HARVARD B USINE SS ScHOOL

9-205-017
OCTOBER 15, 2004

MIHIR A. DESAI

Foreign Exchange Markets and Transactions:

Solutions to Exercises

Calculating and Using Exchange Rates

Exercise1 Fill in the table using the direct and indirect quotes provided.

Currency U.S.S Equivalent Currency per U.S.S Equivalent of 100 U.S.$

China (Yuan Renminbi) 0.1208 8.278 827.81

Japan (Yen) 0083 120.38 12,038

tettii

Mexico (Peso) 0940 10.6428 1064.28

Singapore (Dollar) 5617 1.7803 178.03

Taiwan (Dollar) 0.02878 34.7464 3474.64

Turkey (Lira) 000001 1,612,903 161,290,300

U.K. (Pound) 1.5734 6356 63.56

Venezuela (Bolivar) 0006 1597.44 159,744

tanpserritiragi4Mi

Euro 1.0773 9282 92.82

u.s.s equioalent are direct quotes showing the number of U.S. dollars equivalent to one unit of the foreign
curreney To convert a direct quote to an in direct quote take the inverse of this ratio, i.e. 1 unit offoreign
Currency/U.S. dollars equivalent = Currency per US$

tCurrency per U.S.S are indirect quotes showing number of foreign currency units equal in value to 1
u.ss; to convert an indirect quote to direct quote take the inverse of the ratio, ie.: U.s.$ number of foreign
currency units per U.s.S = U.S.$ Equivalemt

Professor Mihir A. Desai and Research Associates Christina B. Pham and Kathleen Luchs prepared this supplement as an aid to instructors and
students in the classroom use of the note Foreign Exchange Markets and Iransactions, HBS. No. 205-016. This supplement provides solutions to
the exercises in the note.

Copyright 2004 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any torm or by any means electronic, mechanical,

or otherwise-without the permission of Harvard Business School.

photocopying, recording,

Ude Jagannathan, iE
oER UnAUg u1.COpying
or pOsting is an intringement of copyright. Parnmissions@hbsp.harvard.edm
This document is authorized for educator review use only by or 617.783.7860
 and Transactions: Solutions to Exercises
205-017 Foreign Exchange Markets

Calculating cross exchange rates

Exercise 2 p o

Use these exchange rates to answer the questions beloW:

Country Currency per U.S.S

China- yuan renminbi (CNY) 8.2871

Japan -yen (JPY) 119.040

Argentina - peso (ARS) 2.975
16.41.0
Vietnam-dong (VND)

A Japanese manutacturing firm, Japanohondapokemon, placed a purchase order with Beijing

conglomerate, Maydinchina, to procure 10,000 tons of raw materials at a cost of 9,030,200 yuan
renminbi. How many yen does the Japanese firm have to exchange in order to pay the bill in yuan

renminbi?

Answer: 129,714.255.65.PY
rate is 119.040 JPY/8.28710 CNY 14.36 =

See Formula 1 in the note.. The JPY/CNY cross exchange

this rate, or 14.36 x 9,030,200
JPY/CNY. To pay the bill, the Japanese firm needs 9,030,200 CNY at exchange
= 129,714,255.65 JPY

Silverman Pouches, has an Argentinean client who

A trader at well-known investment banking firm, Vietnamese
markets. The trader suggests the purchase of
is interested in investing in emerging bond. How
at 1,604,100 Vietnamese dong (VND) per
government-issued bonds, currently selling 250 bonds?
will it cost if the client wants to purchase
many Argentine pesos (ARS)

Answer: 74.375 ARS

VND .000185462
cross exchange rate is 2.975 ARS/16,041
=

See Formula 1 in the note. The ARS/VND 297.50 ARS. For 250 of
bond costs .000185462 ARS x 1,604,100
ARS/VND. At this exchange rate, each
bond 74,375 ARS.
these bonds, the trader needs 250x 297.50 price per
=

copyrignt. Permissions@hbsp.harvard.edu
or posting is an iniringement o
use only by Ude Jagannathan, iEOnEun Aug zU1. Opying
authorized for educator review or 617.783.7860
Thisdocument is
 Foreign Exchange Markets and Transactions: Solutions to Exercises
209-017

Exercise 3 Fill in the cross rates table below. Derive the missing rates from the rates already
provided.

