INTERNATIONAL FINANCIAL MANAGEMENT Questions

Assignment Requirements

Please answer the two questions and make sure the answers are correct. If you are not sure of the answers please let me know.In the paper please write only the answer don’t rewrite the questions.
Thanks .

I. (15 Points)
In the course of constantly monitoring interest rates and exchange rates quoted by different banks around the world, an FX arbitrager observes the following quotes:
Money- market rates:
90-day interest rates (spread is zero)
British pounds £: 6% p.a.
US Dollar $: 5% p.a.
Foreign Exchange Markets:
Spot: $1.4560/£
90-day Forward: $1.4414/£.
For the above data, answer the following questions:
1. Is there a covered interest rate arbitrage opportunity available to the FX arbitragers? Why? Support your answer by showing appropriate calculations.
(3 Points)
2. What actions the foreign exchange dealer would take to exploit the covered arbitrage profits? Show all the steps and calculations leading to arbitrage profit net of the transaction cost. The transaction size is $30 million or its £
equivalent at the current spot rate. Also assume that the transaction costs
are 0.18% of the transaction size to be deducted from the gross arbitrage
profit at the end of the 90-day period. (6 Points)
3. How the actions of arbitragers as above will bring adjustments in interest
rates and FX rates that would restore equilibrium. (3 Points)
4. Suppose the interest rates stay at the levels quoted, what should be the noarbitrage
annualized forward premium/discount on $ against £? Under this
scenario, what would be the $-return in £-terms? (3 Points).

II. (10 Points)
On Monday morning, an investor takes a short position in one euro futures contract
that matures on Wednesday afternoon. The agreed-upon price is $1.3524/€ for a contract size of €125,000. At the close of the trading on Monday, the futures price falls to $1.3100/€. At Tuesday close, the price falls further to $1.2956/€. At Wednesday close when the contract matures, the price settles at $1.3396/€.
1. By how much the investor’s margin account will change in dollars each day
FIN 672, Exam 1 (Part B), Page 3 of 3
beginning Monday due to the marking-to-market settlement process? (6
Points)
2. If the short position is held until maturity, what dollar amount will the investor receive effectively on one contract?(2 Points)
3. What should be the spot exchange rate on Wednesday close to avoid any
arbitrage? (2 Points)

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