End-of-Chapters 7 and 8 Problems

# End-of-Chapters 7 and 8 Problems - Moore School of Business...

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1 Moore School of Business Spring 2012 University of South Carolina IBUS 401 – INTERNATIONAL FINANCIAL MANAGEMENT Answers to selected end-of-chapters problems Chapters 7 and 8 Parity Conditions Problems assigned: Chapter 7: 1, 2, 3, 4, 5, 6, 11, 12, 13, 14, 15, 17, 21, 22, 23, 27, 28 1. Locational arbitrage can occur when the spot rate of a given currency varies among locations. Specifically, the ask rate at one location must be lower than the bid rate at another location. The disparity in rates can occur since information is not always immediately available to all banks. If a disparity does exist, locational arbitrage is possible; as it occurs, the spot rates among locations should become realigned. 2. Yes! One could purchase New Zealand dollars at Yardley Bank for \$.40 and sell them to Beal Bank for \$.401. With \$1 million available, 2.5 million New Zealand dollars could be purchased at Yardley Bank. These New Zealand dollars could then be sold to Beal Bank for \$1,002,500, thereby generating a profit of \$2,500. The large demand for New Zealand dollars at Yardley Bank will force this bank's ask price on New Zealand dollars to increase. The large sales of New Zealand dollars to Beal Bank will force its bid price down. Once the ask price of Yardley Bank is no longer less than the bid price of Beal Bank, locational arbitrage will no longer be beneficial. 3. Triangular arbitrage is possible when the actual cross exchange rate between two currencies differs from what it should be. The appropriate cross rate can be determined given the values of the two currencies with respect to some other currency. 4. in class. 5. Covered interest arbitrage involves the short-term investment in a foreign currency that is covered by a forward contract to sell that currency when the investment matures. Covered interest arbitrage is plausible when the forward premium does not reflect the interest rate differential between two countries specified by the interest rate parity formula. If transactions costs or other considerations are involved, the excess profit from covered interest arbitrage must more than offset these other considerations for covered interest arbitrage to be plausible. 6. \$1,000,000/\$.80 = C\$1,250,000 × (1.04) = C\$1,300,000 × \$.79 = \$1,027,000 Yield = (\$1,027,000 – \$1,000,000)/\$1,000,000 = 2.7%, which exceeds the yield in the U.S. over the 90-day period.

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2 The Canadian dollar’s spot rate should rise, and its forward rate should fall; in addition, the Canadian interest rate may fall and the U.S. interest rate may rise. 11. in class.
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End-of-Chapters 7 and 8 Problems - Moore School of Business...

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