FINA3326 APPLIED FINANCIAL MANAGEMENT
APPLIED FINANCIAL MANAGEMENT
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FINA3326 APPLIED FINANCIAL MANAGEMENT
TUTORIAL QUESTIONS 04
Prepare for Week 05 Discussion
For the tutorial prepare questions 1 to 8.
Chapters 4, 5 and 7 questions are for revision.
1. One year interest rates on Euros are at 4.23% and Swiss Francs are at 2.89%. The CHF is selling at
a one-year forward premium of 1.6%. Show whether or not there is an investment opportunity?
What types of transaction costs would likely affect this?
2. Quoted six-month nominal interest rates in Europe are 4.54% In the U.S. they currently sit at 5.33%.
The current spot price of the EUR is EUR / USD 1.3405. Assuming interest rate parity is holding,
what will the 6-month forward rate be on the EUR?
3. Suppose that three month interest rates in Australia are 7.66% for borrowing and 5.66% for lending
and in New Zealand they are 8.63% for borrowing and 6.63% for lending. If the current spot rate
is 1.1578 / 1.1601 AUD / NZD and the current three-month forward rate is 1.020 / 1.046 AUD /
NZD.
a) Would investors in either Australia or New Zealand be likely to invest overseas?
b) As an arbitrageur where would you borrow?
c) Assuming no additional transaction costs, what percentage arbitrage profit could be generated
(Calculate as a percentage of your initial borrowings)?
4. On August 16, the spot quotation on the pound was GBP / USD 1.9833 with the September futures
contract closing at 1.9843. Yet on the 1st August the pound was valued at around GBP / USD 2.04.
What do you think has happened to the price of the September pound futures contract over the
month of August? Why?
5. The 3-month forward bid price on August 20 for the EUR is 1.4622, at the same time the price of
IMM Euro futures for delivery on December 7th is 1.4403. How could a speculator or arbitrageur
profit from this situation? What will be the profit per futures contract (size is €125,000)? In
attempting to exploit this, what issues must be addressed?
6. Imagine you find the following two quotes available to you from two retail currency dealers, one
in Zurich, one in London:
• GBP / CHF 1.7275 / 1.7990
• CHF / GBP 0.5565 / 0.5798
Assuming no additional transaction costs, is there an arbitrage opportunity, and if so what
percentage return can you generate?
7. Using the following quotations in the interbank market, calculate any triangular arbitrage profit
opportunities. If so, what percentage return can you generate?
EUR / GBP 0.8622 / 0.8624
EUR / USD 1.4150 / 1.4152
GBP / USD 1.6456 / 1.6459
8. Would you be more likely to find triangular arbitrage opportunities in either retail or interbank
markets? What barriers would exist that would prevent triangular arbitrage opportunities? Can
triangular arbitrage exist in an efficient market?
REVISION QUESTIONS
Chapter 4
20. Speculation. Blue Demon Bank expects that the Mexican peso will depreciate against the dollar from its spot
rate of $.15 to $.14 in 10 days. The following interbank lending and borrowing rates exist:
Lending Rate Borrowing Rate
U.S. dollar 8.0% 8.3%
Mexican peso 8.5% 8.7%
Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million peos in the
interbank market, depending on which currency it wants to borrow.
a. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited
funds? Estimate the profits that could be generated from this strategy.
b. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to
appreciate from its present spot rate of $.15 to $.17 in 30 days. How could it attempt to capitalize on its
expectations without using deposited funds? Estimate the profits that could be generated from this strategy.
21. Speculation. Diamond Bank expects that the Singapore dollar will depreciate against the dollar from its spot rate
of $.43 to $.42 in 60 days. The following interbank lending and borrowing rates exist:
Lending Rate Borrowing Rate
U.S. dollar 7.0% 7.2%
Singapore dollar 22.0% 24.0%
Diamond Bank considers borrowing 10 million Singapore dollars in the interbank market and investing the funds
in dollars for 60 days. Estimate the profits (or losses) that could be earned from this strategy. Should Diamond
Bank pursue this strategy?