International Financial Markets
Spring 2015
Professor A. Yaron
#3: Eurocurrency Markets, Forward
Contracts and Interest Rate Parity
Homework Questions
_
1. Suppose that the CAD/GBP rate is 2, and the 360-day interest rates are 10 percent for the
CAD, and
INTERNATIONAL FINANCE
Assignment #2:
Currency Hedging for World-Wide Portfolio Managers
Professor Amir Yaron
Due: Monday February 23rd, 2015, 10:30AM-Finance Dept.
Read the entire case before you start working. An Excel file available on the class Canvas
INTERNATIONAL FINANCIAL MARKETS
FNCE-219
Assignment #1:
DenCarr
Professor Amir Yaron
Due: Monday, January 28th, 2013
Mr. Axel Hansen, the head of DenCarr's treasury department, must make a decision
whether to hedge a sale of trucks to a foreign (Costa Ri
whether they are separated or not. In our formal language, the
correlation coefficient of the baskets falling is one and there are no
economies. However, if it is guaranteed or certain that when one basket
falls, the other will not as when the baskets are
B parallel to SB, the marginal rate of substitution (/) between the
expected return and risk does not change. Hence, the substitution effect
between them does not occur and the only effect in operation is the
income effect really a wealth effect in the co
have been mainly due to innovations in transactions technology. 5.9 Is
there a positive portfolio demand for money balances in the modern
economy? The modern economy with a well-developed financial sector
has a plethora of financial assets that are as ris
hold only the risky assets and his demand for the riskless asset will be
zero. If the individual chooses a point on SG, he will hold a portfolio
consisting of the riskless asset and some combination of the risky ones,
with only the riskless asset held at
S B were such that the optimal point were to the left rather than right
of point A. Portfolio selection and speculative demand 157 indicated in
Figure 5.12 by the point A , which now implies a higher proportion
(indicated by point a ) of the portfolio he
Tobins analysis that refers specifically to Keyness arguments on the
speculative demand was presented in Chapter 2. Portfolio selection and
speculative demand 155 Figure 5.10 has the expected value of terminal
wealth on the vertical axis and the standard
5.5.5 Optimal choice The preceding two subsections analyzed the risk
averters indifference curves and the opportunities open to him. Since
such an individual prefers to be on a higher indifference curve to being
on a lower one, he will prefer to be on the
to: x1 +x2 = W (16) Hence, integrating both sides of this equation
specifies that: ln U (W ) = k1 W so that: U (W ) = exp (k1 W )
Integrating again, U(W ) = k2 (1/ ) exp (k1 W ) = ab exp ( W )
where k1 and k2 are constants of integration, a = k2 and b = (
that the individual has a CARA utility function, so that he maximizes:
EU(W ) = t t2 t Now assume that fluctuates such that t = 0 +
t and t+1 = 0 t. Derive the individuals speculative demand
functions Msp t and Msp t+1. 8. In the preceding two questions,
instance, the degree of risk aversion to the slope of the utility function
under certainty, as can be seen from the absolute and relative measures
of risk aversion, as well as from the Friedman and Savage (1948)
arguments, which were used in this chapter
further, so that the optimal combination, with given preferences, will
include still more of the riskless asset and even less of the risky assets.
