Question (1): Determine which of the following questions are True (T) and

which are False (F) and correct False Statements:

1. Exercise rate is the rate used in hedging with a forward contract.

False: exercise rate is the rate used in hedging with the option contract

2. Hedging is conducted mainly using the spot exchange rate

False: Hedging is conducted using forward or exercise rate.

3. Forward discount is the difference between the forward rate and the spot rate
that prevails at the time of signing the forward contract knowing that the
forward rate is less than that spot rate.
True

4. Speculation aims at achieving profit from exchange rate differences across

different markets.
False: Arbitrage aims at achieving profit from exchange rate differences
between markets.
Or
Speculation aims at achieving profit from exchange rate differences over
time.

5. As the exchange rate between dollar and the Egyptian pound increases as
determined by the Central Bank, this would imply a having a depreciation in
the value of the Egyptian pound.
 False: As the exchange rate between dollar and the Egyptian pound
increases as determined by the Central Bank, this would imply a having
a devaluation in the value of the Egyptian pound.

6. A decrease in the exchange rate would represent a gain for you as long as you
are operating in a short position.
True

7. Flat currency occurs when the future spot rate exactly equals forward rate
determined previously in forward contract.
True

Question (2): Solve the following Numerical Questions:

1. Suppose that you are an American computer producer and import raw
materials from Japan that worth 62,500,000 Yen that are due after 90 days.
The current spot rate in the day of the transaction is $0.005 per Yen. As you
expect the Yen to appreciate against dollars, you decided to sign an option
contract with the bank upon which the agreed exercise rate is $0.0055 per
Yen.

Required:
a. If the spot rate in 90 days is $0.0052 per Yen, would you prefer to use the
option contract or not? Is it optional for you to use the exercise rate or is it
obligatory?
Solution: It is better not to use the option contract as the exercise rate
is higher than the spot rate after 90 days. It is optional not obligatory
to use the option contract and the exercise rate.

b. What was your dollar gain or loss from holding the option contract?
 Solution: Loss if we applied the option contract = 0.0055 – 0.0052 =
0.0003 per Yen. So, total loss = 0.0053 * 62500000 = $18750
Another way:
Using option contract, cost = 0.0055 * 62500000 = $ 343750
Using spot rate in 90 days, cost = 0.0052 * 62500000 = $ 325000
Loss = $– $ = - $ 18750

2. Suppose that 1British Pound: $2.4110 in New York, $1: 3.997 Yen in Japan,
and 1Yen: 0.1088 British pound in London.

Required:

a. If you own 100 British pound, how can you achieve profit by using these
exchange rates?
Solution:
Rates you have now are:
New York 1BP: $2.4110 or $1: 0.41477 BP
London 1Yen: 0.1088 BP or 1BP: 9.19118 Yen
Japan $1: 3.997 Yen or 1Yen: $ 0.25019

100 BP converted in New York to $241.1

$241.1 converted in Japan to 963.6767 Yen
963.6767 Yen converted in London to 241.10227BP

b. What is the value of your profit?

Solution: Profit = 241.10227 – 100 = 141.10227 BP
c. Suppose that you are a Japanese mobile producer and import raw materials
from USA that worth $36,400,000 that are due after 30 days. The current spot
rate in the day of the transaction is 0.07 Yen per $. As you expect the dollar
to appreciate against yen, you decided to sign a forward contract with the bank
upon which the agreed forward rate is 0.075 Yen per dollar.

Required:
a. If the spot rate in 30 days is 0.072 Yen per dollar, would you prefer to use the
forward contract or not? Is it optional for you to use the forward rate or is
obligatory?
Solution: The forward contract is not preferable to be used as the spot
rate after the 30 days are lower than the forward rate. However, the
forward rate is obligatory to be implemented or used not optional.

b. What was your dollar gain or loss from holding the forward contract?
Solution: the loss from using the forward contract is 0.075-0.072 =
0.003 per dollar. Thus the total loss is 0.003 * 36400000 = 109200 Yen
Another way of solution:
Using forward contract, cost = 0.075 * 36400000 = 2730000 Yen
Using spot rate in 30 days, cost = 0.072 * 36400000 = 2620800 Yen
Loss = 2620800 – 2730000 = -109200Yen

c. Do you have a forward premium or a forward discount? By how much?

Solution: Forward premium by 0.075 – 0.070 = 0.005 Yen per dollar