U.S. Vietnam Taiwan Indonesia Egypt

Dollar VNDong TDollar Rupiah EPound

Egypt 5.97540 0.00371 0.15926 000639

Indonesia 9353.35 0.5831 248.845 1562.5

Taiwan 37.52 0.002344 0.00402 6.279

Vietnam 16,041.0 *****

426.621 1.715 2695.4

U.S. 0.000062 0.02665 000107 0.16735

inverse of this 1/5.9754 is the

(Hint: The Egypt EPound/U.S. dollar rate is given as 5.9754. The
-
-

U.S. dollar/EPound exchange rate, which can be inserted in the table. In the same way, use the other
rates given to calculate the inverse ra tes. To complete the table, use currency pairs
exchange
referenced to the same currency to calculate cross exchange rates according to Formula 1.)

First calculating the inverse rates from the exchange rates given provides the following:

16735 U.S.S/EPound (1/5.9754)

000062 U.S.5/VNDong (1/16,041)

rate can be calculated, as in

From these two currencies referenced to the U.S.5, the EPound
-

VNDong cross

Formula 1 in the note

0.000062 EPound/VNDong 0.000371EPound/VNDong

1EPound x0.000062 USD 0.016735
0.16735 USD 1 VNDong

this: 1/,000371 = 2695.4 VNDong/EPound

The VNDong/E Pound exchange rate is the inverse of

to calculate other crOss rates.

the can be used
referenced to sane currency
Other currency pairs
3

is an intringement of copyright. Permissions@hbsp.harvard edu

Aug 2021. Copying or posting
HE OIHER until
for educator review use only by Ude Jagannathan, or 617.783.7860
This document is authorized
 Transactions
Solufions to Exercises
Markets and
Foreign Exchange
205-017

Calculating Bid/Ask Spreads

Exercise 4 You are planning a trip to Europe
and Japan and want to change
O
U.S. dollars into euros

and yen. Your bank provides the following quotes:

Bid Ask
$1.194 $1.245
Euros
009245 S.00967
Yen

converted $500 into euros

How much would you lose if you
What the bank's bid/ask spreads?
are
then back into dollars?
and $500 into yen, and

(1.245-1.194)/1.245 4.1%
is 4.1%:
Bid/Ask spread for the euro

ask price of 1.245 and for S500 you will receive

E401.61 ($500/1.245)
The bank will sell euros as its
receive $479.52
The bank will buy euros at its bid price of andfor E401.61 you will
1.194

4.1% ofthe total sum (20.48/500)

$500.00-479.52= $20.48 or
Cost ofthe fwo transactions:

(00967-00924)/.00967 = 4.45%
4.45%
Bid/Ask spreadfor the yen is
:

yen( receive 51,706.31 $500/00967)

The bank will sell yen as its and for $500 you will
ask price of.00967
51,706.31 yen you will receive $477.77
at its bid price of.00924 and for
The bank will buy yen
total sum (22.23/500)
$500.00-477.77= $22.23 or 4.45% ofthe
Costofthe two transactions:

Permissions@hbsp.harvard.edu
or posting is an infringement of copyright.
HE OTHER UnUi AUg
2021. Copying
for educator review use only by Ude Jagannathan, or 617.783.7860
This document is authorized
 Foreign Exchange Markets and Transactions: Solutions to Exercises s-017

Currency Appreciations and Depreciations

Exercise 5 You are given two different exchange rates per pair of currencies. Determine whether
the currency in question appreciated or depreciated. Mark the correct column. NOTE: You are given
a mixture of direct and indirect quotes.

Dates Exchange Rate Currency to Consider Appreciated Depreciated

4/24/2003 0.91130 EUR/USD
EUR
4/28/2003 0.90630 EUR/USD

6/17/1997 23.2 BHT/USD

BHT X
1/13/1998 55.8 BHT/USD
4/25/2002 1.6430 CHF /USD
CHF
4/26/2002 0.6140
USD/CHF
6/26/2002 0.0008324 USD/KRW KRW
2/18/2003 0.0008286 USD/KRW

