INTERNATIONAL

BUSINESS FINANCE FINS3616

Tutorial Week2
Chapter2

CONTACT DETAILS
YourTutor&TutorinCharge: PeterAndersen peter.andersen@unsw.edu.au

Besuretocheckyourstudentemailaccountlots throughoutthesemester,asIllbesendingyoumyslides andlotsofothermaterials.

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ASSESSMENTS
ASSESSMENT TutorialAttendance Midsemester Examination Group Project Final Exam DATE Everyweek Week7 Weeks11+12 Exam Period HOWMUCH 5% 30% 25% 40%

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CLASS PARICIPATION
COMPONENT HOWTOGETIT
ShowingupONTIMEeveryweek. ONTIMEisuntil15minutespastthestartof thehour.

HOW MUCH

Attendance

However,thiswillbecomestricterforstudents whokeeparrivingafterclassstarts. Attendinglessthan9ofthe12tutorialswill resultinamarkof0%outofthe5%.

5%

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CHAPTER 2 QUESTION 3
Q. Whatisaspotexchangeratecontract?Whendoesdeliveryoccuronaspot contract? A. Whencurrenciesintheinterbankspotmarketaretraded,certainbusiness conventionsarefollowed. Forexample,whenthetradeinvolvestheU.S.dollar,businessconvention dictatesthatspotcontractsaresettledin2businessdaysthatis,thepayment ofonecurrencyandreceiptoftheothercurrencyoccursin2businessdays. Onebusinessdayisnecessarybecauseofthebackofficepaperworkinvolved inanyfinancialtransaction. Theseconddayisneededbecauseofthetimezonedifferencesaroundthe world.
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CHAPTER 2 QUESTION 3
Q. CONTINUED. A. Severalexceptionstothe2businessdayrulearenoteworthy: 1. 2. ForexchangesbetweentheU.S.dollarandtheCanadiandollarorthe Mexicanpeso,theruleis1businessday. Ifthetransactioninvolvesthedollarandthefirstofthe2daysisaholiday intheUnitedStatesbutnotintheothersettlementcenter,thefirstdayis countedasabusinessdayforsettlementpurposes. FridaysarenotpartofthebusinessweekinmostMiddleEastern countries,althoughSaturdaysandSundaysare.Hence,nonMiddle EasterncurrenciessettleonFridays,andMiddleEasterncurrenciessettle onSaturdays.

3.

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CHAPTER 2 QUESTION 10
Q. WhatisadepreciationoftheThaibahtrelativetotheMalaysianringgit? Whathappenstothebahtpriceoftheringgitinthissituation? A. AdepreciationoftheThaibahtrelativetotheMalaysianringgitmeansthatit willtakemorebahttobuyoneringgit. Thus,thebahtpriceoftheringgitisnowhigherafterthedepreciationofthe baht. wastheoriginalrate. Letssaythat ThequestionstatesthattheTHBhasdepreciatedrelativetotheMYR. Thismeansthat,conversely,theMYRhasappreciatedrelativetotheTHB.
i.e.eachMalaysianringgitisnowabletobuymoreThaibahtthanbefore.

Sothenewappreciatedpriceoftheringgitmaybe

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CHAPTER 2 PROBLEM 1
Q. MississippiMudPies,Inc.needstobuy1,000,000Swissfrancs(CHF)topayits Swisschocolatesupplier.ItsbankerquotesbidaskratesofCHF1.3990/USD CHF1.4000/USD.WhatwillbethedollarcostoftheCHF1,000,000? A. Howtobreakthisdown: ThecompanywantstobuyCHF,whichmeanstheyresellingUSD. IftheyresellingUSD,theyllhavetodothatatthelowerCHF/USDprice, whichisthebanksbidofCHF1.3990/$. RememberthebankmustmakeaprofitoneachUSDfromtheir bid/ask IfthecompanyispurchasingCHF1,000,000atapriceofCHF1.3990/USD, howmanyUSDdotheypay?
CHF 1, 000, 000 Cost in USD CHF1.3990/USD 1, 000, 000 USD 714, 796 USD 1.3990
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CHAPTER 2 PROBLEM 2
Q. IftheJapaneseyenU.S.dollarexchangerateis104.30/$,andittakes25.15 Thaibahts topurchase1dollar,whatistheyenpriceofthebaht? A. Topreventtriangulararbitrage,thedirectquoteoftheyenpriceofthebaht (/THB)mustequaltheyenpriceofthedollartimesthedollarpriceofthe baht(whichisthereciprocalofthebahtpriceofthedollar):

YEN104.30/USD YEN4.1471/THB THB25.15/USD

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ASIDE: TRIANGULAR ARBITRAGE

Howtotellifthereisatriangulararbitrageprofitandhowtomakeit: Whenyouarrangethequotesasfollows,thecrossmultiplicationshould equalone
i.e. CAD1.60 USD1.25 EUR0.5 1 USD EUR CAD

