FM303 - THE FOREIGN EXCHANGE MARKET

PROBLEM SET 2: WEEK 3

SOLUTION GUIDE

1. On 12 August, a Commonwealth Bank dealer in Melbourne concluded a transaction with

a Citibank dealer in New York. The former agreed to buy from the latter USD5 000 000 at
an exchange rate (AUD/USD) of 1.77 for delivery on 14 August. On the delivery date, the
exchange rate rose to 1.83. How much would the Commonwealth Bank be required to pay
to settle the transaction?

Solution
In this problem, 12 August is the contract date, whereas 14 August is the delivery date. What
is relevant for this transaction is the exchange rate agreed upon on the contract date, which is
1.77. Therefore the Commonwealth Bank is required to pay:

1.77  5 000 000  AUD8 850 000

2. The exchange rate between the British pound and the Australian dollar (GBP/AUD) rose
from 0.3780 to 0.3960 in one week.
(a) Calculate the percentage appreciation or depreciation of the Australian dollar.
(b) Using the result obtained in (a), calculate the percentage appreciation or depreciation
of the pound.
(c) Calculate the corresponding values of the AUD/GBP exchange rate.
(d) Using the result obtained in (c), calculate the percentage appreciation or depreciation
of the pound.
(e) Using the result obtained in (d), calculate the percentage appreciation or depreciation
of the Australian dollar.

Solution
(a) The Australian dollar appreciates by:
0.3960
S ( AUD / GBP)   1  0.048 = 4.8%
0.3780
(b) By using equation (2.4), the percentage depreciation of the pound is:
1
 1  0.046 = -4.6%
1  0.048
(c) The corresponding values of the reciprocal exchange rate (GBP/AUD) are:
1
 2.6455
0.3780
1
 2.5253
0.3960
(d) The pound depreciates by:

1
 2.5253
 1  0.045  4.5%
2.6455
(e) From (d) the percentage appreciation of the Australian dollar is:
1
 1  0.047 = 4.7%
1  0.045

3. If the exchange rate between the British pound and the Australian dollar (GBP/AUD) is
0.3980, what is:
(a) the direct quote from an Australian perspective?
(b) the indirect quote from an Australian perspective?
(c) the direct quote from a British perspective?
(d) the indirect quote from a British perspective?

Solution
From an Australian perspective, GBP/AUD is the indirect quotation, and vice versa. Therefore:
(a) 2.5126
(b) 0.3980
(c) 0.3980
(d) 2.5126

4. The USD/AUD exchange rate is quoted as 0.4977–0.5176.

(a) What is the bid–offer spread in points and in percentage terms? What is the monetary
value of the point in this case?
(b) Calculate the AUD/USD exchange rate. What is the bid–offer spread in points and in
percentage terms? What is the monetary value of the point in this case?

Solution
(a) The bid–offer spread is:
0.5176-0.4977=0.0199
or 199 points. In percentage terms it is:
0.0199
 0.040  4%
0.4977
The value of one point is 100th US cent.

(b) The bid and offer AUD/USD exchange rates are calculated, respectively, as:
1
 1.9320
0.5176
1
 2.0092
0.4977

2
The bid–offer spread is:
2.0092-1.9320=0.0772
or 772 points. In percentage terms it is:
0.0772
 0.040  4%
1.9320
The value of one point is 100th Australian cent.

5. Dealer A quotes 0.6030–0.6050 for the EUR/AUD exchange rate to Dealer B. What is:
(a) the price at which A is willing to buy the Australian dollar?
(b) the price at which A is willing to buy the euro?
(c) the price at which B can buy the Australian dollar?
(d) the price at which B can buy the euro?
(e) the price at which A is willing to sell the Australian dollar?
(f) the price at which A is willing to sell the euro?
(g) the price at which B can sell the Australian dollar?
(h) the price at which B can sell the euro?

