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Ans.
Ans.
1
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
In the above case the exchange margin of .08 % shall be deducted from Spot
October Rate i. e. 49.2500 + 0.2200 =49.4700 and .08% of 49.4700 is .03957 so
the bank shall give a net sell rate of Rs. 49.4304 for purchase of Mail Transfer net
of Margins.
Less: Exchange Margin .(08/ 100) x 49.47 = 0.03957 49.4302 Rs. 247,152.12
¥ = 81.87 x 1
$ = 1/ 0.9544
C$ Bid 0.9546
C$ Ask
¥ = 85. 76
2
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
C$ Bid
¥ = 81.89 x 1
C$ Ask 0.9544
¥ = 85.80
C$ Ask
Buy C$ @ 85.75 and Sell C$ @ 85.76 by making Arbitrage Profit of 0.01 Yen.
4. The current Bank interest rate of U.S. and India are 4.5 % and 8.5 %
respectively. The present spot market rate in U.S. $ is Rs. 45.36. What
will be the 12 months forward rate?
F = 1+ I h
So 1 + IF
F = 1+ 0.085 = 47.096
So 1 + 0.045
5. The current Inflation rate of U.S. and India are 3 % and 8% respectively.
The present spot market rate in U.S. $ is Rs. 45.36. What will be the 12
months forward rate?
Ans. S1 = ? , So = 45.36, I h = 8% , IF= 3 %.
S1 = 1+ P h
So 1 + PF
S1 = 1+ 0.08 = 47.56
3
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
So 1 + 0.03
6. Calculate the arbitrage possibilities, if Spot rate: Rs 42.0010 = $ 1
6 month forward rate: Rs 42.8020 = $ 1, Annualized interest rate on:
– 6 month rupee: 12 %.
– 6 month dollar: 8%.
Ans.
• The rule is that if the interest rate differential is greater than the premium
or discount, place the money in the currency that has a higher rate if
interest or vice –versa.
Given the above data:
• Negative interest rate differential= (12-8)= 4%
• Forward premium (annualized) = Forward rate-Spot rate * 100 * 12
Spot rate 6
= 42.8020 – 42.0010 * 100 * 12 = 3.8141 %
42.0010 6
• Negative interest rate differential> forward premia, therefore, there is a
possibility of arbitrage inflow in India.
• Suppose, investment = $1000 by taking a loan @ 8% in US. Invest in India
at spot rate of Rs 42.0010 @ 12 % for six months and cover the principal +
interest in the six month forward rate.
• Principal= $ 1000 = Rs 42001, Interest on investment for six months
= Rs 42,001 * 12/ 100* 6/12 = Rs 2520.06
• Amount at the end of six months = Interest + Principal
= Rs 42001+ 2520.06 = Rs 44,521.06
• Converting the above in dollars at the forward rate
= $ 44,521.06 / 42.8020 = $ 1,040.16
• The arbitrageur will have to pay at the end of six months
= $1,000+ ($1000* 8/100 *6 /12)
• Hence, the arbitrageur gains ($1040.16 -$1040) = $ 0.16 on borrowing
$1000 for six months.
4
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
– Rs/US $
– London Rs.: 42.5730--42.61
– Tokyo $: 42.6350 -- 42.6675
– Can make money out of it?
Ans.
• Buy at London market at 42.6100 and sell the same at Tokyo market for
Rs.42.6350.
• Suppose you buy from London for 100 million Rupees you can get 100
million /42.61=$2,346,866.932
• Sell $ 2,346,866.932 in Tokyo market at Rs. 42.6350 gives
Rs.100,058,671.16
• There is transaction costs involved.
• Note: selling price of one market should be higher than buying price of
another market.
8. Following are three quotes in three FOREX markets
‒ 1$=Rs.48.3011 in Mumbai
‒ 1pound=Rs.77.1125 in London
‒ 1Pound=$1.6231 in New York.
• Are there any arbitrage gains possible? Assume there are no
transaction costs and the arbitrageur has $1,000,000.
Ans.
• The cross rate between Mumbai and London with respect to $/pound
=77.1125/48.3011 =$1.5965/pound
• But in New York the price is quoted $1.6231
• There is an opportunity to earn by buying Indian rupee in Mumbai market
and convert them into pounds in London Market
• Then convert pounds into Dollors in New York market.
