ifm assignment 1

U JUST GT PUNKED MUAHAHAHAHAHAHA

Question 1

Countries that hold the value of their currency will certainly gain in terms of export competitiveness, this is because goods exported from a country will be relatively cheaper and importing countries will likely to buy goods at a cheaper rate.

Foreign exchange reserves will have surpluses from the gains of trade. Export > import will give a positive net balance in the trade balance.

A significant danger is that by increasing the price of imports and stimulating greater demand for domestic products, which can aggravate inflation.

Living standards increase because of job opportunities created through FDI’s by MNC’s.

(98 words)

Question 2

a)

The foreign exchange market participants may be categorized as foreign exchange dealers and brokers, central banks, firms conducting international trade transactions, investors and borrowers in the international capital markets, foreign currency speculators, and arbitrageurs.

FX dealers’ quote two way prices, being prices at which they are prepares to both buy and sell foreign currencies to other market participants. FX brokers obtain the best prices in the global FX market and match FX dealers buy and sell orders for a fee

Central banks hold reserves of foreign currencies conduct international transactions on behalf of their government and occasionally buy or sell their home currency to influence the exchange rate in the FX markets.

Firms conducting international trade transactions will need foreign currency to pay for goods and services. Currencies commonly used are USD, GBP, JPY, and UER.

Investors and borrowers conduct capital transaction in the international markets are also usually denominated in foreign currencies.

Speculators buy and sell foreign currencies in the hope of making profits from exchange rate movements. An arbitrageur conducts a series of FX transactions to gain from price differentials in different FX markets.

(186 words)

b) i)

Beginning

RM/AUD = 1 / 2.7000 = 0.3704

Traded

RM/AUD = 1 / 3.8000 = 0.2632

Malaysia Currency depreciated by 0.1072 points. (28.84%)

Prove for (28.84%)

(0.1072 points / 0.3704) x 100% = 28.84%

b) ii)

Beginning

AUD/RM 2.7000

Traded

AUD/RM 3.8000

Australian Dollar appreciates by 1.1 points. (40.74%)

Prove for (40.74%),

1.1 points / AUD/RM 2.7000 = 0.4074

0.40741 x AUD/RM 2.7000 = 1.100007

1.100007 + AUD/RM 2.7000 = 3.800007 @ AUD/RM 3.8000

c)

Yen/USD 0.0080

F$/USD 0.5900

Yen/F$ = 0.0080 / 0.5900 = 0.01356

Yen/D$ 0.01356

Question 3

a)

Currency options

An option is a contract that gives the holder the right, but not the obligation, to buy or sell a given quantity of an asset on or before a specified data in the future, at prices agreed upon today. Currency options provide the right to purchase or sell currencies.

Currency futures

Currency futures contracts specify a standard volume of a particular currency to be exchanged on a specific standard settlement date. Currency futures contract can be purchased by speculators who expect the currency to appreciate, or sold if the currency expects to depreciate.

Differences between Options and Futures

i) No obligation on the part of option holder

A range of prices are offered and also that the purchaser does not have to fulfill the contract, it can be allowed to lapse.

ii) Buying of option contracts require payment of a price/premium which is non refundable

Because the buyer of an option has the right but not the obligation to conduct a transaction, the seller of an option will charge the buyer a premium

iii) Potential losses for option holders are limited; maximum the premium paid to buy the options contract.

Insurance policy claim is made where the options policy pays out the difference when the market goes above the guaranteed price.

b)

Call options can be purchased by speculators who expect the currency who expect the currency to appreciate.

Put options on a specified currency can be purchased by speculators who expect that currency to depreciate

For example, currency call options are commonly purchased by corporations that have payables in a currency that is expected to appreciate. Currency put options are commonly purchased by corporations that have receivables in a country that is expected to depreciate.

Speculators may purchase call options on a currency that they expect to be appreciate.

Profit = Selling (spot) price – buying (strike) price – option premium.At breakeven, profit = 0Thus, breakeven spot price = strike price + premium

Speculators may purchase put options on a currency that they expect to depreciate.

Profit = Selling (strike) price – buying (spot) price – option price.

c)

When the decision to exercise the option, the premium is paid when the option is bought. The option-writer receives the premium payment whether or not the option-buyer eventually exercises the option.