Solution
(a) The price at which A is willing to buy the Australian dollar is A’s bid rate, which is 0.6030.
(b) The price at which A is willing to buy the euro is the price at which A is willing to sell the
AUD, which is 0.6050.
(c) The price at which B can buy the Australian dollar is A’s offer rate, which is 0.6050.
(d) The price at which B can buy the euro is the price at which B can sell the Australian dollar,
which is 0.6030.
(e) The price at which A is willing to sell the Australian dollar is A’s offer rate, which is 0.6050.
(f) The price at which A is willing to sell the euro is the price at which A is willing to buy the
Australian dollar, which is 0.6030.
(g) The price at which B can sell the Australian dollar is A’s bid rate, which is 0.6030.
(h) The price at which B can sell the euro is the price at which B can buy the Australian dollar,
which is 0.6050.

6. If the exchange rate between the Australian dollar and the Japanese yen, expressed in
indirect quotation from an Australian perspective, is 70.10–71.60, what is the direct
quotation for this rate? What are the mid-rates in both cases?

Solution
If JPY/AUD is 70.10-71.60, the bid AUD/JPY rate is 1/71.60=0.0140 and the offer rate is
1/70.10=0.0143. Thus, the direct quotation is 0.0140-0.0143. The mid-rate is the average of the

3
bid and offer rates, which gives 70.85 = (70.10+71.60)/2 and 0.01415 = (0.0140+0.0143)/2.

7. At 9.30 a.m. Dealer A calls Dealer B and asks for a quote on the AUD/GBP exchange
rate. Dealer B responds by quoting 2.5500–2.5540. Dealer A decides to buy GBP200 000 at
the quoted rate. At 3.30 p.m., Dealer B quotes 50–90. Will dealer A make a profit or a loss
by selling the pound at 3.30 p.m.?

Solution
The rate that B quotes at 3.30 p.m. is 2.5550–2.5590. A’s selling price for the pound is 2.5550,
in which case the profit/loss realised by selling the pound is:
200 000  (2.5550  2.5540)  AUD200

8. The exchange rate between the Australian dollar and the euro, expressed in direct
quotation from an Australian perspective, rises from 1.62405 to 1.62808. Calculate:
(a) the appreciation or depreciation of the euro in points and pips.
(b) the appreciation or depreciation of the Australian dollar in points and pips.
Solution
(a) The appreciation/depreciation of the euro is:
1.62808  1.62405  0.00403
or 40.3 points, which is equivalent to 403 pips.
(b) In indirect quotation, the exchange rate declines from 0.6158 to 0.6142, in which case the
appreciation/depreciation of the Australian dollar is:
0.6142 – 0.6158 = -0.0016  16 points or 160 pips
or 160 points, which is equivalent to 1600 pips.

Note: 0.001 = 10 points, or 0.0001 = 1 point, and 10pips = 1 point

9. The following exchange rates are quoted:

USD/AUD 0.5674
JPY/AUD 70.43
GBP/AUD 0.3891
EUR/AUD 0.6075
Calculate the following cross rates: JPY/USD, GBP/USD, EUR/USD, JPY/GBP, JPY/EUR
and EUR/GBP.

Solution
70.43
S ( JPY / USD)   124.13
0.5674

4
 0.3891
S (GBP / USD)   0.6859
0.5674
0.6075
S ( EUR / USD)   1.0707
0.5674
70.43
S ( JPY / GBP)   181.01
0.3891
70.43
S ( JPY / EUR)   115.93
0.6075
0.6075
S ( EUR / GBP)   1.5613
0.3891

10. The following exchange rates are quoted:

GBP/AUD 0.3820–90
AUD/EUR 1.6400–80
Calculate the bid–offer spread on the exchange rate between the pound and the euro
expressed in direct quotation from a British perspective.

Solution
(GBP / AUD) b 0.3820
(GBP / EUR) b    0.6265
( EUR / AUD) a 1 / 1.6400

(GBP / AUD) a 0.3890

(GBP / EUR) a    0.6411
( EUR / AUD) b 1 / 1.6480
Thus, the bid–offer spread is 0.0146 or 146 points.

