BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020

THE INTERNATIONAL UNIVERSITY (IU) – VIETNAM NATIONAL UNIVERSITY –

HCMC

THE MIDTERM EXAMINATION – BEHAVIROAL FINANCE

Date: 23/4/2020
Duration: 90 minutes
Name: Phạm Thị Thạch Thảo Student ID: BAFNIU17060

SUBJECT:
Dean of School of Business Lecturer
Signature: Signature:

Full name: Full name: Vu Thuy Mai Uyen, MSc.

GENERAL INSTRUCTION(S)
1. This is open book examination
2. This exam will NOT be conducted through Blackboard; you must prepare your exam
using Microsoft Word processing software on a computer
3. Name your file as shown:
studentid#_classnumber_name_instructorname_Spring2020
4. Please also type studentid#_classnumber_name_instructorname_Spring2020 into
the header of your document. The file will be separated from the blackboard
submission file when given to the professor; therefore, the exam must be identifiable
to the professor by your student id#.
5. It is recommended that before beginning to write that you name and save the
document and also activate any automatic save function that your word processing
software may have
6. You are also advised to create a copy of the document on another storage medium,
either by putting your document in a folder that synchronizes to a service such as
Dropbox or Box, or by occasionally copying the document onto a flash drive or
network drive.
7. Your work will be checked for plagiarism, so just don't do it. Failure to uphold the
standards of academic honesty will result in a failing grade for the course and,
potentially, other serious disciplinary action up to and including expulsion.
8. Make sure to keep the saved file until final grades have been released.

THIS EXAM INCLUDES 2 SECTIONS A AND B.

SECTION A: ANSWER THREE QUESTIONS refering to your student ID, if your student
ID ends with even number (0,2,4,6,8), please answer question 2 of section A and if your
student ID ends with odd number (3,5,7,9), please answer question 1 of section A
SECTION B: ANSWER ONE QUESTION refering to your student ID, if your student ID
ends with even number (0,2,4,6,8), please answer question 1,3,5 of section B and if your
student ID ends with odd number (3,5,7,9), please answer question 2,4,6 of section B

GOOD LUCK!
BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020
SECTION A: 30 MARKS

QUESTION 1: 30 marks

In the past, the Chinese Government kept an exchange rate of 6.8 yuan to US$1. However, a
spokesperson for the People’s Bank of China, the country’s central bank, said that it would
begin to allow the market to play a much greater role in determining the exchange rate. It is
expected that a more flexible rate will result in an increase in the value of the Chinese
currency.

China has had a surplus on the current account of its balance of payments in recent years.
Economists believe that an appreciation of its currency should help to reduce the size of the
surplus.

The decision by China will please the United States (US) and many other countries which
have a large trade deficit with China. The President of the US has said that “market-
determined exchange rates are essential to global economic vitality.” If the Chinese
Government had not decided to allow its exchange rate to be determined by market forces,
many American companies would have demanded tough protectionist measures to reduce the
number of Chinese imports coming into the US. They had criticized the Chinese Government
for keeping its currency artificially weak which gave Chinese exporters an unfair advantage.

a) What types of exchange rate regime does China follow? Explain [10]

b) Analyze how a rise in the external value of the yuan might affect China’s current
account balance. [10]

c) Explain why a large surplus for China over many years in the current account of the
balance of payments could be a problem for other countries, such as the US. [10]

QUESTION 2: 30 MARKS

In 2014, the government of Kazakhstan devalued its currency, the tenge. A year later the
country still had a current account deficit. Therefore, in 2016 it considered adopting a floating
exchange rate which might help to remove the deficit. However, it had concerns that this
might affect the country’s inflation rate which was already high at 17%.

a) Explain two advantages of a floating exchange rate. [10]

b) Explain why floating exchange rate might help to remove current account deficit. [10]

c) Discuss whether or not a reduction in a current account deficit on the balance of

payments will benefit an economy. [10]

ANSWER FOR QUESTION 2:

A. Two advantages of floating exchange rate:

- Because floating exchange rate is flexible, so when the country which has floating
exchange rate is deficit, the exchange rate will change (floating down in detail) to
automatically remove current account imbalances.

- Because in floating exchange rate regime, demand of home currency is how home
currency worth or valued, so that government does not have to reserve money as
interfering to influence the currency value.
BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020
B. Floating exchange rate might help to remove current account deficit because:

When the current account deficit that means the value of goods and services imported
is greater than the value of goods and services exported. Floating exchange rate
allows home currency's value flexible. If the currency weakens, it will reduce the
home demand for foreign goods (since goods will now be more expensive), and will
increase the home export volume (since exports will appear cheaper to foreign
countries). => Help to remove current account deficit

C. A reduction in a current account deficit on the balance of payments will benefit an

economy or not?

In my opinion, reduction in a current account deficit on the balance of payments

might and might not benefit an economy for some reason:

* Might benefit because:

- As I said above, the current account deficit that means the value of goods and
services imported is greater than the value of goods and services exported, so that a
decrease in current account deficit may occur because the demand of import decreases
or/and the demand of export increases => the domestic economic grows

- When occurs reduction in a current account deficit, the exchange rate of tenge will
be appreciated against other currency, so that will reduce inflation rate

* Might not benefit because:

- As the current account deficit reduces the value of goods and services imported
(includes raw material and capital goods) it can lead to GDP will decrease and in long
run, it will decrease exported as well

- When the appreciation of tenge occur, it can reduce the deficit in long term
BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020
SECTION B: 70 MARKS

