $1,081,500.

1. Convert $1,000,000 to £.  

$1,000,000 x £/$1.600 = £625,000.

Invest.

£625,000 x 1.05 = £656,250.

Sell Forward.

£656,250 x $1.648/£ = $1,081,500.        

You are indifferent between the two strategies.

1. You are a portfolio manager in New York with $1,000,000 to invest on behalf of your clients for
   2 years.

Spot = $1.600/£.

F2y = $1.660/£.

i$ = ?

i£ = 5.00%.

There are two investment strategies.  Invest in dollars for two years, or convert the dollars to pounds, invest in pounds, and sell pounds forward.

1. Find the 2-year dollar interest rate that makes you indifferent between the two strategies.

1. ($1,000,000 x £/$1.600) x (1.05)2 x $1.660/£ = $1,4143,843.75.

                       Convert                    Invest        Sell

                                                                      Forward

1. Invest only in US and solve for r that makes you indifferent.

$1,143,843.75 = $1,000,000 x (1 + r)2.

r = 6.95%.

1. Can you write your answer as a general formula that works for any number of time periods?

             (1 + i$)t     =     F    .

             (1 + i£)t            S

     The Interest Rate Parity condition is the answer.

1. Find the percent changes in the renminbi and in the dollar.  Beginning value = RMB8.28/$.  Current value = RMB6.3/$.

%ΔRMB:  +31.43%.

%Δ$:  -23.91%.

Remember: always use the foreign currency price of the currency whose percent change you are calculating.  So for the percent change of the dollar, use RMB/$.  And for the percent change in the RMB, use $/RMB.

1. Weak currencies have high interest rates in order to attract investors.

1. Forward premium.  We know this because when the Ask points ae less than the Bid points, you subtract the points from the spot rate to get the forward quote.  So, the dollar is stronger in the forward market than in the spot market.

Some problems from the text book:

1. Over the past five years, the exchange rate between the pound and the dollar has changed from $1.90/£ to $1.45/£.  Would you agree that over the 5-year period, British goods have become cheaper for buyers in the US?

The answer depends on what has happened to the rate of inflation.  During the past five years, the dollar appreciated 31.03%, or about 5.6% per year on a compound annual basis.  And the pound depreciated 5.3% on a compound annual basis.  If annual inflation in the UK exceeded US inflation by less than 5.3% per year, then UK goods became cheaper for Americans to buy, because the pound weakened by more than was necessary to preserve PPP.  If  annual inflation in the UK  exceeded US inflation by more than 5.3% per year, then UK goods became more expensive for Americans to buy, because the weakened by less than was necessary to preserve PPP.