11. On the basis of the following exchange rates, construct a cross exchange rate matrix that does
not include the Australian dollar. All exchange rates must be expressed in bid–offer terms.
GBP/AUD 0.3820–0.3900
EUR/AUD 0.6020–0.6080
CHF/AUD 0.8800–0.8860

5
 Solution
The correlation matrix, giving the bid and offer rates expressed in both direct and indirect
quotations, is the following:

Bid Ask Cross-Rate Matrix

GBP/AUD 0.3820 0.3900 Bid Ask Bid Ask Bid Ask
EUR/AUD 0.6020 0.6080 GBP EUR CHF
CHF/AUD 0.8800 0.8860 GBP 1 EUR/GBP CHF/GBP
EUR GBP/EUR 1 CHF/EUR
CHF GBP/CHF EUR/CHF 1

Cross-Rate Matrix
Bid Ask Bid Ask Bid Ask
GBP EUR CHF
GBP 1.0000 1.5436 1.5916 2.2564 2.3194
EUR 0.6283 0.6478 1.0000 1.4474 1.4718
CHF 0.4312 0.4432 0.6795 0.6909 1.0000

Watch this if you have time

https://www.youtube.com/watch?v=iJdFvsMinF4
Excel sheet uploaded on the moodle
12. A German foreign exchange dealer trading the Australian dollar against the euro
conducts the following transactions over a five-day period in November:

Date Exchange rate (EUR/AUD) Amount (euro)

14 Nov . 0.5563–0.5613 +5000000
15 Nov. 0.5661–0.5711 +10000000
18 Nov . 0.5581–0.5631 -7000000
19 Nov . 0.5566–0.5616 +8000000
20 Nov . 0.5562–0.5612 -12000000

(a) Construct a blotter to show these transactions and the positions in both currencies.
(b) Calculate the average exchange rate at which the dealer bought and sold the
Australian dollar.
(c) Calculate the unrealised profit/loss on the final position.
(d) What would the dealer do to square the final position?

Solution
(a) The blotter would look like this:
EUR deal EUR balance EUR/AUD rate AUD deal AUD balance
amount amount
+5 000 000 +5 000 000 0.5563 -8 987 956 -8 987 956
+10 000 000 +15 000 000 0.5661 -17 664 724 -26 652 680
-7 000 000 +8 000 000 0.5631 12 431 185 -14 221 495
+8 000 000 +16 000 000 0.5566 -14 372 979 -28 594 474
-12 000 000 +4 000 000 0.5612 21 382 751 -7 211 723

6
(b) The average exchange rate is:
4 000 000
 0.5547
7 211723
(c) Because there is a short position on the AUD and since the market rate is higher than the
average rate, the position is unprofitable. The unrealised profit/loss is:
7 211723  (0.5547  0.5612)  46 876 (euros)
(d) To square the position the dealer must buy AUD7 211 723 at 0.5612.

13. The spot and forward rates between the Australian dollar and the euro (AUD/EUR) are
as follows:
Spot 1.6030
One-month forward 1.6260
Three-month forward 1.5920
Calculate the forward spread in percentage per annum for both maturities. State whether
the Australian dollar sells at a premium or a discount.

Solution
The one-month forward spread is:
1.6260  1.6030
 12  0.172  17.2%
1.6030
which means that the euro is selling at a premium. Similarly, the three-month spread is:
1.5920  1.6030 12
  0.028  2.8%
1.6030 3
which means that the euro is selling at a discount.

14. The following are the spot and swap forward values of the EUR/AUD exchange rate:

Spot 0.6020–0.6100
One-month forward 20–40
Three-month forward 40–60
Six-month forward 80–40
Calculate the outright forward rate for each maturity. State whether the euro sells at a
premium or a discount.

Solution
The outright forward rates are as follows. The AUD sells at a premium for the one-month and
three-month maturities and at a discount for the six-month maturity.

7
Exchange rate Bid Offer
Spot 0.6020 0.6100
One month 0.6040 0.6140
Three months 0.6060 0.6160
Six months 0.5940 0.6060