UNIVERSITY OF BIRMINGHAM

BIRMINGHAM BUSINESS SCHOOL

 

FOREIGN EXCHANGE MARKETS: 07 28818

 

Autumn 2016

 

CLASS EXERCISES FOR LECTURE TOPIC 2

 

Question 1

(a)(i) Distinguish between a spot indirect bid exchange rate of one pound to the US dollar and a 3-month forward direct exchange rate of one pound to the dollar.  Illustrate your answer with numerical examples.                                                                                

                                                                                                      (15 marks)

 

(ii) The spot exchange rate of one pound to the euro is €1.2650-742 and the three month forward exchange rate of one pound to the euro is €1.2620-45.

 

Is the pound trading forward at a discount or premium against the euro?

What is the annualised rate of forward discount or premium on the pound against the euro?

                                                                                                      (15 marks)

 

 

(b)(i) What is a cross exchange rate? What is it used for?            (10 marks)

 

(ii) If the US dollar is quoted as $1.6300-65 and the euro is quoted as €1.2600-40, what is the implicit cross exchange rate of one euro to the dollar, from the point of view of an investor in the UK?

                                                                                                      (20 marks)

 

(c)(i) Given the exchange rate of the US dollar stated in (b)(ii) above (i.e. $1.6300-65), if you have pounds and want to buy dollars, how much pounds will you be charged for $1,500?  If you have dollars and want to buy pounds, how much dollars will you pay for £750?

                                                                                                      (5 marks)

 

(ii) If the exchange rate of the US dollar to the pound changed from $1.6300-65 to $1.5550-85, has the pound appreciated or depreciated?  How is the change in the value of the pound likely to affect exports from the UK to the US and imports from the US to the UK?

                                                                                                       (10 marks)

 

(d)(i) What is the bid-ask spread of exchange rates? 

(ii) Interpret the following exchange rates of one pound to the euro: €1.2300-550.  

(iii) Calculate the percentage spread of the rates.

                                                                                                     (10 marks)

 

 

(e) Abimbola had £1,500 with him when he left home in the morning on Monday, 3^rd November, 2008, to go to France.  He paid £25 taxi fare to the Airport in Birmingham and changed the remaining pounds that he had with him to euros at the Airport. He stayed in France until Friday morning, 7^th November, 2008, and returned to the UK that morning.  He spent 80 per cent of the euros that he took with him to France and changed the remaining euros to pounds when he arrived at the Airport in Birmingham on 7^th November, 2008.  The exchange rates that were used for Abimbola on 3^rd November and 7^th November, 2008, were as follows:

 

3rd November, 2008			7th November, 2008
Bid rate	Offer rate		Bid rate	Offer rate
€1.2650	€1.2780		€1.2300	€1.2550

 

How much pounds and pence did he receive from the foreign exchange dealer at the Airport in Birmingham when he changed the remaining euros that he had with him to pounds on 7^th November, 2008?                                                                                                                                                             

                                                                                                     (15 marks)

                                                                                              Total = 100 marks

 

 

Question 2

(a) Suppose that the following exchange rates are available today:

 

	Japanese Yen (¥)	US dollar ($)	Euro (€)
UK pound (£)	£0.0067/¥	£0.6061/$	£0.8994/€

 

(i) From the point of view of investors in the UK, are these quotes direct or indirect?                                                                            

 

                                                                                                       (5 marks)

 

(ii) From the quotes in the table above, calculate the amount of Japanese yen needed to buy a UK£ and the amount of US dollars ($) needed to buy a euro (€).

 

                                                                                                       (5 marks)

 

(b) Describe the differences between a bilateral arbitrage opportunity, a triangular arbitrage opportunity and a covered interest arbitrage opportunity.

 

                                                                                                       (20 marks)

 

(c) The following quotes of the spot exchange rate of one pound to the Canadian dollar (i.e. S(C$/£)) were obtained at the same time from three bureau-de-change offices in Birmingham:

 

Bureau-de-change office	Spot exchange rate quote
A	C$2.2385-400
B	C$2.2370-90
C	C$2.2360-80

(i) Explain why these quotes provide an opportunity for arbitrage profit.   (3 marks)

 

(ii) Describe the steps that you will take to realise the arbitrage profit referred to in section (c)(i) and calculate the amount of arbitrage profit that you will realise on a transaction of £100,000.

                                                                                                                    (7 marks)

 

(d) Do the following quotes provide an opportunity for arbitrage profit?

 

       S($/£) = $1.7477/£

       S(€/£) = €1.4873/£ and

       S($/€) = $1.1650/€.

 

Ignore transaction costs and explain your answer.

 

If the quotes provide an opportunity for arbitrage profit, then describe the steps that you will take to realise the profit and calculate the amount of arbitrage profit that you will realise on a transaction of £250,000.        

                                                                                                                 (25 marks)

 

(e)(i) Assume that the exchange rate of one pound to the US dollar (i.e. S($/£)) was quoted as $1.6484-6516 in the US on 16^th November, 2009, and that transaction cost for buying or selling pound sterling in the US and the UK was 0.1% of the amount of currency bought or sold. Given this information, what should the range of the direct spot exchange rate of the £ to one $ be on the foreign exchange markets in the UK on 16^th November, 2009, if there would be no arbitrage opportunity?

 

                                                                                                                 (20 marks)

 

(ii) Further to question (e)(i) above, if the mid-point of the direct exchange rate of the £ to one $ was quoted as £0.6020/$ in the UK on the date referred to above, was there an opportunity for arbitrage profit?  If there was, then describe the steps that you would have taken to realise the profit and calculate the amount of arbitrage profit that you would have realised on a transaction of £1,000,000, or on an equivalent amount in US dollars, which would have been $1,650,000.

 

                                                                                                                 (15 marks)

                                                                                                                                  Total = (100 marks)

 

 

 

Samuel Fosu

19-09-2016

 

 

答案部分：

FOREIGN EXCHANGE MARKETS: 07 28818

 

   

Topic 2:   Foreign Exchange Rate Quotations

 

Objectives:  (a)  to explain foreign exchange rate quotations; and

 

                     (b)  explain some of the techniques that can be used to determine

                                whether there is an opportunity for arbitrage profit.

              

 

The additional exercises for this lecture topic are –

 

SM5  P 1.1, 1.2, 1.6, 1.7, 1.9, 1.10, 1.15, 1.16, 1.17 and 1.19.

SM6  P 1.1, 1.2, 1.6, 1.7, 1.9, 1.10, 1.15, 1.16, 3.3 and 1.18.

 

The answers to all these questions are in the book by Solnik and McLeavey.

 

Please note that SM5 is the previous edition. The title of the previous edition is “International Investments”. You can get copies from the library.

 

 

Samuel Fosu