LECTURE 3

QUESTIONS

LONG FORM QUESTIONS

1. An FX trader in S(CAD/$) is currently quoting a small figure bid-ask of 35-40, when the
rest of the market is trading at CAD1.3436-CAD1.3441. What is implied about the trader’s
beliefs by his prices?

ANS 3. - The trader must be thinking that the value of Canadian dollar for U.S. dollar is
going increase thus he is trying to grow his supplies of Canadian dollars by buying $ at
CD1.3435/$1.00 only by decreasing U.S. dollars purchases and selling from inventory at a
price lower than the retail price of CD1.3440/$1.00.

2. What is triangular arbitrage? What is a condition that will give rise to a triangular arbitrage
opportunity?

Triangular arbitrage is a riskless strategy that involves trading large amount by concurrently
buying and selling three different currencies. It is the process where the two related goods are
responsible of setting the third price. It involves extracting benefits of pricing difference from
three currencies by purchasing second currency after selling US dollar and further buying
third currency by selling second currency. Lastly again sold to make a purchase for some US
dollars. This opportunity arises to the inefficiency in the market due to discrepancies of the
cross-exchange rates and exchange rate. - When the direct exchange occurs between two
currencies, it is not report to cross-exchange rate, and then the arbitrage profit is earned from
the second to third currency. It is not possible that all currencies convert through dollar. For
that, there are some professional banks who do direct marketing between non-dollar
currencies. Thus, there are cross-rate bid-ask quotations force regulations, triangular profit is
possible in case of inconsistency of direct quotes with crossexchange rates.

3. Over the period 2008 to 2013, the exchange rate between the British pound and U.S.
dollar, S($/£), has changed from about 1.90 to about 1.45. Would you agree that over this
five-year period that British goods have become cheaper for buyers in the United States?
 4. Using the American term quotes from below (taken from Exhibit 5.4 in your textbook),
calculate the three-, and six-month forward cross-exchange rates between the Australian
dollar and the Swiss franc. State the forward cross-rates in terms of direct quotes for CHF
in Australia.

AUD in US$ per US$ CHF in US$ per US$

Spot 0.9542 1.0480 Spot 1.0614 0.9421
3m Fwd 0.9482 1.0546 3m Fwd 1.0624 0.9412
6m Fwd 0.9425 1.0610 6m Fwd 1.0636 0.9402
5. A foreign exchange trader with a U.S. bank took a short position of £5,000,000 when the
S($/£) exchange rate was 1.55. Subsequently, the exchange rate has changed to 1.61. Is
this movement in the exchange rate good from the point of view of the position taken by
the trader? By how much has the bank’s liability changed because of the change in the
exchange rate?

6. Using the information in question 7. calculate the three-, and six-month forward premium
or discount for the CHF vs. the AUD vs. the S(AUD/CHF) rate. For simplicity, assume
each month has 30 days. What is the interpretation of your results?
7. Given the following information, what are the implied S(SGD/NZD) cross-rate bid-ask
quotations?
European
American Terms Terms
Bank Quotations Bid Ask Bid Ask

New Zealand dollar .7265 .7272 1.37511.3765

Singapore dollar .6135 .6140 1.62871.6300

8. Assume you are a trader with Deutsche Bank. From the quote screen on your computer
terminal, you notice that Dresdner Bank is quoting S(€/$) = 0.7627 and Credit Suisse is
quoting S(SF/$) = 1.1806. You learn that UBS is making a direct market between the
Swiss franc and the euro, with a current S(€/SF) quote of .6395. Show how you can make
a triangular arbitrage profit by trading at these prices. (Ignore bid-ask spreads for this
problem.) Assume you have $5,000,000 with which to conduct the arbitrage. What
happens if you initially sell dollars for Swiss francs? What S(€/SF) price will eliminate
triangular arbitrage?

9. The current S($/£) rate is $1.95/£ and the three-month forward rate is $1.90/£. Based on
your analysis of the exchange rate, you are quite confident that the spot exchange rate
 will be $1.92/£ in three months. Assume that you would like to buy or sell £1,000,000.

a. What actions do you need to take to speculate in the forward market? What is the
expected dollar profit from speculation?
b. What would be your speculative profit in dollar terms if the spot exchange rate
actually turns out to be $1.86/£.

10. Omni Advisors, an international pension fund manager, plans to sell equities denominated
in Swiss Francs (CHF) and purchase an equivalent amount of equities denominated in
South African rands (ZAR).

Omni will realize net proceeds of 3 million CHF at the end of 30 days and wants to
eliminate the risk that the ZAR will appreciate relative to the CHF during this 30-day
period. The following exhibit shows current exchange rates between the ZAR, CHF, and
the U.S. dollar (USD).

Currency Exchange Rates

S(ZAR/USD) S(ZAR/USD) S(CHF/USD) S(CHF/USD)
Maturity Bid Ask Bid Ask
Spot 6.2681 6.2789 1.5282 1.5343
30-day 6.2538 6.2641 1.5226 1.5285
90-day 6.2104 6.2200 1.5058 1.5115

a. Describe the currency transaction that Omni should undertake to eliminate

currency risk over the 30-day period.

b. Calculate the following:

• The CHF/ZAR cross-currency rate Omni would use in valuing the Swiss equity
portfolio.
• The current value of Omni’s Swiss equity portfolio in ZAR.
• The annualized forward premium or discount at which the ZAR is trading versus
the CHF.
MULTIPLE CHOICE

1. The difference between a broker and a dealer is

A. Brokers operate in equity markets, dealers operate in multiple asset classes.

B. brokers bring together buyers and sellers, but carry no inventory; dealers stand ready to
buy and sell from their inventory.

