ASSIGNMENT COVER SHEET

(Family name) (Given names)

Student’s name DJAJA JUSTIN NATANAEL
ID number 29882605 Phone 0435 275 907

Unit name Trade finance and foreign exchange Unit code Ecf 2721

Title of assignment ECF2721 Trimester A 2020 Assignment #1

Lecturer/tutor Thandinkosi ndhela
Is this an authorised group assignment? Yes No
If this submission is a group assignment, each student must attach their own signed cover sheet to the assignment.
Has any part of this assignment been previously submitted as part of another unit/course? Yes No
Tutorial/laboratory day & time Tuesday (2:30-4:00) and Thursday (10:30-12:00)
Due date 28 april 2020 Date submitted 28 april 2020
All work must be submitted by the due date. If an extension of time to submit work is required, a Special Consideration
Application (In-semester Assessment Task) must be submitted.
Has an extension been approved? Yes No If yes, please give the new submission date ….…/..…./…….

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assignment.
Signature ...................................................................................................... 28 april 2020
Date………………………………
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Updated: Feb 2017

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 Assignment 1
1. Choose any one country’s currency that you are interested in. Write down how the currency’s
exchange rate policy has been changed over the last 5 decades, at least from the late 1960s. You can
find the history of a currency through Google or Wikipedia search. Your answer must not be over 2
pages in length. [8 marks]
The currency of interest is the United States Dollar. The currency has undergone multiple changes, such
as the need for the creation of the Federal Reserve to control the monetary system. The panic of 1907 is
such an instance where there was a worldwide crisis in the 20th century, where the United States Congress
created the Federal Reserve System. The reserve released two types of notes, which were the regular
Federal Reserve note currently in use and the limited Federal Reserve banknote. The size of the notes
used in currency was reduced in 1928 to a standard size of 6.1 inches by 2.6 inches, and the standard
continues to be applied in the modern day ( Laura, 2019 ). The standard was implemented as a cost-
cutting measure when generating the currency. Notably, the U.S. Dollar is one of the currencies that have
a standard size for notes across different denominations, unlike other currencies that have different sizes.
The original prints of the Federal Reserve notes were limited to denominations of $5, $10, $20,
$100,$500,$1,000,$5,000, and $10,000 ( Janet, 2015). In 1963, the Federal Reserve introduces the $1 bill
as a replacement for the $1 silver certificate, while in 1976, the $2 bill was launched. The mega-value
bills above $100 were last printed in 1945 but were fully discontinued in 1969, and the Mint incinerated
most of the notes. The other notable changes to the Dollar after 1969 were observed in 1971, after the
abandonment of the Gold Standard that had been existing since 1862 ( Jennifer, 2020 ). The design of the
Dollar presented various security vulnerabilities that made it easy to counterfeit with sophisticated
equipment that was easily available from the 1980s because of the evolution of technology, and the ability
to buy technology for personal use.
The Federal Reserve implemented the first security measure in 1991, where security threads and micro-
printing techniques were implemented. Five years later, the $50 and $100 bills were redesigned and given
additional and enhanced security features ( Joshua, 2018 ). The features included a blue security ribbon
that was implemented in 2013 for all concurrent denominations. The Mint stopped the production of the
maligned dollar coin, but the $1 bill continues to be used. The $1 bill notably retains the old design with
no security features because of its low value, which counterfeiters and fraudsters do not attempt to
counterfeit. The $2 bill is defined as the rarest of all U.S. currency, but it continues to be circulated
despite relatively few bills of the currency being printed by the Mint ( Tommy, 2015 ).

2. Go to the Federal Reserve Economic Data (FRED) at the U.S. Federal Reserve Bank – St. Louis
and get the daily exchange rates (https://fred.stlouisfed.org/categories/94) for the U.S. dollar against
the Australian Dollar, the U.K. British pound, and answer the following questions. Note that the
exchange rates are quoted based on American terms for the U.S.
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 (a) On 20 January 1971, what was the exchange rate between the Australian Dollar and the
U.K. pound, EAU$/£? (round to 3 decimal places) [2 marks]
The website does not have a direct rate of the Australian Dollar against the UK Pound but has information
about the U.S. Dollar against the Australian Dollar and the U.S. Dollar against the U.K. pound for that
day.
USD to GBP – 2.4080
USD to AUS – 1.1193
To get the rate, we divide the rate of USD to AUS by the rate of USD by GBP
Therefore, the exchange rate between the Australian Dollar and the U.K pound was EAU$0.46/1£
(b) The 6-month interest rate in Australia was 2.50% on 20 January 1971. If everybody knew
the actual exchange rate of EAU$/£ on 20 July 1971 as of 20 January 1971, what should be
the 6-month interest rate in the U.K. according to the uncovered interest parity? [3 marks]
The formula for uncovered interest parity is:
F0=S01+ib1+ic
Where
F0 =Forward rate
S0 =Spot rate
i c =Interest rate in country c
i b =Interest rate in country b
The 6-month interest rate in the U.K. according to the uncovered interest parity

