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MBAA 653
Problem Set: Modules 3 and 4
Directions:
Solve the following problems according to the instructions in the module assignment.
The following exchange rates were published in today’s paper Fictional Exchange Rate Press.
$1 is equal to 5.00 Widgetstan baht (WB)
1 Widgetstan baht = 0.80 Dudeandgal pesos (DP)
You want to purchase 100,000 Dudeandgal pesos with U.S. dollars.
How many U.S. dollars will you need for your purchase?
You believe in purchasing power parity. In your analysis, you assume locational arbitrage guarantees spot exchange rates are properly aligned. The spot rate of the British pound is $1.80. The spot rate of the Swiss franc is 0.3 pounds. Your inflation expectations are 7 percent in the United Kingdom, 5 percent in Switzerland, and 2 percent in the United States. One-year interest rates are 6 percent in the United Kingdom, 2 percent in Switzerland, and 4 percent in the United States.
What is your expected spot rate of the Swiss franc in one year with respect to the United States dollar?
The country of Daytona, whose currency is the U.S. dollar and the country of Prescott have the same real interest rate of 3 percent. The expected inflation over the next year is 6 percent in Daytona versus 21 percent in Prescott. The one-year currency futures contract on Prescott’s currency (called the pres) is priced at $.30 per pres.
What is the spot rate of the pres assuming interest rate parity holds?
4. Estimate the expected profit or loss if an investor sold a one-year futures contract today on one million Canadian dollars and settled this contract on the settlement date. Information for the contract is as follows:
• PPP exists
• Canadian inflation next year expected to be 3 percent
• United States inflation next year expected to be 8 percent
• Spot rate for Canadian dollar is $0.90
• One year futures contract for Canadian dollar is priced at $0.87
New York Co. has agreed to pay 10 million Australian dollars (A$) in two years for equipment that it is importing from Australia. The spot rate of the Australian dollar is $.65. The annualized U.S. interest rate is 4 percent regardless of the debt maturity. The annualized Australian dollar interest rate is 12 percent regardless of the debt maturity. New York plans to hedge its exposure with a forward contract that it will arrange today. Assume that interest rate parity exists.
Determine the amount of U.S. dollars that New York Co. will need in 2 years to make its payment.
