Question and problem

Chapter 3,
1. From base price levels of 100 in 2000, Japanese and US price levels
in 2003 stood at 102 and 106, respectively. If the 2000 $:¥
exchange rate was $0.007692, what should the exchange rate be in
2003? In fact, the exchange rate in 2003 was ¥1 = $0.008696. What
might account for the discrepancy?
2. Two countries, The US and England, produce only one good, wheat.
Suppose the price of wheat in the US is $3.25 and in England is £
1.35.
a. According to the law of one price, what should the $:£ spot
exchange rate will be?
b. Suppose the price of wheat over the next year is expected to rise
to $3.50 in the US and £1.60 in England. What should the one-
year $:£ forward rate be?
c. If the US government imposes a tariff of $0.50 per bushel on
wheat imported from England, what is the maximum possible
change in spot exchange rate that could occur
3. In July, the one year interest rate is 12 % on British pounds and 9%
on US dollar
a. If the current exchange rate is £ 1= $1.63. What is the expected
future exchange rate in one year?
b. Suppose a change in expectations regarding future US inflation
causes the expected future spot rate to decline to £ 1= $1.52.
What should happen to the US rate?
4. Suppose three year deposit rates on eurodollar and eurofranc
(Swiss) is 12% and 7%. If the current spot rate for Swiss franc is
$0.3985. What is the spot rate implied by theses interest rates for
francs three year from now?
Chapter 4

1. Suppose you observe the following direct spot quotations in NY and

Toronto, respectively: 0.8000-50, and 1.2500-60. What are the
arbitrage profits per $1 millions?
2. Suppose the euro is quoted at 0.7064-80 in London, and the pound
sterling is quoted at 1.6244–59 in Frankfurt. Is there a profitable
arbitrage situation? Describe it.
3. Here are some prices in the International money markets:
- Spot rate = $0.75/SFr
- Forward rate (one year) = $0.77/SFr
- Interest rate (SFr) = 7% per year
- Interest rate ($) = 9% per year
a. Assuming no transaction cost or taxes exist, is there arbitrage
opportunity in the above situation? Describe the flows?
b. Suppose now that transaction cost in the foreign exchange
market equal 0.25%per transaction. How much we can earn in
this situation?
4. Telerate Screen company get market information as follows:
- Spot rate = $ 0.711-22/SFr
- Forward rate (30 days) = $ 0.726-32/SFr
- Interest rate (US$ = 4.99 -5.03% per year
- Interest rate (SFr) = 3.14 –3.19 % per year
a. Do we have an arbitrage opportunity in this situation?
b. What steps must you take to capitalize on it?
c. What is the profit per $1 million arbitraged?
7. Suppose today’s exchange rate is $0.62/SFr. The 6 month interest
rates on dollars and SFr are 6% and 5%, respectively. The 6 month
forward rate is $0.6185. A foreign exchange advisory service has
predicted that the SFr will appreciate to $0.64 within six months.
a. How would you use forward contracts to profit in the above
situation?
b. How would you use money market instruments (borrowing and
lending) to profit?
c. Which alternatives (forward contracts or money market
instrument) would you prefer? Why?
Chapter 5
1. A company enters into a short future contract to sell 5,000 bushels
of wheat for 250cent per bushel. The initial margin is $3,000 and
the maintenance margin is $2,000. What price change would lead to
a margin call? Under what circumstances could $1,500 be withdraw
from the margin account?
2. An investor enter into a short cotton futures contract when the
futures price is 50 cents per pound. One contract is for the delivery
of 50,000 pounds. How much does the investor gain or lose if the
cotton price at the end of the contract is (a) 48.20 cents per pound
and (b) 51.30 cents per pound?
3. A pig farmer expects to have 90,000 pounds of live hogs to sell in
three months. The live-hogs futures contract on the CME is for the
delivery of 30,000 pounds of hog. How can the farmer use the
contract for hedging? From the farmer’s viewpoint, what are the
pros and cons of hedging?
4. Suppose that on October 24, 2007 you take a short in an April 2008
live-cattle futures contract. You close out your position on January
21, 2008. The futures price (per pound) is 61.20 cents when you
enter into the contract, 58,30 cents when you close out your
position, and 58.80 cents at the end of December 2007. One
contract is for the delivery of 40,000 pounds of cattle. What is your
total profit?
5. On April, the spot price of pound was $1.86 and the price of the June
future contract was $1.85. During April, the pound appreciated, and
by May 1 it was selling for $1.91. What do you think happened to
the price of June pound futures contract during April? Explain.
6. Suppose the forward ask price for March 20 on SFr is $0.7127 at the
same time the price of IMM SFr futures for delivery on March 20 is
$0.7145. How could an arbitrageur profit from this situation? What
will be the arbitrageur’s profit per futures contract (contract size is
SFr 125,000)?
7. On Monday morning, an investor takes a long position in a pound
futures contract that matures on Wednesday afternoon. The agreed-
on price is $1.78 for BP62,500. At the close of trading on Monday,
the future price has risen to $1.79. At Tuesday close, the future
price rises further to $1.80. At Wednesday close, the future price
falls to $1.785, and the contract matures. The investor trade off the
contract, detail the daily settlement process. What will be the
investor’s profit (loss)?
Chapter 6
1. Citicorp sells a call option on Deutsche marks (Contract size DM
500,000) at a premium of $0.04 per DM. If the exercise price is
$0.71 and the spot price of Mark at date of expiration is $0.73. What
is Citicorp’s profit (loss) on the call option?
2. Three put options on a stock have the same expiration date and
strike prices of 55$, 60$, and $65. The market prices are $3, $5,
and $8, respectively. Explain how a butterfly spread can be created.
Construct a table showing the profit from the strategy. For what
range of stock prices would the butterfly spread lead to a loss?