FINA 4500
Spring 2011
page
1
of 4
Problem Set 1:
Parity Relationships and Arbitrage
1.
The following prices are observed.
Formulate an arbitrage strategy to profit from the
situation.
•
Euro per Dollar exchange rate is 0.75 spot.
•
Pound per Dollar exchange rate is .60 spot.
•
Euro per Pound exchange rate is 1.50 spot.
2.
The following prices are observed.
Formulate an arbitrage strategy to profit from the
situation.
•
Swiss Franc per Dollar exchange rate is 1.004 spot.
•
Pound per Dollar exchange rate is .40 spot.
•
Swiss Franc per Pound exchange rate is 2.008 spot.
3.
The following prices are observed.
Formulate an arbitrage strategy to profit from the
situation.
•
Dollar per Euro exchange rate is 1.30 spot and 1.31 for 180day forward (one
Euro buys $1.30 spot and $1.31 forward).
•
German interest rate is 4.0% compounded daily.
•
U.S. interest rate is 1.0% compounded daily.
4.
Suppose the interest rate in Switzerland is 6% and the expected inflation rate there is
1%.
Meanwhile the interest rate in the United States is 2% and the expected U.S.
inflation rate is 0.5%.
What direction will funds flow?
What pressures would result
on interest rates in the two countries?
5.
Suppose the interest rate in Japan is 5% and the expected inflation rate there is 1%.
Meanwhile the interest rate in the United Kingdom is 10% and the expected U.K.
inflation rate is 7%.
What direction will funds flow?
What pressures would result
on interest rates in the two countries?
Note that if real interest rates were not equal in any two countries, capital would flow to
the highest real rate.
6.
Round Rock National Bank lent $1,000,000 to Block Watne Homes, with very
substantial collateral, at a floating rate pegged at 2% above the TBill rate.
The
Bank borrowed $1,000,000 in Eurodollars from HSBC Bank in England, at 1% over
LIBOR (London Interbank Offered Rate).
Round Rock National's correspondent,
Citicorp, offered to arrange a swap with $1,000,000 principal that would allow
Round Rock to receive interest at 1% over LIBOR and pay at 1% over Tbill.
Is the
swap attractive to Round Rock National?
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FINA 4500
Spring 2011
page
2
of 4
7.
The following prices are observed.
Formulate an arbitrage strategy to profit from the
situation.
•
London gold price per ounce is 750 spot and 772.50 for 180day forward.
•
London silver price per ounce is 10.00 spot and 10.30 for 180day forward.
•
London tin price per ton is 100 spot and 103 for 180day forward.
•
London Dollar exchange rate is .60 spot and .58 for 180day forward.
•
U.S. interest rate is 1.00% compounded daily.
8.
You are an expatriate working for CommerzBank in Frankfurt West Germany, and
observe the following prices.
Formulate an arbitrage strategy to profit from the
situation.
•
Dollar per Euro exchange rate is 1.30 spot and 1.31 for 180day forward.
•
German interest rate is 5.00% with daily compounding.
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 Spring '08
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 Exchange Rate, Inflation, Interest Rates, Arbitrage, arbitrage strategy

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