• Rs.48.3011X 1 million Dollar=Rs.48,301,100
5
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
• Pounds=48,301,100/77.1125=626,371.8592
• Dollars=626,371.8592X1.6231 =$1,016,664.164.
The gain is = $16,664.164.
9. Determine arbitrage gain from the following data:
6
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
10.Euro is quoted in Chennai Spot Rs. 58.05, 6 Months forward at Rs. 58.40.
Interest Rates in Chennai is 6% and in Frankfurt 5% p.a.
Ans.
7
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
Ans.
• TT Selling Rate:
• Spot Selling Rate + Exchange Margin
• = 24.95 + ( 24.95 x 0.10/ 100) = 24.975
• 2 Months forward selling rate is TT selling Rate – 2 Months Discount
• 24.975 – 0.20 = 24.775
8
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
9
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
• If you were to buy $5,000,000 worth of British pounds and then sell
them five minutes later without the bid or ask changing, how much of
your $5,000,000 would be "eaten" by the bid-ask spread?
Ans.
• Convert dollars to pounds:
• ($5,000,000)/(2.10) = £2,380,952.38
• Convert pounds back to dollars:
• £2,380,952.38 X 2.07 = $4,928,571.43
• Loss due to bid-ask spread:
• $5,000,000 - $4,928,571.43 = 71,428.57
18.The dollar-euro exchange rate is $1.5968 = €1.00 and the dollar-yen
exchange rate is ¥108.0030 = $1.00.
10
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
11
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
21.The dollar-Swiss Franc exchange rate is $0.8922 = SF1.00 and the dollar-
Australian Dollar exchange rate is $0.7620 = AUD1.00. What is the Swiss
Franc to Australian Dollar (SF/AUD) cross rate?
Ans.
• SF/AUD = (SF/$) X ($/AUD)
• SF/AUD = (1/(0.8922)) X (0.7620) = 0.854069
22.The Dollar to Swiss Franc spot exchange rate is $0.8918/SF1.00, the
Dollar to Pound spot exchange rate is $1.6302/£1.00, and the SF to Pound
spot exchange rate is SF1.7914/£1.00.
• Determine the triangular arbitrage profit that is possible if you have
$8,000,000.
Ans. Calculate the implied cross rate:
• SF/£ = (SF /$) X ($/£)
• SF/£ = (1/(0.8918)) X 1.6302 = 1.827988
• Note that the implied SF/£ cross rate is larger than the actual exchange
rate. This means that pounds are less costly (in terms of SF) using the
actual exchange rate.
• This indicates we should buy SF using dollars and exchange them into
pounds at the actual exchange rate. (Note: If you purchase the wrong
currency first, you will end up with a loss that is equal to the gain you get
if you go in the other direction.)
• Trade dollars for SF:
• $8,000,000 x (1/(0.8918)) = SF8,970,621.22
• Trade SF for pounds (using actual exchange rate):
• (SF8,970,621.22)/(1.7914) = £5,007,603.67
• Trade pounds for dollars:
• £5,007,603.67 X 1.6302 = $8,163,395.50
• Profit = $8,163,395.50 - $8,000,000 = $163,395.50
12
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
23.The current spot exchange rate is $2.0507/£ and the three-month forward
rate is $2.0753/£. You enter into a short position on £120,000.
• At maturity, the spot exchange rate is $2.0919/£. How much have you
made or lost?
Ans.
• You are short, so you must sell at the forward price.
• At maturity, you buy pounds at the spot rate:
• £120,000 X $2.0919 = $251,028
• You sell the pounds at the forward rate:
• £120,000 X $2.0753 = $249,036
• Your profit or loss is the sale value minus the cost: $249,036 - $251,028 =
loss of $1,992
24.The current spot exchange rate is $2.0507/£ and the three-month forward
rate is $2.0753/£. You enter into a long position on £120,000.
• At maturity, the spot exchange rate is $2.0919/£. How much have you
made or lost?
Ans.
• You are long, so you must buy at the forward price.
• At maturity, you buy pounds at the forward rate:
• £120,000 X $2.0753 = $249,036
• You sell the pounds at the spot rate:
• £120,000 X $2.0919 = $251,028
• Your profit or loss is the sale value minus the cost: $251,028 - $249,036 =
gain of $1,992.
25.The current spot exchange rate is $1.7261/£ and the three-month forward
rate is $1.7779/£. You enter into a short position on £130,000.
• At maturity, the spot exchange rate is $1.7672/£. How much have you
made or lost?