With a call option, the writer retains the full premium so long as the current market price remains below the exercise price. If the market price goes above the exercise price, the writer begins to lose the premium. If the market price rises above the exercise price plus the premium (The break-even price), the writer is in loss position.

With a put option the writer retains the full premium so long as the current market price remains above the exercise price. If the market goes below the exercise price, the writer begins to lose the premium. If the market price falls below the exercise price plus the premium (the break-even price), the writer is in loss position.

d)

Strike price – US$0.9600/ €Premium – US$0.0090/ €Expiration date 3 months

i)

Value of long call Exercise long call? Value of short callSpot Price V = max(S – E, 0) - P S > X? V = P-Max(S – X, 0)

US$0.9000/ € - US$0.069/ € No US$0.069/ €US$0.9200/ € - US$0.069/ € No US$0.069/ €US$0.9400/ € - US$0.069/ € No US$0.069/ €US$0.9600/ € - US$0.009/ € Indifferent US$0.009/ €US$0.9800/ € US$0.011/ € Yes - US$0.011/ €US$1.0000/ € US$0.031/ € Yes - US$0.031/ €

US$1.0200/ € US$0.051/ € Yes - US$0.051/ €

At spot price US$0.9000/ €, Value of long call =

V = max(US$0.9000/ € - US$0.9600/ €, 0) - Premium – US$0.0090/ € = -0.069

At spot price US$0.9600/ €,



V = max(US$0.9800/ € - US$0.9600/ €, 0) - Premium – US$0.0090/ € = 0.011

At spot price US$1.0000/ €



V = max(US$1.0200/ € - US$0.9600/ €, 0) - Premium – US$0.0090/ € = 0.051d)

Strike price – US$0.9600/ €Premium – US$0.0090/ €Expiration date 3 months

ii)

Value of long put Exercise long put? Value of short putSpot Price V = max(S – E, 0) - P X > S? V = P-Max(S – X, 0)

US$0.9000/ € US$0.069/ € Yes - US$0.069/ €US$0.9200/ € US$0.069/ € Yes - US$0.069/ €US$0.9400/ € US$0.069/ € Yes - US$0.069/ €US$0.9600/ € US$0.009/ € Indifferent - US$0.009/ €US$0.9800/ € - US$0.011/ € No US$0.011/ €US$1.0000/ € - US$0.031/ € No US$0.031/ €

US$1.0200/ € - US$0.051/ € No US$0.051/ €

At spot price US$0.9000/ €, Value of long put =






At spot price US$1.0000/ €




d)

iii) In order to find out the break even point,

Spot price - Exercise price - Premium = 0

? – 0.96 – 0.009 = 0

Spot price at break even point = 0.969

4)

a) ¥

¥80.00/$NZ ¥120.00/US$

$NZ US$

$NZ1.6000/US$

Convert $NZ to ¥,

NZ$10,000,000 x ¥80.00/$NZ = ¥800,000,000

Convert ¥ to US$,

¥800,000,000 / ¥120.00/US$ = US$ 6,666,666.667

Convert US$ to $NZ,

US$ 6,666,666.667 x $NZ1.6000/US$ = $NZ10,666,666.67

Profit in $NZ,

$NZ10,666,666.67 - $NZ10,000,000 = $NZ666,666.67

Profit in US$,

$NZ666,666.67 / $NZ1.6000/US$ = US$416,666.67

b)

Bank Bid Price Ask PriceCitibank New York US$0.9650/€ US$0.9670/€

Barclays London US$0.9640/€ US$0.9660/€

The information on Euro at both banks is revised to include the bid/ask spread. Based on these quotes, you can no longer profit from locational arbitrage. If you buy Euro from Citibank New York at US$0.9670/€ and sell to Barclays London at US$0.9640/€ you would make a loss.

If you tried the other way around and buy euro from Barclays London at US$0.9660/€ and sell to Citibank New York at US$0.9650/€ you would also make a loss.