CASE1:Ifitislessthan1,sellthecurrenciesinthenumeratortobuythe currenciesinthedenominatorofeachquote.
e.g. CAD1.60 USD1.25 EUR0.4 USD EUR CAD

0.8

i.e. 1

SellCAD1.60tobuyUSD1.00. Becauseourarbitragetest<1, our%profitsherecouldbe SellUSD1.00andbuyEUR0.80. calculatedquicklybytakingthe reciprocalasfollows: SellEUR0.80andbuyCAD2.00. (1/0.80) 1=0.25=25% YounowhaveCAD0.4morethanwhenyoustarted.
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ASIDE: TRIANGULAR ARBITRAGE

Howtotellifthereisatriangulararbitrageprofitandhowtomakeit: Whenyouarrangethequotesasfollows,thecrossmultiplicationshould equalone
i.e.

CAD1.60 USD1.25 EUR0.5 1 USD EUR CAD

CASE2:Ifitisgreaterthan1,sellthecurrenciesinthedenominatortobuy thecurrenciesinthenumerator.
e.g.

CAD1.60 USD1.25 EUR0.6 USD EUR CAD

1.2

i.e. 1

SellUSD1.00andbuyCAD1.60. Becauseourarbitragetest>1,our %profitsherecouldbecalculated SellCAD1.60andbuyEUR0.96. quicklybysubtracting1. SellEUR0.96andbuyUSD1.20. 1.2 1=0.2=20% YounowhaveUSD0.2morethanwhenyoustarted.

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CHAPTER 2 PROBLEM 3
Q. Asaforeignexchangetrader,youseethefollowingquotesforCanadian dollars(CAD),U.S.dollars(USD),andMexicanpesos(MXN): USD0.7047/CADMXN6.4390/CADMXN8.7535/USD Isthereanarbitrageopportunity,andifso,howwouldyouexploitit?? A. FliptheMXN/CADquoteandthenarrangethemtofollowtherules

USD0.7047 CAD0.15530 MXN8.7535 0.9580 i.e. < 1 CAD MXN USD

Asitislessthan1,sellthecurrenciesinthenumeratortobuythecurrenciesin thedenominator. Becauseourarbitragetest<1, I. SellUSD1.00andbuyCAD1.4190. our%profitsherecouldbe calculatedquicklybytakingthe II. SellCAD1.419andbuyMXN9.1372. reciprocalasfollows: (1/0.9580) 1=0.0438 III. SellMEX9.1369andbuyUSD1.0438. IV. YounowhaveUSD0.0438morethanwhenyoustarted.
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ASIDE: APPRECIATION/DEPRECIATION
Q. Theexchangerateatthestartoftheyearwas .However,the valueoftheUSDhassincethenappreciatedby25%againstthevalueofthe AUD.WhatisthecurrentUSDpriceofoneAUD? A. ItistemptingtosaythatiftheUSDhasappreciatedby25%againsttheAUD, thentheAUDhasdepreciatedby25%againsttheUSD. SothatyoucouldjustworkoutthenewpriceofanAUDbymultiplyingby0.75 again,inwhichcaseyouwouldget THISISWRONG!!!(itdoesntworkmathematically). Letstakealookatwhy:
First, canbeinvertedto IftheUSDappreciates25%againsttheAUD,howmanyAUDcanoneUSD purchase? x(1+0.25) = SowhatisthevalueifweconvertbacktotheUSDpriceofanAUD? ..whichisthesameas1.00DIVIDEDby(1+0.25) ratherthanmultipliedby(1 0.25),whichisincorrect
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CHAPTER 2 PROBLEM 4
Q. TheMexicanpesohasweakenedconsiderablyrelativetothedollar,andyou aretryingtodecidewhetherthisisagoodtimetoinvestinMexico.Suppose thecurrentexchangerateoftheMexicanpesorelativetotheU.S.dollaris MXN9.5/USD.YourinvestmentadvisoratGoldmanSachsarguesthatthe pesowilllose15%ofitsvaluerelativetothedollaroverthenextyear.What isGoldmanSachssforecastoftheexchangeratein1year? A. AlthoughtheMexicanpesoiscurrentlyquotedasMXN9.5/USD,thisisthe equivalentofUSD0.10526/MXNwhenwetakethereciprocal. IfthevalueoftheMXNfallsby15%,itwillbeworth: USD0.10526/MXNx(1 0.15)=USD0.08947/MXN ThiscanbereexpressedasMXN11.1765/USDwhenwetakethereciprocal. ThisisthesameasMXN9.5/USDdividedby(1 15%).

