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Econ+161B++sample+final+and+solution++W+2011

Econ+161B++sample+final+and+solution++W+2011 - Econ 1613...

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Unformatted text preview: Econ 1613 Final Exam Aeohrabian Summer 2006 3. Between 1980 and 1995, the yen/dollar exchange rate moved from yen 226l63/d0llar to yen 9396‘ During the same lS»year period the consumer price index (CPI) in Japan rose from 910 to l l92 and the US CPl rose from 82.4 to 152.4. 1f PPP had held over this period, what would the yen/dollar exchange rate have been in l995’? be What happened to the real value ofthe yen in terms of dollars during, the period? 15 Nike of Portland, Oregon, has purchased a French company, which produces a line of running shoes for children. The purchase price is FF 12,000,000 with full payment due to the French owners in 6 months. The following data is available: Present spot rate FF 6.0000/3 Sixamonth forward rate FF 6.20000/S Sixvmonth French interest rate 11.00% per annum Sixumonth Unitecl States interest rate 8.00% per annum Six—month call optien ofFF at 6,000 30% premium Sixamonrh put aption on FF at 6000 25% premium Aseeme ea: Nike ear: berrew er invest 3%: fire giver: interesi reres’ie {he greeted Staiee emi France Eriélie’s seer ef eaeiiei is 14%. {fiempere rile eiterea‘riee weye fer 35kg :e sewage this fereige exeeeege expeeere ieeéedirrg éeieg eeihieg, 3. In January, 1977 (when DM3 e $1) it was expected that by the end of 1977 the price level in the US. wouid have risen by 10% and in West Germany by 50/01 The real rate of interest in both countries is 4%, it. Use the PPP to project the expected DMs per $1 at the end of 1977 {the expected future spot rate of DMS per $1). 13. Use the Fisher relation to estimate the nominai interest rates in each country which makes it possible for investments in each country to earn their real rate of interest. (3. Use the [RPT to estimate the current oneyear forward rate of DM’s per $1. d. Compare your estimate of the current forward rate in (c) with your estimate of the expected future spot in (a). . Tay Enterprises of Los Angeles has just sold merchandise for DM 250,000 to a customer in Germany, with payment due in Deutschemarks three months from today. Tay Enterprises can borrow for three months from a bank in Los Angeles at 10% amount, or from a bank in Germany at 7.5% per atmum. Tay‘s weighted average cost of capital is 12% per annum. Today‘s spot rate (direct basis) is 0.5540/DM. Three month option contracts are available with the following characteristics. Contract size DM 125,000 Strike price 0.5520i’DM Option mention}, per option 200 at Assume that you in fact hedged the transaction by the use of option. contracts. On the day the option matures, three months from new; the spot exchange rate is 0,550GIDM. Would yeti exercise the option at that time? or seii Deutsehernarks in the soot market? Why, acct what is the {totiae advantage at one choice ottet the other? he What woettt haste heee goes cotter sates oteeeees? three moottis heece. it” gets. her: heégeet eta the mooey market? it; {Eieee toéeyis iotesest :etest whet shoete he the ttteeeeeootis toteeard eachsege sate foe iltetttseEeriiarits? cit Given this forested exchengc fate. What wooiti have: heee year dciiet sates otoceeés had yet; hedgeet aria the toward meeétet? e, Giver: the choice? woeitt yeti ereter a {steward hedge or 3 money market hedge? 113333? aeti ethat is the cotter efieeetege of eoe choice ester the edict“? 5, You have the following quotations and expectations for the British pound Present spot rate $1.7800/ E Six~month forward rate SlSSlOO/E Your expectation for spot rate in six months $1.8500/ E Six-month call options on pounds at a strike price of $1.78 sell for a premium of 4 cents per pound sterling. Assume your have $5,000,000 with which to speculate. Ignore transaction costs, taxes, and interest that might be earned on idle cash balances. If your expectations prove correct: a) What would be your dollar profit from speculating in the spot market? b) What risks are associated with this speculation? e) How much capital must be committed? d) What would be your dollar profit from speculating Via the forward market? 2 e) What risks are associated with this forward speculation? l D How much capital must be committed? l g) What would be your dollar profit from speculating via the option market? it) What risks are associated with this option speculation? i) How much capital must be committed? j) What are the consequences for the three alternatives if interest can be earned on idle cash balances? l. Econ 163.8 625. Solution to Fina! £xam Summer 2006 A.Soi1rabian 2:?- m” ha/ng/A/xs (”f/1775 ,2 w fit , 6 427°} £9 ” gafftj/Ifép) J3 r275 ”14/52 *4: M : WM flaw} “‘1 ”1‘77! {71775 :- $.oaéz/g( 0/? ygéosfi flew £71775?” $Wflé/i 50 g 24:55 a //zCz'ouZfi/c! mom flax? [4/77” way/a9 wflfiqt [Gil/pl fz/gxojqa/é/ea [6,72 M3 /?7j, k/aw (“a 2 Mara/5! if. kit/‘7’ axlqém ngyi/f? l?! ’ 5417/49 .1 (a) ;c2?a§'5 - 47 if? i: i €24” t X’W’W/ézaf ’ i zgiigw “‘ ff / ' f“? A \ “2 S ffm/ fiffiéfiflfi ) M f iz’z/éfiwxflfij 5X5; 94% x! [044; 4735 L W: @4276 f 14/: 76) : zzé-éj’ 1‘: it ‘004422/f fl” é/fi/Zrflfafl Vzv/w/f 5M Jun/«”47 fl‘fl {5.157320% 1/25/an /7X<9— 75', fl’: 21w &///£C1&%2¢/( (097534?