Reference no: EM133598332

Assignment: International Finance

Question I. What are the effects of the following on the Yen/US dollar exchange rate (briefly explain):

1. an increase in US. imports of merchandise
2. a Federal Reserve purchase of foreign exchange
3. a sharp increase in the US rate of inflation
4. higher US interest rates
5. an increase in US investments overseas through international mutual funds.
6. a surge in foreign direct investment into the US
7. larger US Federal budget deficits accompanied by a tight monetary policy

Question II. If the yen/dollar exchange is 122 yen per dollar, and the US. annual inflation rate is 5% while the Japanese annual inflation rate is 1%, what is the purchasing power parity exchange rate? Is the dollar overvalued or undervalued versus the yen. Is purchasing power parity a good measure of what the exchange rate should be?

Question III. Assume that the one-year interest rate in New Zealand is 6 percent. The one-year interest rate in the US is 10 percent. The spot rate of the New Zealand dollar is $0.50. The one-year forward rate is $0.54. Does interest rate parity exist? Is covered interest arbitrage feasible for US investors? For New Zealand investors? Show all work.

Question IV. Cray Research sold a supercomputer to the max Planck Institute in Germany on credit and invoiced 10 million Euro payable in six months. Currently, the six-month forward exchange rate is $1.10/Euro and the foreign exchange advisor for Cray predicts that the spot rate is likely to be $1.05/Euro in six months.

Question 1. What is the expected gain/loss from a forward hedge?

Question 2. If you were the financial manager of Cray Research, would you recommend hedging the euro receivable? Why or why not? Explain?

Question 3. Suppose the foreign exchange advisor predits that the future spot rate will be the same as the forward rate quoted today. Would you recomend hedging in this case? Why or why not? Explain?

Question 4. Suppose now that the future spot exchange rate is forecast to be $1.17/Euro. Would you recommend hedging? Why or why not?

Question V. The Hong Kong dollar's value is tied to the US dollar in currency board relation. Explain how the following trade patterns would be affected by appreciation in the Japanese yen against the US dollar:

1. Hong Kong exports to Japan and

2. Hong Kong exports to the United States.

Question VI. XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. Assume that the forward rate is the best predictor of the future spot rate.

Question 1. What is the future dollar cost of meeting this obligation using the money market hedge?

Question 2. What is the future dollar cost of meeting this obligation using the option hedge?

Question VII. Given the following:

A. The UK inflation rate is expected to decline, while the US inflation rate is expected to rise.

B. British interest rates are expected to rise, while US rates are expected to fall.

Question 1. Using the above information, do you expect, the pound to appreciate or depreciate in the future? Explain.

Question 2. Explain how you can hedge the above exchange risk using forward contracts, money market hdge and currency options.