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FIN3IFM Assignment Question type: 40% calculation, 60% essayQuestion 1: (10 marks)Distinguish between the following types of foreign exchange exposure:1. Transaction exposure2. Economic exposure
Question type: 40% calculation, 60% essay
Question 1: (10 marks)Distinguish between the following types of foreign exchange exposure:1. Transaction exposure2. Economic exposure3. Translation exposureGiven 1 example for each.
Question 2: (20 marks)Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million pay- able in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and the six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six- month interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States.a. Should a firm hedge? Why or why not? (5 marks)b. Compute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using a forward contract. (2 marks) Show all workingsc. If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case? (5 marks)d. If Airbus decides to hedge using put options on U.S. dollars, what would be the “expected” euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate. (5 marks)e. At what future spot exchange do you think Airbus will be indifferent between the option and money market hedge? (3 marks) Question 3: (20 marks)A U.S. firm holds an asset in France and faces the following scenario: State 1 State 2 State 3 State 4Probability 25% 25% 25% 25%Spot rate $1.20/€ $1.10/€ $1.00/€ $0.90/€P* €1,500 €1,400 €1,300 €1,200P $1,800 $1,540 $1,300 $1,080
In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the asset. a. What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure? (10 marks)Show all workingsb. If the U.S. firm hedges against this exposure using the forward contract, what is the variance of the dollar value of the hedged position? (10 marks) Show all workings
Question 4: (10 marks)What were the weaknesses of Basel II that became apparent during the global financial crisis that began in mid-2007? Question 5: (10 marks)How did the credit crunch become a global financial crisis? Question 6: (15 marks)What is a structured investment vehicle and what effect did they have on the credit crunch? Question 7: (15 marks)What is a collateralized debt obligation and what effect did they have on the credit crunch?
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5. The assignment is worth 10% of the total subject score and is marked out of 100 marks. Each question is worth as indicated.