Question 1: 20 MARKS

1. If the current spot rate were USDGBP 2 and the one-year forward rate were USDGBP
1.80, then the dollar is selling forward discount or forward premium? [10]
2. At the beginning of 2019, the USDAUD exchange rate was 1.40. At the same time,
the forecast change in the USDAUD in 2019 was 2.00% and the forecast inflation rate
of the US in 2019 was 2.3%. What should be the forecast inflation rate for Australia
in 2019, according to PPP theory? [10]
Answer:
1. In this case, GBP is home currency, it follow direct quote.
So the dollar is selling forward discount or forward premium:
F−S 360 1.8−2 360
F$ = x x 100 = x x 100 = -10%
S n 2 360
Thus, USD is selling forward at a discount 10% again GBP
2. USD is home currency, it follow indirect quote
Beginning rate−ending rate
We have: % ∆ =2% = x 100 => Ending exchange rate =
endingrate
USDAUD 1.3725
According PPP, we have
S ending 1+ π (USD) 1.3725 1+ 2.3 %
=  =  π ¿) = 4.3497%
S beginning 1+ π ( AUD) 1.4 1+ π ( AUD)

QUESTION 2: 20 MARKS

1. If the current spot rate were GBPUSD 0.5 and the 90-day forward rate were GBPUSD
0.56, then the dollar is selling forward discount or forward premium? [10]
2. At 9:30 AM, Jason_Dealer of Bank of American calls Susan_Dealer of Barclays and
asks for a quote on GBPAUD exchange rate. Susan reponds by quoting 2.5500 –
2.5540. Jason decides to buy £200,000 at the quoted rate. At 3:30PM, Susan quotes
50-90. Will Jason make a profit or a loss by selling the pound at 3:30PM? How much
profit or loss will Jason make? [10]
QUESTION 3: 30 MARKS

Suppose that you’re given these quotes from three different banks:

 Bank of America: USDEUR 0.8911/0.8929

 HSBC: EURAUD 1.5183/1.5213

 Chase: USDAUD 1.3586/1.3614

a) What are the cross rates from these quotes? [10]

b) Is there any arbitrage opportunity? [5]

c) How would you take advantage of any arbitrage situation? [10]
d) What is your profit? [5]
Answer:
BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020
Mid-point for three banks:

 Bank of America: USDEUR 0.892

 HSBC: EURAUD 1.5198

 Chase: USDAUD 1.36

A, 1st cross rate:

 HSBC: EURAUD 1.5198
 Chase: USDAUD 1.36
=> USDEUR 0.8949
2nd cross rate:
• Bank of America: USDEUR 0.892
• HSBC: EURAUD 1.5198
=> USDAUD 1.3557
3rd cross rate:
• Bank of America: USDEUR 0.892
• Chase: USDAUD 1.36
=> EURAUD 1.5247
B, For each cross rate, we have different arbitrage opportunity
C, I choose the 1st cross rate to take arbitrage opportunity
• Bank of America: USDEUR 0.892
• HSBC: EURAUD 1.5198
• Chase: USDAUD 1.36
Cross rate: USDEUR 0.8949

Bank of
End with $1,003,200 America Start with $1,000,000
Trader receives $1,003,200 Trader sells $1,000,000 to
Chase at USDAUD 1.36

Bank of America Chase

- Trader receives EUR 894,855 - Trader receives AUD 1,360,000
- Trader sells EUR 894,855 to Bank of America at - Trader sells AUD 1,519,800 to HSBC at
USDEUR 0.892 EURAUD 1.5198

D, So my profit is $1,003,200 - $1,000,000 = $3,200 without any risk.

QUESTION 4: 30 MARKS

Suppose that you’re given these quotes from three different banks:

 Bank of America: USDEUR 0.700/0.7010

BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020
 Chase: GBPUSD 1.700/1.701

 HSBC: GBPEUR 1.200/1.201

a) What are the cross rates from these quotes? [10]

b) Is there any arbitrage opportunity? [5]

c) How would you take advantage of any arbitrage situation? [10]
d) What is your profit? [5]
QUESTION 5: 20 MARKS

Suppose that the current spot exchange rate is €0.80/$ and the three-month forward
exchange rate is €0.7813/$. The three-month interest rate is 5.6 percent per annum in the
United States and 5.40 percent per annum in France. Assume that you can borrow up to
$1,000,000 or €800,000.

Show how to realize a certain profit via covered interest arbitrage, assuming that you
want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit.
[20]

Answer:

It follow indirect quote

S−F 360 0.8−0.7813 360

F€ = x x 100 = x x 100 = 9.5738%
F n 0.7813 90

∆ i=i € - i $ = 5.4% - 5.6% = 0.2%

=> IRP does not hold => arbitrage opportunity

The following diagram will show how we earn profits from transactions.
Start: i $ = 5.6% p.a (90 days) End
Borrow from bank.
$1 mil $1 mil *1.014 = $1,014,000 (payoff)
$ 1,037,757.584

S$/€ = €0.8/$ (convert into €) F$/€ = €0.7813/$ (convert back to €)

$1 mil * €0.8/$ i€ =5.4% p.a (90 days)

€800,000 * 1.0135= €810,800 (received amount)
= €800,000 (deposit into bank)
Therefore, the profits that we would expect to earn = $1,037,757.584- $1,014,000 =
$23,757.584

QUESTION 6: 20 MARKS

Suppose that the current spot exchange rate is €0.80/$ and the three-month forward
exchange rate is €0.7813/$. The three-month interest rate is 5.6 percent per annum in the
BAFNIU17060_ BAFN17IU11 _PhamThiThachThao_VuThuyMaiUyen_Spring2020
United States and 5.40 percent per annum in France. Assume that you can borrow up to
$1,000,000 or €800,000.

Show how to realize a certain profit via covered interest arbitrage, assuming that you
want to realize profit in terms of euros. Also determine the size of your arbitrage profit. [20]