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CHAPTER 2 PROBLEM 5
Q. DeutscheBankquotesbidaskratesof$1.3005/$1.3007/ and104.30 104.40/$.WhatwouldbeDeutscheBanksdirectaskingpriceofyenpereuro (/)? A. Thedirectaskingpriceofyenpereuro(/)isthepriceatwhichyouthe customerwillbuyeurosfrom(andsellyen to)thebank. Sofirst,identifytheratesatwhichyoucanbuyeurosandsellyenagainstthe dollar. Theseare$1.3007/ and104.40/$respectively
notethatsellingYenisthesameasbuying$,hencethehigheraskpriceper$

Then,createthecrossrate:
USD 1.3007 YEN104.40 1.3007 YEN104.40 EUR USD EUR YEN135.79 YEN135.79 / EUR EUR
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CHAPTER 2 PROBLEM 6
Q. AluminaLimitedofAustraliahascalledMitsubishiUFJFinancialGrouptoget itsopinionabouttheJapaneseyenAustraliandollarexchangerate. Thecurrentrateis67.72/A$,andMitsubishithinkstheAustraliandollarwill weakenby5%overthenextyear.WhatisMitsubishiUFJsforecastofthe futureexchangerate? A. IftheAustraliandollarweakensby5%overthenextyear,itwilltake5%fewer JapaneseyentopurchasetheAustraliandollar.Thus,theforecastis 67.72/A$ x(1 0.05)=64.334/A$
AskyourselfifthevalueoftheYENappreciatesby25%againsttheAUD,bywhat%wouldtheAUD depreciateagainsttheYEN?Whatabout100%?Whatabout100,000,000,000%

AUD

1 1 1 1 YEN 1 0 . 25 1 %

0.20 20%
0.50 50%

1 1 1 1.00

Thereisanasymptoteat100%,becausean exchangeratecanneverbecomenegative.

1 1 0.99999999 99.999999% 1 1,000,000,000

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ADDITIONAL TUTORIAL QUESTION 1

Q. Illustratethedifferencebetweendirectandindirectquotesofanexchange rate. A. AdirectquoteforaGIVENcurrencygivesthepriceofoneunitoftheOTHER currencyintermsofthegivencurrency.Thatis,intheform GIVENCURRENCYX.XXXX/OTHERCURRENCY. e.g.AUD1.3781/EURisadirectquotefortheAUD AnindirectquoteforaGIVENcurrencygivesthepriceofoneunitofthegiven currencyintermsoftheothercurrency.Thatis,intheform OTHERCURRENCYX.XXXX/GIVENCURRENCY. e.g.EUR0.7256/AUDisanindirectquotefortheAUD

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ADDITIONAL TUTORIAL QUESTION 2

GiventhatEUR/AUD=0.8316 0.7661(i.e.1AUD=unitsofEUR). Q. Isthisadirectorindirectquote(andfromwhoseviewpoint)? ThisisanindirectquotefromtheAustralianperspective,astheBid>Ask. Despitehowthislooks,rememberthatthequotingbankmuststillmakea profitfromthebid/askspread. Q. Converttheaboveratetobothdirectandindirectquotationfromtheother countrysperspective. Alternatively,adirectquotefromtheAustralianperspectivewouldbe: AUD/EUR=1.2025 1.3053 ChangingittoadirectquotefromtheEurozoneperspective,weget: EUR/AUD=0.7661 0.8316 AndsothusanindirectquotefromtheEurozoneperspectivewouldgive AUD/EUR=1.3053 1.2025

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SUMMARY OF DIRECT vs. INDIRECT

XXXCurrencyperspective DIRECT INDIRECT
XXX/YYY: LHS<RHS YYY/XXX:LHS >RHS

YYYCurrencyperspective
YYY/XXX: LHS<RHS XXX/YYY:LHS >RHS

AUSTRALIANperspective DIRECT
AUD1.2025/EUR AUD1.3053/EUR

EUROZONEperspective
EUR0.7661/AUD EUR0.8316/AUD

INDIRECT

EUR0.8316/AUD EUR0.7661/AUD

AUD1.3053/EUR AUD1.2025/EUR

AlwaysremembertoFIRSTlookatwhethertheBidislessthantheAsk: IfBid<Ask,itsaDirectquotesotheperspectivecurrencyisinthenumerator. IfBid>Ask,itsanIndirectquotesotheperspectivecurrencyisinthedenominator.

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ADDITIONAL TUTORIAL QUESTION 3

Q. GiventhatHKD/AUD=5.1235 5.0338andYEN/AUD=86.24 84.71 CalculatetheequilibriumcrossratebetweentheHKDandtheYen. A. Toanswerthisquestion,weneedtofindtwocrossrates:
1. 2. TheHKD/YENrateatwhichwecouldsellHKDtothebankto buyYEN. TheHKD/YENrateatwhichwecouldsellYENtothebanktobuyHKD.