1/30/1999 1.0038ARS/USD USD

2/5/2001 1.00050 USD/ARS

1/30/2000 2.3442 CAD/GBP

CAD X
9/20/2000 2.0927 CAD/GBP
12/12/2002 0.01629 INR /1QD INR X
2/2/2003 68.028910D/INR

12/27/2002 1.776AUD/USD USD

12/28/2002 1.7831 AUD/USD

relative to another currency, compare

the exchange rates on

To determine if one currency appreciated

has
to use the same form of
the exchange ratefor the comparison.
different dates, being sure

vard.edu
Permissions@hbsp.harva
infringement of copyright.
2021. Copying or posting is an
HE OTHER Uuntil Aug
Ude Jagannathan,
authorized for educator review use only by or 617.783.7860
This document is
 205-017
Foreign Exchange Markets and Transactions: Solutions to Exercises

Measuring Currency Fluctuatioms

Exercise 6 If the Mexican peso depreciates 50% against the U.S. dollar, how much would the peso
have to appreciate to get back to its original level?

Assume the peso depreciated 50%, from 10 MXN/USD to 20 MXN/uSD:

Exchange Rate 1 Exchange Rate 2

10 MXN 20 MXN
1 USD 1 USD

For the peso to get back to its original level, the exchange rate would have to change from 20 MXN/USD to
10 MXN/USD, a change of 10 MXN. Following Example 6 in the note

Amount change 100 % change

Original exchange rate

x 100 100% appreciation

10

The peso would have to appreciate 100% relative to the U.S. dollar for
it to regain its original level.

rate moved from 3.2020 BRL/USD

to 3.1606 BRL/USD
Exercise 7 The Brazilian real (BRL) exchange
change and note whether it appreciated or
Calculate the real's percentage
over two days.
depreciated.
(3.2020-3.1606). The percentage change is:
The BRL/USD exchange rate
has clhanged by .0414 BRL
Amount change X 100 % change
Original exchange rate

0414 X 100 1.3%

3.202

relative to the US dollar

The real appreciated 1.3%

Permissions@hbsp.harvard odu
infringement of copyright.
Copying or posting is an

HE OTHERunlAug 2021.
Ude Jagannathan,
educator revigw
use only by or 617.783.7860
authorized for
This document is
 Foreign Exchange Markets and Transactions: Solutions to Exercises 205-017

Calculating Actual and Implied PPP Exchange Rates

Exercise 8 Below is an excerpt from the 2003 Big Mac Index. Using the values given, fill in the table
with the missing values.

The Economist Big MacIndex

Big Mac Prices Actual dollar Under(-)/ over(+)
In local currency Implied PPP of exchange rates valuation against
In dollars
thedollar April 22, 2003 thedollar %
United States $2.71 2.71
Australia A$ 3.00 1.86 1.11 1.61 -31
Brazil Real 4.55 1.48 1.68 3.07 45
China Yuan 9.90 1.20 3.65 8.28 -56
Denmark Krone 27.75 4.10 10.2 6.78 +51
Egypt Pound 8.00 1.35 2.95 5.92 50
Hong Kong HK$11.50 47 4.24 7.80 -46
Malaysia M$5.04 1.33 1.86 3.80
Russia Ruble 41.00 32 15.1 31.1 -51
South Korea Won 3,300 2.71 1218 1,220 nil
Switzerland | SFr 6.30 4.59 2.32 1.37 +69
Source: "McCurrencies," The Economist, April 24, 2003, p. 80.

(Note: See Example 7 in the note for an explanation of the Big Mac Index.)

Big Mac prices in dollars: Price in local currency/dollar exchange rate

e.g. for China 9.90/8.28 1.20 (the price of a Big Mac in China in dollars at the actual dollar
exchange rate)

Implied PPP of the dollar: Big Mac price in local currency/ Big Mac price in U.S. or $2.71

eg. for Denmark: 27.75/2.71 = 10.2 (meaning that at an exchange rate of 10.2 krone/U.S.S there
would be purchasing power parity between the two currencies a t least for Big Macs)

Actual dolar exchange rates: Big Mac price in local currency/Big Mac price in U.S. $

eg for Egypt: 8.00/1.35 = 5.92

Under/Over valuation against the dollar: the percentage difference between the actual exchange rate and the
implied PPP exchange rate
e.g. for Australia: (lmplied PPP exchange rate - Actual exchange rate)/Actual exchange rate x 100

