2017 EXAMINATIONS

MSc International Business and Strategy

MSc Money, Banking & Finance
MSc Quantitative Finance

ECON 406/456 International Money & Finance ` (MAIN) (2 hours)

Candidates should answer ALL questions from Section A and TWO from Section B.

Section A accounts for 40 per cent of the available marks

Section A:

1. On February 3rd 2017 OANDA quoted the following exchange rates against the US dollar
(USD) for the Turkish Lira (TRY) and the Mexican Peso (MXN):

Currency Bid Offer

TRY 3.6849 3.7049

MXN 20.3316 20.3916

 What bid and offer rates would you provide to a Mexican company for the TRY? (Your
answer will be in terms of MXN).

(4 marks)

2. As a US arbitrageur, the following were ‘spot’ US dollar (USD) quotes for the Australian
dollar (AUD) on February 3rd 2017. The relevant one-year interest rates in the USA and
Australia are also provided, together with a forward exchange rate quote you have received
from a dealer:

Bid Ask

USD/AUD spot 0.7679 0.7689

USD/AUD forward quote 0.75 0.7536

(12 months)

Interest rate (USD) 0.7% 0.75%

Interest rate (AUD) 1.3% 1.4%

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  Explain your strategy for exploiting any implied arbitrage opportunities in the
quotations.

(3 marks)

 What is your USD profit per 1 million USD arbitraged?

(5 marks)

3. A British company has imported hydro-electric generators from the Czech Republic and must
pay 1 million Koruna (CZK) in three months’ time. The firm wishes to hedge this commitment
and, although a futures contract for the CZK is not currently available, the Czech currency is
closely managed against the € (EUR). A futures contract for EUR 125000, priced in £(GBP), is
available on the Chicago Mercantile Exchange. The firm has run some regressions as follows:

GBP EUR
ΔS( )=α 1 + β1 Δf ( ) (1 )
CZK CZK
GBP GBP
ΔS( )=α 2 + β 2 Δf ( ) (2 )
CZK EUR
GBP CZK
ΔS( )=α 3 + β3 Δf ( ) (3 )
EUR EUR

 Which regression would be relevant to the British firm and how many futures contracts
would be needed if the estimated β coefficient of the equation is 0.35? Please state
whether you would buy or sell.

(4 marks)

 An alternative contract is for GBP 62500 priced in EUR. How many of these contracts
would be needed and would they be bought or sold (the current exchange rate is EUR
1.16 per GBP)?

(4 marks)

4. As a US manufacturer of agricultural machinery and parts, you have a stream of expected

payments from Eurozone customers, with the first receipt of EUR 170,000 due one year from
now:

Year 0 1 2 3

EUR amount 170,000 230,000 250,000

EUR interest r1 = 0.01 (1 yr loan) r2 = 0.015 (2 yr loan) r3 = 0.025 (3 yr loan)

rate pa.

 Using the concept of duration, calculate the amount and timing of a single forward
transaction that would best hedge the risk of EUR depreciation. Note that the interest
 rates given are conventional annual rates for an immediate loan lasting for one, two and
PV t
three years respectively. Duration =
∑t
N
( totalPV ) t

(5 marks)

 An alternative hedge could involve a forward sale of EUR one year from now, using
forward interest rate agreements to determine the size of the sale at that time. Calculate
the relevant forward interest rates and the amount of the one year forward sale of EUR.

(5 marks)

5. For the German car manufacturer, Volkswagen, the UK is an important export market. When
the GBP depreciates against the EUR, the firm’s lack of a UK manufacturing presence places
it at a competitive disadvantage and profit margins on these sales are squeezed. With the
GBP/EUR exchange rate likely to be influenced for some time by uncertainty over the Brexit
decision, the company seeks to a partial hedge against this risk. It wishes to borrow GBP at
fixed interest rates. Concerned that interest rates at home may be forced higher by the
same uncertainty, the UK mobile network provider, Vodafone, wishes to borrow at floating
rates in EUR. The relevant interest rates facing each firm are as follows (EURIBOR refers to
the Euro Interbank Offered Rate):

EURIBOR interest rate GBP fixed interest rate

Volkswagen EURIBOR + 1% 3.5%

Vodafone EURIBOR + 3% 4.5%

 Assuming that a swap bank would charge a fee amounting to 0.5% in order to arrange it,
can you identify any advantage for the firms of entering into a fixed for floating currency
swap?

(4 marks)

 Assuming that the floating leg of the swap would take place at EURIBOR ‘flat’, show how
a swap could be arranged so that both firms could share equally in any gain you identify.

(4 marks)

 To what extent is the relative riskiness of the two borrowers reflected in your
calculations?

(2 marks)

Section B

(Answer TWO questions. Each question accounts for thirty marks)

6. The covered interest parity condition states that international interest rates are effectively
equalised by forward currency discounts or premiums. Exceptionally low interest rates in the

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USA following the 2008 financial crisis appear to have encouraged heavy USD borrowing by
non-US entities. Discuss the consistency of these two observations.
7. In countries with pegged, or managed, exchange rates the occasional devaluation of these
rates is usually aimed at improving the balance of trade in goods and services. Outline the
possible mechanisms by which this objective might be achieved in economies with differing
trade patterns. Contrast the processes you describe with that of ‘internal devaluation’ within
the Eurozone.

8. The covered interest parity condition implies a value of zero for the ‘cross currency basis’.
Provide a definition of the basis, and possible explanations for its persistent deviations from
the zero value prediction in recent years.

9. Discuss the sources of foreign exchange exposure confronting international business.

Evaluate the argument that firms are wasting money by hedging against such exposure.

End of paper

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