Shrikhande International Finance

Fall 2010

Problem Set 1

Chapter 7

1. The $:€ exchange rate is €1 = $0.95, and the €:SFr exchange rate is SFr 1 = € 0.71. What is the $:SFr exchange rate?

Answer. SFr 1 = € 0.71 x $0.95 / € = $0.6745.

2. Suppose the direct quote for sterling in New York is 1.1110‑5. How much would £500,000 cost in New York? What is the direct quote for dollars in London?

Answer. £500,000 cost £500,000 x $1.1115/£= $ 555,570. The direct quote for the dollar in London is just the reciprocal of the direct quote for the British pound in New York or 1/1.1115 ‑ 1/1.1110 = 0.8997‑0.9001.

3. Suppose the quote on British pounds is $1.624-31.

a. If you converted $10,000 to British pounds and then back to dollars, how many dollars would you end up with?

Answer. For $10,000, you would buy pounds at the price of $1.631, giving you £6,131.21 ($10,000/1.631) and resell them at the bid price of $1.624. The latter transaction would yield $9,957.08, resulting in a round-trip cost of $42.92.

b. Suppose you could buy pounds at the bid rate and sell them at the ask rate. How many dollars would you have to transact in order to earn $1,000 on a round-trip transaction (buying pounds for dollars and then selling the pounds for dollars)?

Answer. For every pound you could buy at the bid and sell at the ask, you would earn the spread of $0.007. To earn $1,000, you would have to transact £142,857.14 ($1,000/$0.0007). At the current bid rate of $1.624, this is equivalent to $232,000 (142,857.14 x $1.624).

4. Calculate the 30‑day, 90‑day, and 180‑day forward discounts for the British pound.

Answer. Here are the relevant rates for the pound:

Spot: £1 = $1.8220

30‑day forward: £1 = $1.8180

90‑day forward: £1 = $1.8086

180‑day forward: £1 = $1.7949

The 30‑day forward discount is: [($1.8180 ‑ $1.8220)/$1.8220] x 12 x 100 = ‑2.63%

The 90‑day forward discount is: [($1.8086 ‑ $1.8220)/$1.8220] x 4 x 100 =...