AstheAUDisinthedenominator,itseasiertothinkofwhatyou(acustomer)isdoingwiththeAUD. i.e.webuyAUDfromthebankatthehighprice,andsellAUDtothematthelowprice.

TofindthesellHKD/buyYEN rate,usetheratesfordoingthosethingsagainsttheAUD: IfImsellingHKD,ImsimultaneouslybuyingAUD. AndwhenIbuyAUDfromthebank,Ipaythehigherprice:HKD5.1235/AUD IfImbuyingYEN,ImsimultaneouslysellingAUD. WhenIsellAUDtothebank,Ireceivethelowerprice:YEN84.71/AUD

SothesellHKD/buyYEN rateisHKD5.1235/YEN84.71=HKD0.0604/YEN
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ADDITIONAL TUTORIAL QUESTION 3

Q. GiventhatHKD/AUD=5.1235 5.0338andYEN/AUD=86.24 84.71 CalculatetheequilibriumcrossratebetweentheHKDandtheYen. A. Toanswerthisquestion,weneedtofindtwocrossrates:
1. 2. TheHKD/YENrateatwhichwecouldsellHKDtothebanktobuyYEN. TheHKD/YENrateatwhichwecouldsellYENtothebanktobuyHKD.

AstheAUDisinthedenominator,itseasiertothinkofwhatyou(acustomer)isdoingwiththeAUD. i.e.webuyAUDfromthebankatthehighprice,andsellAUDtothematthelowprice.

TofindthebuyHKD/sellYEN rate,usetheratesfordoingthosethingsagainsttheAUD: IfImbuyingHKD,ImsimultaneouslysellingAUD. AndwhenIsellAUDtothebank,Ireceivethelowerprice:HKD5.0338/AUD IfImsellingYEN,ImsimultaneouslybuyingAUD. WhenIbuyAUDfromthebank,Ipaythehigherprice:YEN86.24/AUD

SothebuyHKD/sellYEN rateisHKD5.0338/YEN86.24=HKD0.0584/YEN
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ADDITIONAL TUTORIAL QUESTION 3

Q. IfthemarketratebetweenYenandHKDinHongKongisHKD/Yen=0.0582 0.061,isthereanarbitrageopportunityforanAustralianarbitrageurwhohas AUD1munderhis/herdisposal? A. No,thereisnoarbitrageopportunityavailable. IfyouweretopurchaseoneYENatthequotedmarketcrossrate(andpayHKD 0.061)andsellitthroughthecalculatedcrossratesfromthepreviousquestion (andreceiveHKD0.0584),youwouldclearlymakealossforeachYEN. Similarly,ifyouweretopurchaseoneYENatthecalculatedcrossrates(and payHKD0.0604)andsellitthroughthequotedmarketrate(andreceiveHKD 0.0582),youwouldlikewisemakealossoneachYEN.

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ADDITIONAL TUTORIAL QUESTION 3

BID
CalculatedCross Rates

ASK

HKD/YEN0.0584

HKD/YEN0.0604

BID

QuotedMarketRates

ASK

HKD/YEN0.0582

HKD/YEN0.061

Thetwobuying(i.e.ask)pricesfortheYENarebothhigherthanthe pricesatwhichyoucouldselltheYEN(i.e.bids). Therefore,noarbitrageispossible.

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ADDITIONAL TUTORIAL QUESTION 3

Q. RepeatpartB.forHKD/Yen=0.0620.065. Yes,thereisanarbitrageopportunityavailable,iftheappropriatetransactions areexecuted.
BID
HKD/YEN0.0584
CalculatedCross Rates

ASK

BID

QuotedMarketRates

ASK

HKD/YEN0.0604

HKD/YEN0.0620

HKD/YEN0.0650

PurchaseYENwithHKDviatheAUDusingthecalculatedcrossrateofHKD0.0604/YEN. ThensellYENforHKDusingthequotedcrossrateofHKD0.0620/YEN. ThethreestepsfromabaseofAUD1mwouldbeasfollows: I. SellyourAUD1matYEN84.71/AUD=ReceiveYEN84.71m II. SellYEN84.71matHKD0.0620/YEN=ReceiveHKD5.25202m III. SellHKD5.25202matHKD5.1235/AUD=ReceiveAUD1,025,084.41 YourprofitisAUD25,084.41.

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Wemultiplied Wemultiplied Wedivided

ADDITIONAL TUTORIAL QUESTION 4

Thefollowingdatawasavailableon10Feb.2000: Spotrate(Retail):USD/AUD=0.63590.6303 3monthforwardmargin=67 3monthinterestrates:5.78%inAustralia,5.92%intheU.S. Q. IstheAUDindiscountorPremium?Why? A. AstheAustralianinterestratesarelowerthanthoseintheUnitedStates,the AUDistradedataforwardpremiumrelativetotheUSD.

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