“ ooflfl/1)/ 4 /1~7/7 00‘ A " a . M0725 /4/'; C/fgpmfl’c w///¢CL¢»+EW7 of Ve/jé’rz fl/f (EM/495%” {Mama/6 0/7 jaw/my» fi/d/fi $ - a5 fljvmé of flex? 7904; V052 jay/kw fl/Zofl fl? (1.5. fpf {mdehb/J Mgr/[Cf fia/fl/KJ ‘ 2. a. Buy forward contract, 12,000,000/6.2 = $1,935,484. This will be paid in six month. b. Money market hedge. Borrow dollars, exchange for francs, invest in France for six months, and then pay for purchase. You need today 12,000,000/1.055 = FF11, 374,407. Buy francs today with dollars: FF11, 374,407/6 2 $1,895,735. Today’s dollar cost of $1,895,735 is worth $1895, 407(104) = $1,971,564 in six months, if invested at the U.S. T~Bili rates. This makes the future cost greater than the cost of forward hedge. if the cost of capital of 14% had been used, the future cost would be even greater. c. Option hedge. Buy a call at FF6.00 for a 35 premium. Cost of call will be 0.03 X FF12, 000,000 = FF360,000, or FF360,000/6 = $60,000. Time adjusted for six months: 60,000 X 1.07 = $64,200. Maximum cost = (FF12, 000,000/6) + 64,200 = $2,064,200. Minimum cost = anything + $64,200. indifference with forward hedge: FF12, 000,000/X = $1,935,484 — $64,200; X = FF6.4127/S if the franc is weaker than FF6.4127/$, the option is better than forward. 3. a. (et — eo )/eo = (ih — if)/1+if (et - 1/3)/1/3 = (.10 — .05)/1 + .05 et = 5.3490/DM 0r DMZ.8653/$ b. rh = Ah + ih = .04 .10 = .14 rf=Af+if= .04+.05= .09 c. (ft - eo)/eo = (rh - rf)/1+rf (ft - 1/3)/1/3 = (.14 — .09)/1+.09 ft = $.3486/S or DM2.8686/S d. Essentially the same, because forward rate is unbiased prediction of future spot rate. 4e. Calculation of proceeds using option market hedge. Buy 2 contracts of three—month 0M put options (worth DMZSO, 000) with a strike price ofS.5520/DM. in three months deliver DMZSO, 000 and receive (250.000)(.5520) = $138,000. if the DM250, 000 were sold in the spot market three months hence they would provide (250,000)(.5500) : $137,500. it would be $500 to your advantage to exercise the option three months hence, rather than buy spot. The cost of the options ($200X2=$400) is a sunk cost and irrelevant to the decision to be made in three months. b. Proceeds from use of money market hedge. Borrow DM today for 3 months at 7.5% per year. Amount to borrow = DM250, 000/(1+.075/4) = DM245,399. Exchange for dollar in spot for (DM245, 399 X .05540 = $135,951), received today. The 3— month future value of this at Tay’s WACC is ($135,951)X(1+.12/4) = $140,029. c. Estimate of forward exchange rates. (F-.554)/.544 X 12/3 X 100 =.- 2.5, F: $.5575/DM. d. Dollar proceeds from a forward market hedge. (DM250,000)(.5575) = $139,375, received in three months. e. Money market hedge is better than forward hedge by $654. 5.a. Speculation in the spot market. Today, buy pound with dollar, in six months, buy dollar with pound. if your expectation is correct, your expected profit is: $5,000,000/1.78 X 1.85 — $5,000,000 = $196,629.00 b. Risk is that the ending rate may be below $1.78/pound. However this risk is offset by the fact that the rate might be higher than 1.78. c. You need $5000, 000 capitals, which would normally have to be paid in two days. The venture is expected to earn $196,629/5000, 000 = 3.93% for six months. Or a rate of return of 7.86% per year. d. Speculation in the forward market. Today, buy six-month forward pound with the dollar. in six months, deliver your $5,000,000 against your order, and simultaneously sell those pounds in the spot market. if your expectation proves correct, your expected profit is: $5,000,000/1.81 X 1.85 — 5,000,000 = $110,497.00. e. Risk is that the ending spot rate may be below $1.8l/pound, although it could also be higher. f. No capital is needed, since a forward transaction involves a promise to deliver cash at a future date. However, if the specuiator did not have a line of credit at the bank acting the dealer, a margin deposit might be required to protect the bank. g. Specuiation in the options market. Today, buy call options on pounds. At 4 cents per pound, one could in theory buy $5,000,000/004 2 an option on 125,000,000 pounds. in six months, exercise your 125,000,000 pounds option, receiving 125,000,000 at $1.78/pouncl, for a total purchase price of $222,500,000. Simultaneously, sell 125,000,000 pounds in spot market at $1.85/pound, receiving $231,250,000. Your results: 231,250,000 - 222,500,000 ~ 5,000,000 = $3,750,000. h. Risk is that if the ending exchange rate is $1.78/pound or less, you lose everything! Your option is worthless and you abandon it (or frame it on your wall as a reminder that high returns come only with high risk!). i. Capital: All $5,000,000 is needed. if things go as expected, you earn a 75% return on the original $5,000,000 (3,750,000/5,000,000). j. if one speculates in the spot market, the pounds acquired could be invested in London at a six-month rate. If one speculates in the forward market, the dollars remain in the United States and can be invested to earn interest at the US, rate. Expected profit in spot transaction is $86,132 more than expected profit via forward market ($196,629 - $110,497), for an annual differential of 3.446% (86,132/5,000,000). By speculating in the forward market, one can invest the free cash in the US, whereas an investment in the spot market means investing the free cash in Britain. If the US. interest rate were 3.446% above the British rate, the two expected results would give identical results. Note, however, that the risk of the spot market versus the forward market is different, so one is not comparing risk-adjusted rates. if one speculates via the options market, one earns no interest. ...
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