To achieve profits from locational arbitrage, the bid price of one bank must be higher than the ask price of another bank.

c)

i)

Spot exchange rate = HK$6.25/US$

3 month forward exchange rate = HK$6.28/US$

3 month I/R in US = 5.6% (divide to 4 months = 1.4%)

3 month I/R in HK = 8.8% (divide to 4 months = 2.2%)

Borrow US$ 1,000,000 at 1.4% interest = US$1,014,000 to return

Convert to other currency to invest,

US$1,000,000 convert to HK$ = US$1,000,000 x HK$6.25/US$ = HK$6,250,000

Invest HK$6,250,000 in HK with interest at 2.2% = HK$6,387,500 gain

Convert bank to US$ in 3 months time = HK$6,387,500 / HK$6.28/US$ = US$ 1,017,117.834

Yield – initial borrowing = US$ 1,017,117.834 - US$1,014,000 = US$ 3,117.83 gain

ii)

Spot exchange rate = HK$6.25/US$

3 month forward exchange rate = HK$6.28/US$

3 month I/R in US = 5.6% (divide to 4 months = 1.4%)

3 month I/R in HK = 8.8% (divide to 4 months = 2.2%)

Borrow HK$ 6,250,000 at 2.2% interest = HK$ 6,387,500 to return

Convert to other currency to invest,

HK$ 6,250,000 convert to US$ = HK$ 6,250,000 / HK$6.25/US$= US$1,000,000

Invest US$1,000,000 in US with interest at 1.4% = US$1,014,000 gain

Convert back to HK$ in 3 months time = US$1,014,000 x HK$6.28/US$ = HK$6,367,920

Yield – initial borrowing = HK$ 6,367,920 - HK$ 6,387,500 = - HK$ 19,580 (loss)

iii) The possibility of arbitrage opportunities have been greatly reduced with the advent of modern telecommunication system. Financial institutions engage in arbitrage create pressure on the price of a currency that will remove any pricing discrepancy.

Small discrepancies are unlikely to generate any gains due to transaction costs and/or ask bid spreads. Only large financial institutions have the technology and large volume of foreign currency to do this transaction. Individual arbitragers are likely to have great amount of reserve to gain from arbitrage opportunities and if there’s a gain, it may be faced out by the transaction costs.

Question 5

Receive = S$10,000,000

Spot rate of Singapore Dollar = US$0.65

One year forward rate of Singapore Dollar = US$0.67

a)

Forward hedge – Sell forward

= S$10,000,000 x US$0.67= US$6,700,000

Money market hedge

S$10,000,000 / (1 + 0.06) = S$9,433,962.264

Convert at a rate of US$0.65 to get US$

= S$9,433,962.264 x US$0.65= US$6,132,075.472

Compound deposit rate – 8%

= US$6,132,075.472 x (1.08)= US$6,622,641.509

Currency option hedge – buy put

Exercise price = US$0.66Premium = US$0.04

Future Spot Rate Exercise? E > S Receive (Spot – Premium) US$

US$0.63/S$1 Yes (US$0.66 - US$0.04) = 0.62 6,200,000US$0.65/S$1 Yes 0.62 6,200,000US$0.67/S$1 No 0.63 6,300,000US$0.69/S$1 No 0.65 6,500,000US$0.72/S$1 No 0.68 6,800,000

E(V) = (0.1 x US$6,200,000) + (0.2 x US$6,200,000) + (0.25 x 6,300,000) + (0.3 x 6,500,000) + (0.15 x 6,800,000)

= 620,000 + 1,240,000 + 1,575,000 + 1,950,000 + 1,020,000

= US$6,405,000

b)

Unhedge

Future Spot Rate Spot x 10,000,000 = US$US$0.63/S$1 6,300,000US$0.65/S$1 6,500,000US$0.67/S$1 6,700,000US$0.69/S$1 6,900,000US$0.72/S$1 7,200,000

E(V) = (0.1 x US$6,300,000) + (0.2 x US$6,500,000) + (0.25 x 6,700,000) + ( 0.3 x 6,900,000) + (0.15 + 7,200,000)

= 630,000 + 1,300,000 + 1,675,000 + 2,070,000 + 1,080,000

= US$6,755,000

Base on the comparison, unhedge strategy yield more. Alpha should not hedge its receivables.

ifm assignment 1

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