(1.11 -1.61)/1.61 x 100 =-31%

This document is authorlzed for educator review use only by Ude Jagannathan, HE OTHER untl Aug 2021. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu
or 617.783.7860
 205-017
Foreign Exchange Markets and Transactions:
Solutions to Exercises

Calculating the Cost of a Forward Contract

Exercise 9 AU.S.
its internal multinational, Hoola
network. In 6 months Hoopa, Inc., hired a
Canadian dollars to when the contract is Canadian IT consulting firm to upgrade
pay the consultants. The over, Hoola Hoopa will need 1.5
into a forward
contract to hedge its company needs to decide whether or not it shouldmillion
exchange rate risk. Fill in the answers below
Equivalent rates listed in the table below. enter
using the U.S. $

U.S.S Equivalent
Country Currency per U.S. $
Canada (Dollar) Mon Fri
0.6879 0.6879
Mon Fri
1-month forward 1.4537
0.6868 0.6869 1.4537
3-months forward .6844 1.4560 1.4558
6-months forward 0.6845 1.4611
0.6803 0.6804 1.4609
Switzerland (franc) 0.7197 1.4699 1..4697
1-month forward 0.7179 1.3895
0.7203 0.7183 1.3930
3-months forward 0.7215 1.3883 1.3922
0.7192
6-months forward .7232
1.3860 1.3904
U.K. (Pound) 0.7213 1.3827
1.5734 1.3864
1.5715 0.6356
1-month forward 1.5703 0.6363
1.5783 0.6368
3-months forward 1.5644 0.6376
5624 0.6392
6-months forward 1.5555 1.5536
0.6400
0.6429 0.6437
Source: The Wall Stret Journal,
Tuesday April 15, 2003, p. C14.

a. Canadian dollar spot rate:

0.6879 (from the Table above)

b. Canadian dollar 6-inonths forward rate:

0.6803 (from the Table above)

C. What it would cost Hoola Hoopa if the company were to

purchase the Canadian dollars
spot
on April 15, 2003:

1,031,850 USD (spot rate 0.6879 x 1,500,00)

d. What it would cost Hoola Hoopa if it hedged with a forward contract on April 15, 2003 to
purchase 1.5 million Canadian dollars 6 months later on October 15, 2003:

1,020,450 USD (the 6monthforward rate 0.06803 x 1,500,000)

This document is authorized for educator review use only by Ude Jagannathan, HEOHER Untu Aug 2021. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu
or 617.783.7860
 Foreign Exchange Markets and Transactions: Solutions to Exercises 205-017

Compare the cost of the forward contract, or the hedged position, with the cost of buying the
Canadian dollars on the spot market on October 15, 2003. Fill in the table below to show the cost of
buying C$1.5 million at different spot rates, and then calculate Hoola Hoopa's potential gains or
losses from hedging with a futures contract.

Spot Rate on Oct Unhedged Hedged Potential Gains/Losses in

15, 2003 Position Position USS from Hedge
0.6521 $978,150 $1,020,450 -$42,300

0.6700 $1,005,000 $1,020,450 -$15,450

0.6803 $1,020,450 $1,020,450 $O

0.6850 $1,027,500 $1,020,450 $7,050

0.6900 $1,035,000 $1,020,450 $14,550

the cost in US$ of C$1.5 million at the various spot rates

(Note: The Company's unhedged position is a forward contract on April 15,
2003. The Company's hedged position is the cost of
given for Oct. 15, dollars 6 months later on October 15, 2003.)
millior Canadian
2003 to purchase 1.5
on the spot 15, rate spot
on Oct. of 2003. Ata rate 0.6521, the
The Company's unhedged position depends the had bought a forward contract in
company would need $978,150
to buy the Canadian dollars. f company
to the
$1,020,450 for the Canadian dollars. In this case, the hedge represents a loss
April, it would have paid at the spot rate. If the rate above
since it could have paid less for the dollars spot moves
company of $42,300, contract is less costly.
0.6803, however, the hedge represents gain for
a the company, since the forward

Permisslons@hbsp.harvard.edu
is an infringement of copyright.
Ude Jagannathan, HE
OTHER until Aug 2021, Copying or posting
educator review use only by
This document is authorized for or 617.783.7860