HKUSTFINA 3404 International Finance Department of Finance Spring 2015 Dr. Kai Li Combined Assignments 3&4 Instructions: The assignment is degisned for a team work of 3 group members. Each member should contribute to the entire assignment, and should be ready to answer questions concerning his/her assignment in class discussions. The due date is May 5, 2015 noon. Each group needs to submit only one write-up or typed solution of the assignment to TA’s (Chenjie Xu) mailbox (close to LSK Room 5067) before that time. Questions 1-14 are multiple choice questions. For each question, please only choose one best answer. 1. Assume that the balance-of-payments accounts for a country are recorded as follows. balance on the current account = BCA = $130 billion balance on the capital account = BKA = -$86 billion Then, under the …xed exchange rate regime, the balance on the reserves account (BRA) should be (ignore statistical discrepancies): A) –$44 billion B) $44 billion C) $216 billion D) none of the above Dollar price per pound (exchange rate) 2. Consider the supply-demand framework for the British pound relative to the U.S. dollar shown in the following chart. The current demand and supply curve is D and S, hence equilibrium exchange rate is $1.90 = £ 1.00. Which of the following statements is correct? S $1.90 $1.80 D D’ S D D=S 1 Q£ As a result. gold and dollar are the two most important reserve assets for the central banks. in which U. B) Supply for British pounds exceeds the demand of pounds at the exchange rate of $1:80 = $1:00. the U. as the consequence that foreign countries tried to attract US dollar.S. As a result. Trade De…cit A) is a capital account surplus B) is a current account de…cit C) is both a capital account surplus and a current account de…cit D) none of the above 4. Under a ‡oating exchange rate regime. A) imports from the US . raising B) imports from the US. central banks from around the world have the incentive to accumulate dollars.000 2 . Suppose you enter into the long position of a Eurodollar interest rate futures with the futures price of 96. The measures these foreign countries can take to attract dollars include stimulating _____ and _____ interest rates. to satisfy the growing need for reserves. A) surpluses. decreasing C) exports to the US. 3. decreasing 5. Resuming Question 4. The U. C) Suppose the demand curve shifts from D to D’. Since gold has a natural scarcity.S. depreciate C) de…cits. the spot rate of the three month LIBOR is 6%. the equilibrium pound exchange rate will depreciate from $1:90 = $1:00 to $1:80 = $1:00: D) Both A) and C) are correct. raising D) exports to the US. the dollar is expected to ____ against gold. dollar is pegged to gold at $35/oz and all other currencies are pegged to dollar. is likely to run BOP _____ . From the 1944 to 1971. appreciate B) surpluses.A) Demand for British pounds exceeds the supply of pounds at the exchange rate of $1:80 = $1:00.S. appreciate D) de…cits. What is your pro…t/loss from holding this futures position? A) you lose $50 B) you gain $50 C) you lose $5. depreciate 6. At the expiration date of the futures contract.000 D) you gain $5. the international monetary system is under the so called “Bretton Woods System”. The total pro…t/loss for the option writer is thus: A) $1875 B) $687.500.06/e.00 = $1.00 = $1.00 = $1. Today’s spot exchange rate is e1. Suppose that your …rm is a U. Today’s spot exchange rate is e1.-based importer of German automobile accessories.000. 10. 8.15. D) Sell a call option on the euro with a one-year maturity.7.20/e to hedge the risky payable. You have just ordered next year’s inventory. C) Since the spot price is more than the forward price. Suppose the option premium and the strike price are $0. which of the following statements is correct? A) the call option becomes cheaper whereas the put option becomes more expensive B) the put option becomes cheaper whereas the call option becomes more expensive C) both the call and the put become cheaper D) both the call and the put become more expensive.S. the one-year forward rate is e1.000 with the strike price of $1. the spot and the futures exchange rate are $1.4/e. In one year your …rm owes a payment of e100. This will …x the cost of e100.15. Consider a put futures option written on one euro futures contract.5 C) $625 D) $-625 9.-based importer of German automobile accessories.405/e and $1. you should trade your dollars for euros today and pay your supplier early. and in one year the exchange rate turns out to be 3 .15/e and $1. Consider both a call option and a put option written on euro.00 = $1. and each euro futures contract is written on e12.000 at $115. and you buy a one-year call option written on e100.000 to your German supplier.S. You pay for them in euros and sell them in dollars. B) Enter into short position in the one-year euro futures contract at e1. Suppose that your …rm is a U. You have just ordered next year’s inventory. You pay for them in euros and sell them in dollars. How can you …x the dollar cost of this order? A) Enter into long position in the one-year euro futures contract at e1.15. At expiration of the option contract.5/e. respectively. When the euro exchange rate becomes less volatile.00 = $1.20. In one year your …rm owes a payment of e100.000. respectively. This will …x the cost of e100.000 at $115.20.000 to your German supplier. Suppose the option premium is $0. Consider a portfolio with 30% investment in A and 70% investment in B. iii) Given the return volatility. What is the standard deviation for the portfolio return? A) 13. A and B. are as follows Stock A B Mean (%) 10 12 SD (%) 18 20 Suppose the two stocks are not correlated. The mean and standard deviation (SD) of two stocks.5% B) 14% C) 15% D) 19. a portfolio on the portfolio frontier has the largest expected return. Which of the following statements about the portfolio frontier is (are) correct? i) Portfolio frontier includes both the e¢ cient frontier and the ine¢ cient frontier. a portfolio on the portfolio frontier has the smallest return variance among all portfolios. what is the expected return for the global minimum variance portfolio? 