Foreign exchange (FX) questions

INTB 336

HW#1 (10 points)

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Due Thursday., Oct 24

(in the beginning of the class, points deduction for lateness after that)

Please be precise and logical in answering the following questions. Please prepare your answers in a separate paper , not on this problem sheet.

1. Please refer to the foreign exchange (FX) rates table, which shows FX closing market rates for Oct 15 (Tuesday) and Oct 16 (Wednesday). And answer the following questions.

i) There are two different ways to quote exchange rates—a direct quotation or an indirect quotation. How are the currencies quoted in the table below—direct quote or indirect quote—in columns 2 & 3 (In US$) and in columns 6 & 7 (Per US$), respectively?

ii) Which currency shown in the list depreciated the most from Tuesday (10/15) to Wednesday (10/16)?

iii) Which currency (or currencies) among the currencies listed in the table below appreciated the most during the period from January 1, 2019, to the present (YTD)?

iv) Please find out from your research why Ecuador currency does not change at the fixed exchange rate of 1.

U.S.-dollar foreign-exchange rates in late New York trading
IN US$ US$ VS. % CHG PER US$
Wed Tues 1-DAY YTD Wed Tues
U.K. pound 1.2828 1.2784 -0.34 -0.5 0.7795 0.7822
Argentina peso 0.0173 0.0172 -0.92 53.4 57.7493 58.2855
Thailand baht 0.03294 0.03285 -0.26 -6.1 30.360 30.440
China yuan 0.1410 0.1412 0.17 3.1 7.0937 7.0818
Euro area euro 1.1073 1.1032 -0.37 3.6 0.9031 0.9065
Ecuador US dollar 1 1 unch unch 1 1
Japanese yen 0.00920 0.00919 -0.10 -0.8 108.75 108.86

Source: The Wall Street Journal, 10/16/2019

https://www.wsj.com/market-data/currencies/exchangerates

2. Suppose you have the following spot exchange rates in FX markets:

£1 = $1.27, €1 = $1.10, and £1 = €1.18.

i) Please check if the cross rate between the euro (€) and the UK pound (£) is consistent or not.

ii) How much profit (in $ terms) can you make from trading $1,000? Describe your trading process to get your profit, if there is any.

iii) How much will you have profit or loss when you follow a reversed order of transaction between UK pound and euro from that in Q2. ii) above?

iv) How do you expect the current cross rate of £1 = €1.18 change after numerous arbitrage transactions in global FX markets take place– go up or down in the value of UK pound with respect to euro? Explain why and how.

3. You purchased a European foreign exchange option contract to buy 5000 UK pound at the price of $1.31/£ which expires today. You have paid $600 for the contract. Suppose the spot rate on the expiration date, today, is $1.32/£, what will be your optimal decision for the contract (exercise or not exercise)?

4. The recent market data on the U.S. and UK are shown as:

the spot rate of the UK pound $1.27/£

the 90-day forward rate $1.28/£

the 180-day forward rate $1.30£

interest rate (TB) in the U.S.: 3% (per year)

interest rate (TB) in the UK.: 1% (per year)

If you have $1 million available for 3 months, where do you want to invest (assume no transaction costs)? Explain why. Please apply all three decision making rules, as discussed in class, and show that your answers are consistent.

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