Determine whether the forward rate is priced appropriately

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Reference no: EM131192073

BUS332 INTERNATIONAL FINANCE INDIVIDUAL ASSIGNMENT

There are two parts in the individual assignment. Each part consists of a case study with a number of questions. Students should answer all questions of each case study.

Part A - Use of Currency Derivative Instruments

1. If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $.00756 or the call option with the exercise price of $.00792? Describe the tradeoff.

2. Should Blades allow its yen position to be unhedged? Describe the tradeoff.

3. Assume there are speculators who attempt to capitalize on their expectation of the yen's movement over the 2 months between the order and delivery dates by either buying or selling yen futures now and buying or selling yen at the future spot rate. Given this information, what is the expectation on the order date of the yen spot rate by the delivery date? (Your answer should consist of one number.)

4. Assume that the firm shares the market consensus of the future yen spot rate. Given this expectation and given that the firm makes a decision (i.e., option, futures contract, remain unhedged) purely on a cost basis, what would be its optimal choice?

5. Will the choice you made as to the optimal hedging strategy in question 4 definitely turn out to be the lowest-cost alternative in terms of actual costs incurred? Why or why not?

6. Now assume that you have determined that the historical standard deviation of the yen is about 5.0005. Based on your assessment, you believe it is highly unlikely that the future spot rate will be more than two standard deviations above the expected spot rate by the delivery date. Also assume that the futures price remains at its current level of 3.006912. Based on this expectation of the future spot rate, what is the optimal hedge for the firm?

Part B - Assessment of Potential Arbitrage Opportunities

1. The first arbitrage opportunity relates to locational arbitrage. Holt has obtained spot rate quotations from two banks in Thailand: Minzu Bank and Sobat Bank, both located in Bangkok. The bid and ask prices of Thai baht for each bank are displayed in the table below:

	MINZU BANK	SOBAT BANK
Bid	$.0224	$.0228
Ask	$.0227	$.0229

Determine whether the foreign exchange quotations are appropriate. If they are not appropriate, determine the profit you could generate by withdrawing $100,000 from Blades checking account and engaging in arbitrage before the rates are adjusted.

2. Besides the bid and ask quotes for the Thai baht provided in the previous question, Minzu Bank has provided the following quotations for the U.S. dollar and the Japanese yen:

	QUOTED BID PRICE	QUOTED ASK PRICE
Value of a Japanese yen in U.S. dollars	$.0085	$.0086
Value of a Thai baht in Japanese yen	¥2.69	¥2.70

would like to be able to estimate the dollar profit resulting from arbitrage over and above the dollar amount available on a 90-day U.S. deposit.

Determine whether the forward rate is priced appropriately. If it is not priced appropriately, determine the profit you could generate for Blades by withdrawing $100,000 from Blades' checking account and engaging in covered interest arbitrage. Measure the profit as the excess amount above what you could generate by investing in the U.S. money market.

4. Why are arbitrage opportunities likely to disappear soon after they have been discovered? To illustrate your answer, assume that covered interest arbitrage involving the immediate purchase and forward sale of baht is possible. Discuss how the baht's spot and forward rates would adjust until covered interest arbitrage is no longer possible. What is the resulting equilibrium state called?

Attachment:- Assignment.rar

Reference no: EM131192073

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