4 . and iii) 13.000 B) $4000 C) -$6. ii) Given the expected return. A) i) only B) i) and ii) C) ii) and iii) D) i).000 11.000 D) -$10. What the pro…t/loss on your hedged position relative to today’s exchange rate? A) $10. ii).4% 14.30/e. In the above question.$1. The best …nancial instrument to hedge a recurrent exposure is: A) forwards B) futures C) options D) swaps 12. compute the net borrowing position for both …rms and the percentage returns for the international banker.11% 15.000. The investment horizon is one year and interests are only paid at the end of the one-year horizon. Use the European option pricing formula to …nd the value of a sixmonth at-the-money (ATM) call option on Japanese yen. The strike price is $1 = U100. Suppose the exchange rate changes to $1. Fixed Floating A B 10.7%. where F denotes the forward exchange rate calculated in b). (please round the numbers in the …nal results to three signi…cant digits only) 17. you long a oneyear forward contract which is written on one million AUD. and the exchange rate is $1/AU$.1/AU$ in one year. The annualized the interest rates are r$ = 5:5% and rU = 6%. LIBOR+0.3% Suppose that A prefers to issue …xed-rate debt whereas B prefers to issue ‡oating-rate debt. Suppose today the (annualized) interest rates on USD and AUD are 0% and 4%.3% LIBOR+0.1%.38% C) 10.5% 9.67% B) 13.6%.3% LIBOR+0. Suppose …rm A can issue …xed-rate debt of the same maturity at 10:3% or ‡oating-rate debt at LIBOR + 0:5%. In addition. 9. If you were an investment banker. (Hint: …rst determine the forward rate using the strict form of IRP) c) Repeat b) when a forward contract is written on AUD 1. Firm B can issue …xed-rate debt at 9:3% or ‡oating-rate debt at LIBOR + 0:3%. you borrow one million USD and use the proceeds to buy one million AUD.89% D) 11. Consider the following two strategies. b) Calculate your pro…t/loss (quoted in USD) from strategy B. and LIBOR+0. how could you arrange an interest rate swap between A and B to make everybody happy? Write in the …gure the cash ‡ows with arrows to describe your answers.A) 13. Compare your result with that in a): what conclusion can you draw? 16. In strategy B. In strategy A.000/F instead. (Hint: you may use the following numbers: 9.2%) 5 . The volatility is 25 percent per annum. a) Calculate your pro…t/loss (quoted in USD) from strategy A. respectively. Evaluate (I) and (II). What is Boeing’s dollar denominated receivable net of the option premium? b) the same question for the scenario when the spot exchange rate turns out to be $1:5=$ on the expiration date. are they true or false and why. Suppose you buy a call option with C0 = $0:03=$ and X = $1:5=$. ii) $1:6=$.e. iii) $1:3=$ 19. Both options are written on pounds and will expire in one year. you will have the same portfolio return volatility. Both A and B have identical expected returns and standard deviations. 20. Again Evaluate (I) and (II). One of your friends have made the following comments: (I) “No matter how you set up your portfolio between A and B. Suppose that Boeing decides to use option market hedge. Assume that the option premium was $0:02=$. you will have the same expected return” (II) “No matter how you set up your portfolio between A and B. 6 . i.” a) Suppose the returns of the two assets have 0 correlation. In addition. and buy a put option with P0 = $0:02=$ and X = $1:5=$ at the same time. and it purchased a put option on 10 million pounds with an exercise price of $1:46=$ and a one-year expiration. b) Now suppose the return correlation between the two assets is 1. suppose that contract sizes are $1m: a) draw the pro…t pro…le on this portfolio one year later b) what is your pro…t (loss) when the pound exchange rate one year later is i) $1:5=$.18. Suppose that Boeing corporation exported a Boeing 747 to British Airways and would receive $10 million in one year. You are considering investing in one or both assets called A and B. a) assume that the spot exchange rate turn out to be $1:30=$ on the expiration date. 000. option hedging and tunnel forwards hedging respectively under each exchange scenario (assuming the time value of option cost is 0 for simplicity)? 28.0098/U.000. The company will receive revenue of $60. the company will have U100. Suppose in June 1993. what is the expected dollar pro…t with 100% hedge with forwards? 25. TCAS bid C$290000 for the project. What should the manager do? Suppose the exchange rate in September turns out to be $0. the weak dollar scenario $0. revenue minus cost and tax payment) with no hedge? 24. Suppose each exchange rate scenario happens with equal probability (1/3) and the company has an income tax of 30%. What is the expected dollar pro…t with 100% hedge with options (assuming the time value of option cost is 0 for simplicity)? Questions 26-28 are based on the case: TCAS 26.68/C$. what is the expected dollar pro…t (i.000.22/e. — 1993 21. Suppose the company wouldn’t know if the bid is successful until 90 days later. does the IRP hold for one month forward and three month forward in June 1993 ? 22. The manager consider three scenarios for the future spot exchange rate: the stable dollar scenario $0.0092/U to hedge away all the exchange risk. option hedging and tunnel forwards hedging respectively under each exchange scenario (assuming the time value of option cost is 0 for simplicity)? 27.000 and incur a cost of e25. Suppose the probability of a successful bid is 21 and three exchange rate scenarios happen with equal probability.76/C$.000 in a year. what would be the payo¤ for forward hedging. Based on Exhibit 8. what is the gain or loss on the option position? What is the gain or loss on the U100. the strong dollar scenario $0.000 income in terms of the spot exchange rate in June? What is the total gain or loss comparing with not hedging in the …rst place? Questions 23-25 are based on the case: Hedging Currency Risks at AIFS 23.000 income in three month (September). The company decide to use option with strike price $0. Conditional on the bid being successful.e. and suppose these two events are independent.7324/C$.Questions 21-22 are based on the case: Ti¤any & Co. calculate the expected payo¤ for each strategy. 7 . Suppose the forward contract is now quoting at $1.000. If the company’s bid fails. what would be the payo¤ for forward hedging.