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MAF306, T1 2021

DEAKIN UNIVERSITY

Faculty of Business and Law

MAF306 International Finance and Investment

Trimester 1, 2021 Examination

Special instructions for Candidates:

• This examination is OPEN BOOK. Calculators are ALLOWED.

• Preparation time: 1 hour (Note that this includes the usual 15mins reading time, as well as time to download/upload exam papers into Cloud Deakin.

• Writing time is Two (2) HOURS.

• Maximum exam time: You must submit your exam response within Three (3) hours. The additional hour includes 15 minutes reading time, and time to download and save the exam paper and upload the completed paper into CloudDeakin.

• Late submissions will not be marked, after the 3-hour time.

• You must type your answers into a single word document using the file name: student id, unit code and the unit's name. For example: 123456789 MAF306 International Finance and Investment.

• Remember to save your work regularly.

• You must upload your responses to the Exam Submission Drop Box on the Cloud Deakin unit site. Number each question clearly.

• It is important that you complete this task individually. Your submission will be reviewed for the purposes of detecting collusion and/or plagiarism.

• If you encounter any technical issues with Cloud Deakin, please contact the IT Service Desk online or via phone (1800 463 888; +61 5227 8888 if calling from outside Australia) and record your ticket number as evidence of technical issues during the examination period.

• In the unlikely event that you cannot upload your completed exam paper, email it as an attachment to your unit chair Harminder Singh. [email protected] within the submission time.

• This examination comprises FIVE (5) questions with a total of 60 marks. Each question is worth 12 marks. You are required to answer ALL questions. This examination constitutes 60 % of your assessment in this unit.

All candidates MUST complete this section.

Type your student ID number here: _________________________________

There are FIVE (5) questions with a total of 60 marks.

Answer All Questions

Question 1: This question has two parts. Students must show their workings.

Part A

• During the currency crisis of September 1992, the Bank of England borrowed DM 33 billion from the Bundesbank when a pound was worth DM 2.78 or $1.912. It sold these DM in the foreign exchange market for pounds in a futile attempt to prevent a devaluation of the pound. It repaid these DM at the post-crisis rate of DM 2.50:£1. By then, the dollar: pound exchange rate was $1.782:£1.

By what percentage had the pound sterling devalued in the interim against the Deutsche mark as well against the dollar?

Part B

Assume annual inflation rates in the US and Australia are 6% and 4% respectively, and the spot rate is US$0.75 per AUD (indirect quote). What is the value of AUD in 1 and 2 years?

[7+5= 12 marks]

Answer 1:

Part A

Answer 1:

Part B

Question 2: This question has three parts. Your answer should not be of more than 100 words for each part.

Part A

What do you understand by the concept Law of one price (LOP)? Under what conditions arbitrage exist. Is it possible for arbitrage to vanish soon after you come across an arbitrage opportunity? Give your answer with an example.

Part B

Your bank is working with an American client who wishes to hedge its long exposure in the Malaysian ringgit. Assume it is possible to invest in ringgit, but not borrow in that currency. However, you can both borrow and lend in U.S. dollars.

i) Assuming there is no forward market in ringgit, can you create a homemade forward contract that would allow your client to hedge its ringgit exposure? If yes, then provide an example.

ii) Several of your Malaysian clients are interested in selling their U.S. dollar export earnings forward for ringgit. Can you accommodate them by creating a forward contract?

Part C

Assuming no transaction costs, suppose £1 = $2.4110 in New York, $1 = FF 3.997 in Paris, and FF 1 = £0.1088 in London. How could you take profitable advantage of these rates?

[4+4+4 = 12 marks]

Answer 2:

Part A

Answer 2:

Part B

Answer 2:

Part C

Question 3: This question has three parts. Your answer should not be of more than 200 words for each part. Show your workings for part-C.

Part A

While doing international business, many multinational companies come across country risk and international business risk. To manage and minimise such types of risk, can these companies negotiate on certain financial aspects of dealing with international partners? From your point of view, what can these strategies be, explain your reasoning?

Part B

Canada based Tim agro trading Co., a fruit jam producer in Montreal, Québec, tells its Indian customers that the company wants to be paid in Canadian dollars. According to its director of export marketing, this simple strategy eliminates all its currency risk. Is he/she right? If yes then why, and if not then why not?

Part C

Suppose that the forward ask price for March 20 on euros is $0.9127 and at the same time the price of IMM euro futures for delivery on March 20 is $0.9145. How could an arbitrageur profit from this situation? What will be the arbitrageur's profit per futures contract (size is €125,000)?

[4+4+4 = 12 marks]

Answer 3:

Part A

Answer 3:

Part B

Answer 3:

Part C

Question 4: This question has three parts. Your answer should not be of more than 200 words for each part.

Part A

What is the basic reason for the existence of the Eurodollar market? From your perspective, what factors have accounted for its growth over time?

Part B

On October 14, 1993, Portugal's Ministry of Finance announced that it would scrap the 20 percent withholding tax imposed on the interest payments due to foreigners holding government bonds. At present, foreigners whose governments have a double-taxation treaty with Portugal wait up to two years to claim back a portion of the tax. What might have been Portugal's motivations for scrapping the tax? What are the likely consequences of eliminating the withholding tax?

Part C

While doing international business some countries have comparative advantage and some have absolute advantage, what do you understand by each of these advantages? Do you think there can be a scenario where one country can have absolute advantage, and another can have relative example? Give an example of your understanding in this regard.

[4+4+4 = 12 marks]

Answer 4:

Part A

Answer 4:

Part B

Answer 4:

Part C

Question 5: This question has two parts. Show your workings for quantitative part.

Part A

Company A, a low rated‑ firm, desires a fixed rate‑, long-term‑ loan. A currently has access to floating interest rate funds at a margin of 1.5% over LIBOR. Its direct borrowing cost is 13% in the fixed rate‑ bond market. In contrast, company B, which prefers a floating rate‑ loan, has access to fixed rate‑ funds in the Eurodollar bond market at 11% and floating rate‑ funds at LIBOR + ½%.

i) How can A and B use a swap to advantage, explain your reasoning?

ii) Suppose they split the cost savings; how much would A pay for its fixed rate funds? How much would B pay for its floating rate funds?

Part B

To manage your currency exposure of inflow of Singapore Dollar (SGD) in six months’ time from now, you have come across two types of derivatives, which are forward and futures, which out of these two you will chose and why?

[8+4 = 12 marks]

Answer 5:

Part A

Answer 5:

Part B

FORMULA SHEET

Purchasing Power Parity

1. One-period equation ii. Multi-period equation

International Fisher Effect

1. One-period equation ii. Multi-period equation

Calculating cross-rates

(This formula calculates cross rates between euro and yen, where there is no quote available for exchange rate between them but available against another currency, the $).

Interest rate parity and Covered Interest Arbitrage

Interest Rate Parity Direct Quote Interest Rate Parity Indirect Quote

Covered interest Arbitrage relationship, where funds will flow from the home country (outward arbitrage), if and only if:

Direct Quote Indirect Quote

Covered interest Arbitrage relationship, where funds will flow to the home country (inward arbitrage), if and only if:

Direct Quote Indirect Quote

Forward Premium/Discount (%) on foreign currency – direct quote

Forward Premium/Discount (%) on foreign currency - indirect quote

e0 – f1 * 360 * 100

f1 n

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