C. brokers transact in stocks and bonds; currency is bought and sold through dealers.

D. none of the above

2. The current exchange rate is S($/£) = 2.00. Compute the correct balances in Bank A's
correspondent account(s) with Bank B if a currency trader employed at Bank A buys
£45,000 from a currency trader at Bank B for $90,000 using its correspondent relationship
with Bank B.

A. Bank A's dollar-denominated account at B will rise by $90,000.

B. Bank B's dollar-denominated account at A will fall by $90,000.

C. Bank A's pound-denominated account at B will rise by £45,000.

D. Bank B's pound-denominated account at A will rise by £45,000.

3. The current S($/€) exchange rate is 1.50. Compute the correct balances in Bank A's
correspondent account(s) with Bank B if a currency trader employed at Bank A buys
€100,000 from a currency trader at Bank B for $150,000 using its correspondent
relationship with Bank B.

A. Bank A's dollar-denominated account at B will fall by $150,000.

B. Bank B's dollar-denominated account at A will fall by $150,000.

C. Bank A's pound-denominated account at B will fall by €100,000.

D. Bank B's pound-denominated account at A will rise by €100,000.

4. Suppose that the current S(€/$) exchange rate is 0.80. The direct quote, from the U.S.
 perspective is

A. €1.00 = $1.25.

B. €0.80 = $1.00.

C. £1.00 = $1.80.

D. None of the above

5. If the S($/€) bid and ask prices are 1.50 and $1.51, respectively, the corresponding S(€/$)
bid and ask prices are

A. €0.6667 and €0.6623.

B. $1.51 and $1.50.

C. €0.6623 and €0.6667.

D. cannot be determined with the information given.

6. A dealer in pounds who thinks that the exchange rate is about to increase in volatility

A. may want to widen his bid-ask spread.

B. may want to decrease his bid-ask spread.

C. may want to lower his ask price.

D. none of the above.

7. The dollar-euro exchange rate is S($/€) = 1.25 and the dollar-yen exchange rate is S(¥/$)
= 100. What is the S(¥/€) cross rate?

A. ¥125 = €1.00

B. ¥1.00 = €125

C. ¥1.00 = €0.80

D. None of the above

USD equivalent
Country BID ASK
Switzerland (Franc) CHF 0.7648 0.7652
Euro€ 1.4000 1.4200

8. What is the bid cross-exchange rate for Swiss Francs priced in euro S(EUR/CHF) when
faced with these prices?
Hint: Find the price that a you as a customer could sell CHF to buy EUR.

A. €0.5386/CHF

B. €0.5389/CHF

C. €0.5463/CHF

D. €0.5466/CHF
9. Suppose a bank customer with €1,000,000 wishes to trade out of euro and into Japanese
yen. The dollar-euro exchange rate is quoted as S($/€) = 1.60 and the dollar-yen
exchange rate is quoted at S(¥/$) = 120. How many yen will the customer get?

A. ¥192,000,000

B. ¥5,208,333

C. ¥75,000,000

D. ¥5,208.33

10. Suppose you observe the following exchange rates: S($/€) = 0.85; S($/£) = 1.60; and
S(€/£) = 2.00. Starting with $1,000,000, how can you make money?

A. Exchange $1m for £625,000 at £1 = $1.60. Buy €1,250,000 at €2 = £1.00; trade for
$1,062,500 at €1 = $.85.

B. Start with dollars, exchange for euros at €1 = $.85; exchange for pounds at €2.00 =
£1.00; exchange for dollars at £1 = $1.60.

C. Start with euros; exchange for pounds; exchange for dollars; exchange for euros.

D. No arbitrage profit is possible.

11. The forward price

A. may be higher than the spot price.

B. may be the same as the spot price.

C. may be less than the spot price.

D. all of the above

12. The forward market

A. involves contracting today for the future purchase of sale of foreign exchange at the
spot rate that will prevail at the maturity of the contract.

B. involves contracting today for the future purchase of sale of foreign exchange at a price
agreed upon today.

C. involves contracting today for the right but not obligation to the future purchase of sale
of foreign exchange at a price agreed upon today.

D. none of the above

13. The current spot exchange rate is S($/€) = 1.55 and the three-month forward rate is S($ /
€) = 1.50. You enter into a short position on €1,000. At maturity, the spot exchange rate is
$1.60/€. How much have you made or lost?

A. Lost $100

B. Made €100

C. Lost $50

D. Made $150

14. The current spot exchange rate is S($/€) = 1.55 and the three-month forward rate is
S($/€) = 1.50. Based on your analysis of the exchange rate, you are confident that the spot
exchange rate will be 1.52 in three months. Assume that you would like to buy or sell
€1,000,000. What actions do you need to take to speculate in the forward market?

A. Take a long position in a forward contract on €1,000,000 at $1.50/€.

B. Take a short position in a forward contract on €1,000,000 at $1.50/€.

C. Buy euro today at the spot rate, sell them forward.

D. Sell euro today at the spot rate, buy them forward.

15. Which of the following are correct?

 A.
N
Fw($/fc)

B.

C.
■* yv*>' J>

D. All of the above are correct

16. Consider the following spot and forward rate quotations for the Swiss franc:

SWSYT) = 0.85
Fi($/SFr) = 0.86
F:($/SFr) = 0.87
F3($/SFr) = 0.88

Which of the following is true:

A. The Swiss franc is definitely going to be worth more dollarsinsix months.

B. The Swiss franc is probably going to be worth lessindollars insix months.

C. The Swiss franc is trading at a forward discount.

D. The Swiss franc is trading at a forward premium.