13
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
Ans.
• You are short, so you must sell at the forward price.
• At maturity, you buy pounds at the spot rate:
• £130,000 X $1.7672 = $229,736
• You sell the pounds at the forward rate:
• £120,000 X $1.7779 = $231,127
• Your profit or loss is the sale value minus the cost: $231,127 - $229,736 =
gain of $1,391
26.The current spot exchange rate is $1.7261/£ and the three-month forward
rate is $1.7779/£. You enter into a long position on £130,000.
• At maturity, the spot exchange rate is $1.7672/£. How much have you
made or lost?
Ans.
• You are long, so you must buy at the forward price.
• At maturity, you buy pounds at the forward rate:
• £120,000 X $1.7779 = $231,127
• You sell the pounds at the spot rate:
• £130,000 X $1.7672 = $229,736
• Your profit or loss is the sale value minus the cost: $229,736 - $231,127 =
loss of $1,391
27.Suppose that the one‐year interest rate is 5.32% in the United States, the s
pot exchange rate is $1.5694/€1.00, and the one‐year forward exchange ra
te is $1.5313/€1.00.
• Based on interest rate parity, what must the one‐year interest rate be i
n the euro zone?
Ans.
• F = S((1+i$)/(1+i€)
• 1.5313 = 1.5694((1+0.0532)/(1+i€)
• 1.5313(1+i€) = (1.5694)(1+0.0532)
• (1+i€) = [(1.5694)(1.0532)/(1.5313)
• i€ = [(1.5694)(1.0532)/(1.5313)] 1
• = 0.0794 = 7.940%
14
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
28.Suppose that the one‐year interest rate is 4.53% in Italy, the spot exchang
e rate is $1.5296/€1.00, and the one‐year forward exchange rate is $1.5570
/€1.00.
• Based on interest rate parity, what must the one‐year interest rate be i
n the United States?
Ans.
• F = S((1+i$)/(1+i€)
• 1.5570 = 1.5296((1+i$)/(1+0.0453))
• i$ = [(1.0453)(1.5570)]/(1.5296) 1 = 0.06402 = 6.402%.
29.A currency dealer has good credit and can borrow $870,000 (or the equiv
alent in euros) for one year.
• The interest rate in the U.S. is 3.30% p.a.
• In the euro zone the one‐year interest rate is 8%.
• The spot exchange rate is $1.4601 = €1.00 and the one‐year forward excha
nge rate is $1.3811 = €1.00.
What arbitrage profit would be realized if the trader borrows the maximum availa
ble amount of funds?
Ans.
• Borrow Euros and convert to dollars: €595,849.60 X 1.4601 = $870,000
• Invest $ @ 3.3%: $870,000 X (1 + 0.033) = $898,710
• Convert enough dollars to Euros to pay loan:
• Loan payoff = €595,849.60 X (1 + 0.08) = €643,517.57 which equals
€643,517.57 X (1.3811) = $888,762.12
• Profit in $ = $898,710 ‐ $888,762.12 = $9,947.88
• OR:
• Convert all dollars to Euros: ($898,710)/(1.3811) = €650,720.44
• Profit in $ = €650,720.44 ‐ €643,517.57
• = €7,202.87
15
Acropolis Institute of Management Studies and Research, Indore
BBA VI Semester (Finance): International Finance
(Practical Problems)
30.A currency dealer has good credit and can borrow $1,350,000 (or the equi
valent in euros) for one year.
• The interest rate in the U.S. is 8.00% and in the euro zone the one‐year
interest rate is 4.30%.
• The spot exchange rate is $1.4827 = €1.00 and the one‐year forward ex
change rate is $1.5573 = €1.00.
What arbitrage profit would be realized if the trader borrows the maximum
available amount of funds?
Ans.
• Borrow dollars and convert to Euros ($1,350,000/1.4827) = €910,501.11
• Invest € @ 4.3%: €910,501.11 X (1 + 0.043) = €949,652.66
• Convert enough Euros to dollars to pay loan:
• Loan payoff = $1,350,000 X (1 + 0.08)
• = $1,458,000 OR ($1,458,000)/(1.5573) = €936,235.79
• Profit in € = €949,652.66 ‐ €936,235.79 = €13,416.87
OR:
• Convert all Euros to dollar: (€949,652.66)(1.5573) = $1,478,894.09
• Profit in $ = $1,478,894.09 ‐ $1,458,000 = $20,894.09
16