Exchange Rate Relationships
Use Table 6.5 to answer these questions:
a. How many euros can you buy for $100? How many dollars can you buy for
100 euros?
b. How many Swiss francs can you buy for $100? How many dollars can you
buy for 100 Swiss francs?
c. If the euro depreciates with respect to the dollar, will the direct
exchange rate quoted in Table 6.5 increase or decrease? What about the indirect
exchange rate?
d. Is a United States or an Australian dollar worth more?
2. Exchange Rate Relationships. Look at Table 6.5.
a. How many Japanese yen do you get for your dollar?
b. What is the 1-year forward rate for the yen?
c. Is the yen at a forward discount or premium on the dollar?
d. Calculate the annual percentage discount or premium on the yen.
e. If the interest rate on dollars is 6.5 percent, what do you think is
the interest rate on yen?
f. According to the expectations theory, what is the expected spot rate
for the yen in 1 year`s time?
g. According to purchasing power parity, what is the expected difference
in the rate of price inflation in the United States and Japan?
3. Exchange Rate Relationships. Define each of the following theories in a sentence or simple equation:
a. Interest rate parity theory.
b. Expectations theory of forward rates.
c. Law of one price.
d. International Fisher effect (relationship between interest rates in
different countries).
4. International Capital Budgeting. Which of the following items do you need if you do all your capital
budgeting calculations in your own currency?
Forecasts of future exchange rates
Forecasts of the foreign inflation rate
Forecasts of the domestic inflation rate
Foreign interest rates
Domestic interest rates
5. Foreign Currency Management. Ms. Rosetta Stone, the treasurer of International Reprints, Inc., has
noticed that the interest rate in Switzerland
is below the rates in most other countries. She is therefore suggesting that
the company should make an issue of Swiss franc bonds. What considerations
ought she first take into account?
6. Hedging Exchange Rate Risk. An importer in the United States is due to take delivery of silk scarves
from Europe in 6 months. The price is
fixed in euros. Which of the following transactions could eliminate the
importer`s exchange risk?
a. Buy euros forward.
b. Sell euros forward.
c. Borrow euros, buy dollars at the spot exchange rate.
d. Sell euros at the spot exchange rate, lend dollars.
7. Currency Risk. Sanyo
produces audio and video consumer goods and exports a large fraction of its
output to the United States under its
own name and the Fisher brand name. It prices its products in yen, meaning that
it seeks to maintain a fixed price in terms of yen.
Suppose the yen moves from АВАµ108.02/$ to АВАµ100/$. What currency
risk does Sanyo face? How can it reduce its exposure?
8. Managing Exchange Rate Risk. A firm in the United States is due to receive payment of 1 million
Australian dollars in 8 years` time. It
would like to protect itself against a decline in the value of the Australian
dollar but finds it difficult to arrange a forward sale for such
a long period. Is there any other way that it can protect itself?
9. Interest Rate Parity. The
following table shows interest rates and exchange rates for the U.S. dollar and
Mexican peso. The spot exchange rate is
9.5 pesos per dollar. Complete the missing entries:
1 Month 1 Year
Dollar interest rate (annually compounded) 5.5 7.0 Peso interest rate
(annually compounded) 20% ___ Forward pesos per dollar ____ 11.2 Hint: When calculating the 1-month forward
rate, remember to translate the annual interest rate into a monthly interest
rate.
10. Exchange Rate Risk. An
American investor buys 100 shares of London Enterprises at a price of АВАі50
when the exchange rate is
$1.60/АВАі. A year later the shares are selling at АВАі52. No
dividends have been paid.
a. What is the rate of return to an American investor if the exchange
rate is still $1.60/АВАі?
b. What if the exchange rate is $1.70/АВАі?
c. What if the exchange rate is $1.50/АВАі?
Category: Capital management
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