Lecture3

5429 016 exhibit 72 standard normal distribufon 71

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview:   Long- term forward rates and premiums –  Let i(2,¥) and i(2,$) denote the spot interest rates for yen and dollar investments with 2- year maturiFes –  If no arbitrage opportuniFes exist, then the rate of yen per dollar for the 2- year maturity must be F(2) = S * [1+i(2, ¥)]2 /[1+i(2,$)]2 Spot: ¥110/$; i(2,$) = 5% p.a.; i(2, ¥) = 4% p.a.; ¥10M to invest InvesFng in Japan: ¥10M * (1.04)2 =¥10.816M, or $90,909.09 at current spot InvesFng at home: $90,909.09 * (1.05)2 =$100,227.27 You are indifferent between the two if the forward rate is realized Chapter 7 SPECULATION AND RISK IN THE FOREIGN EXCHANGE MARKET 7.1 SpeculaFng in the Foreign Exchange Market Uncovered foreign money market investments Kevin Rudd, was considering several ways to invest $10,000,000 for 1 year. The data are as follows: USD interest rate: 8.0% p.a.; GBP interest rate: 12.0% p.a.; Spot: $1.60/£ Remember that if Kevin invests in the USD- denominated asset at 8%, a~er 1 year he will have $10M * 1.08 = $10.8M Suppose Kevin invests his $10M in the pound money market, but he decides not to hedge the foreign exchange risk. As before, we can calculate his dollar return in three steps. Step 1. Convert dollars into pounds in the spot market. The $10,000,000 will buy $10M/ ($1.60/£) = £6.25M at the current spot exchange rate. This is Kevin’s pound principal. Step 2. Calculate pound- denominated interest plus principal. Kevin can invest his pound principal at 12% yielding a return in 1 year of £6.25M * 1.12 = £7M Step 3. Sell the pound principal plus interest at...
View Full Document

Ask a homework question - tutors are online