Tutorial+19+Solution - BUS3026W Finance II 2009 - Tutorial...

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1 BUS3026W Finance II 2009 - Tutorial 19 - Suggested Solution Due: Monday 12 th October 09 QUESTION 1 a. The advantages of the flexible exchange rate system include: (I) automatic achievement of balance of payments equilibrium and (ii) maintenance of national policy autonomy. [2] b. If exchange rates are fluctuating randomly, that may discourage international trade and encourage market segmentation. This, in turn, may lead to suboptimal allocation of resources. [1] c. Economic agents can hedge exchange risk by means of forward contracts and other techniques. They don’t have to bear it if they choose not to. In addition, under a fixed exchange rate regime, governments often restrict international trade in order to maintain the exchange rate. This is a self-defeating measure. What’s good about the fixed exchange rate if international trade need to be restricted? [2] QUESTION 2 To make a triangular arbitrage profit the Deutsche Bank trader would sell $5,000,000 to Dresdner Bank at €0.7627/$1.00. This trade would yield €3,813,500= $5,000,000 x .7627. The Deutsche Bank trader would then sell the euros for Swiss francs to Union Bank of Switzerland at a price of €0.6395/SF1.00, yielding SF5,963,253 = €3,813,500/.6395. The Deutsche Bank trader will resell the Swiss francs to Credit Suisse for $5,051,036 = SF5,963,253/1.1806, yielding a triangular arbitrage profit of $51,036.
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This note was uploaded on 06/01/2011 for the course FIN 3026W taught by Professor Drtoerien during the Summer '09 term at University of Cape Town.

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Tutorial+19+Solution - BUS3026W Finance II 2009 - Tutorial...

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