# Answers+to+FX+no+4 - 1. Convert £1.359 to \$2.65 @ Spot...

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Click to edit Master subtitle style Answers to FX Class Problems

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Problem #1 Spot £/\$ = 0.5128 means £0.5128 = \$1.000 \$100.00 = £51.28
Problem #2 A) @ Spot £/\$ = 0.5128 (from #1) Assuming PPP, coffee SHOULD cost have same “cost” in each currency: \$2.65 * .5128 = £1.36 B) Good Deal?? Doesn’t seem like it. Expensive!! Implies an exchange rate of: £2.00 = \$2.65 £1.00 = \$1.325 Spot £/\$ = 0.755 Spot \$/£ = 1.325

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Problem #2 Possible reasons might include: US or UK might have special trade deals with coffee exporting nations leading to different costs for coffee (Not open trade) A Venti Caffe Americano might be “valued” differently in each country The currency might be managed or restricted in some way (not freely floating) This might be an arbitrage opportunity!!!!
Arbitrage Opportunity SMG (UK) Hedge Fund would:

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Unformatted text preview: 1. Convert £1.359 to \$2.65 @ Spot £/\$ = 0.5128 2. Purchase a Venti Caffe Americano at SMG Starbucks for \$2.65 3. Quickly (before it cools!) ship it to London and sell for £2.00 • Bought for £1.359 • Sold for £2.00 • Profit = £0.641 !!!! (Ignoring transaction cost!) Problem #3 x 1.10 \$110 £61.714 Exchange £61.714 for \$110 at one-year forward rate F \$/£ = 110.00 = 1.782 61.714 £57.14 ONE YEAR OUT TODAY x 1.08 Exchange \$ for £ Spot \$/£ = 1.75 (Spot £/\$= 0.5714) Invest for one year at 10% Invest for one year at 8% \$100 Problem #4 • If F \$/£ = 1.75 in problem #3, then the £61.714 one year out would be converted into only \$108.00, – £61.714 x 1.75 = \$108.00 • The US\$ investment option results in \$110.00 • An arbitrageur would take advantage by the following:...
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## This note was uploaded on 01/09/2011 for the course SMG 122 taught by Professor Arnold during the Spring '09 term at BU.

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Answers+to+FX+no+4 - 1. Convert £1.359 to \$2.65 @ Spot...

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