This process of decline in the net worth of risky assets and increased
demand for the riskless asset could p
of the CRRA utility function subject to the budget constraint yields the
demand function for the ith risky asset as: xi/W = ki i = 1,2,., n (26)
where: ki = ki(,ij) The variables in bold type indicate the vectors of
the relevant variables (Cuthbertson, 19
(W )/U (W ) = 2c/(b2cW ) Since (b2cW ) > 0, the ARA for the
quadratic utility function is positive and increasing in W , so that as the
investor gets wealthier, he becomes more risk averse. This increase
rather than a decrease makes the quadratic utility
while that for the riskless asset falls. This example illustrates the
behavior of an individual who strongly wishes to maintain the amount of
terminal wealth and, with the decreased after-tax returns on his assets,
has to purchase more bonds than before t
function,25 as we show in the next few paragraphs. Cardinality of the
von NeumannMorgenstern utility function As mentioned earlier, the
von NeumannMorgenstern (NM) utility function is based on a set of
axioms (see Appendix 1) which imply that, for an indi
the result that: = k2 +k1cfw_1x1 +2(1x1 ) (34) This is a general
result for the expected return on the two-asset portfolio. 31 This linearity
is clearly evident if the prospect has only two outcomes x1 and 0, so that
it is (x1, 0; p1, (1p1). 170 The deman
Swaps
Professor Amir Yaron
International Financial Markets
Spring 2016
Amir Yaron
Swaps
Spring 2016 #1
The Course Outline
1. The Swap Market
2. Interest Rate and Currency Swaps
2.1. Plain Vanilla Interest Rate Swaps
2.2. Cross-Currency Swaps
3. Pricing Sw
and was used to show the dependence of the demand for money on the
rates of interest. The varieties of the analytical developments discussed
in this chapter are testimony to the importance of the speculative motive
in the literature on monetary economics.
and even demand deposits do not increase proportionately with his
wealth, so that CRRA may not be suitable for deriving the portfolio
demand for M1. This is not necessarily so for the other components, M2,
M3 and so on, for which CRRA may perform better.
sales and purchases, so that positive balances, related to transactions, are
held in the management and switches of portfolios. In addition, switches
among bonds involve two transactions, each incurring transactions costs,
while a switch from money to bon
, so that the purchase of risk becomes 0a , implying that the proportion
invested in bonds falls to 0a . This proportion is less than the initial
proportion 0a, contrary to the situation shown in Figures 5.11 and 5.12.
In this example, the nature of the i
neighborhood of point a but leaves the optimal combination on the
segment CG will change the demand for the riskless asset and the risky
bundle. It will, however, leave the composition of the risky bundle
unchanged. Such a shift in preferences was termed
where a and b are the constants of integration.27 is known as the
ArrowPratt measure of relative risk aversion. 27 CRRA is often used in
intertemporal consumption analysis, where the intertemporal utility
function is assumed to be time separable and is sp
distributed with mean and standard deviation , as before, the
expected value of this utility function is given by: EU(W ) = ab[exp(
+ 22)] (13) Since b > 0 and 0, maximizing the expected utility
function (13) is equivalent to minimizing [exp( + 22)] or
ma
considerable increase in the ease of transfer from savings accounts to
checking accounts, especially in the banks, have brought about an
increasing dominance of the net return (over transfer costs) on savings
deposits and a continuing increase in the prop
asset increases with wealth but the proportions of the two assets in the
portfolio change as initial wealth W increases. These demand functions
depend upon the expected returns and the variances and covariances.
CARA and the special case when a riskless a
mathematical, based on the expected utility hypothesis, and tends to use
specific cardinal utility functions. The next section presents this type of
analysis. 5.7 Specific forms of the expected utility function 5.7.1 EUH
and measures of risk aversion If w
To derive the asset demand functions, substitute the equations for and
in (31) and maximize the resulting expected utility function with
respect to the quantities of the assets. Since the quadratic utility function
does not possess the CRRA property, the
212 1 +2 2 +2 = 12 +21 1 +2 In Figure 5.4b, a
portfolio consisting only of X3 is represented by the point S.
Combinations of X1 and X3 only in the portfolio would yield the
opportunity locus AS and combinations of X2 and X3 only would yield
the opportunit
mutual funds, etc., so that CARA implies that, beyond a certain amount
of wealth, increases in wealth will be added to the riskless asset
holdings, so that their proportion relative to wealth will increase. This
prediction makes CARA especially unrealisti
opportunity locus for perfect negative correlation (12 = 1) In this case,
= 1x1 2x2 (37) so that = 0 for x1/x2 = 2/1. Given (37), we can
define a riskless composite asset X3 for which 3 = 0. It would combine
X1 and X2 in the proportions given by x1/x2 =
X1 and X2 alone, of X1 and X3 alone and of X2 and X3 alone, give the
opportunity loci in Figure 5.5a as AB, AE and BE respectively. Further,
consider combinations of the points a on AB and b on BE. These
generate the locus ab. If we were similarly to take