2. Today is 15 November 2016. The spot exchange rate between Australian dollars and the euro
today is $1.50 per €1, E$/€ = 1.50. The one-month interest rate (for both deposit and borrowing) in
Australia is 1.50%. The one-month interest rate (for both deposit and borrowing) in Germany is
0.00%. Today you sold Australian wine to an importer in Germany. The payment of €100,000 is
due on receipt of the shipment and will be delivered to you on 15 December 2016 (30 days from
today).
(i) Calculate the payment in Australian dollars if the exchange rate remains at E$/€ = 1.50
on 15 December 2016. [2 marks]
The payment in Australian dollars would be $150,000

(ii) Calculate the payment in Australian dollars if the exchange rate becomes E$/€ = 1.55 on
15 December 2016. [1 marks]
The payment in Australian dollars would be $155,000

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 (iii) Assume that the covered interest parity holds. Calculate the 1-month forward exchange
rate, F$/€, under the covered interest parity (rounding to 4 decimal places). [2 marks]
The equation of covered interest rate parity is:
Ft = St(1 + rASD)/(1 + rGB)
= 1.50(1+1.50)/(1+0)
=3.75/1
F$/€ = 3.7500
(iv) Assume that the covered interest parity holds. Explain how you can avoid the exchange
rate risks completely for the receipt of €100,000. [4 marks]
The exchange risks to ensure that the agreed amount is received can be achieved by implementing
forward contracts. These are derivative security agreements involved in the purchase and sale of assets at
a fixed price and date. The agreement specifies the amount at a certain date and rate for future currency
exchange to be used between two parties. The contract allows the agreed amount to be received during
the time specified in the contract. The implementation of the technique helps businesses budget for the
future within specified date ranges since the amount will be received as per the agreement and will not be
affected by fluctuations in money markets and exchange rates.

[Hint: Consider how you would use the forward market to avoid exchange risk]

3. (a) Assume that today is 6 October 2016. Today, you observe that the exchange rate between AU$
and the US$ is 1.319, EAU$/US$=1.319, the 90-day interest rate in Australia is 0.50%, the 90- day
interest rate in the U.S. is 0.22%, and the 90-day forward rate is 1.376, FAU$/US$=1.376. Note that
the covered interest parity does not hold here. Explain how you can make risk free profits using
spot and forward markets in 90 days, on 4 January 2017, if you can either borrow AU$1.319
million Australian dollars or borrow US$1 million dollars with the interest rates above today. The
answer should have the exact amount of profits in Australian dollars. Do not forget to pay the
principal and interests on 4 January 2017. [5 marks]

Risk free profits will be achievable using forward markets by applied spot and forward markets. The first
step would require that the spot rate is determined at the current time.
The formula for uncovered interest parity is:
F0=S01+ib1+ic
Where
F0 =Forward rate
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S0 =Spot rate
i c =Interest rate in country c
i b =Interest rate in country b
1.376= S0 [(1+0.22)/(1+0.55)]
= S0 (0.787)
S0 =1.376/0.787
S0 = 1.784
If AU$1.319 million is borrowed at an interest rate of 0.55%, the expected payment is AU$2.045 million
However, when the forward rate is applied, then the payable amount would be AU$1.815 million with an
interest of 0.496 million
[Hint: Compare the returns in the 2 countries first and outline all investment steps]

(c) Explain what will happen to the current spot exchange rate (increase, decrease, or no
change) if the forward rate in (a) and the nominal interest rates in two countries remain the
same (the answer should explain the change in the demand for or the supply of U.S. dollars
in the foreign exchange market and also the value for the new exchange rate). [3 marks]
The spot rate exchange rate does not fluctuate and is explained through empirical studies that make
assumptions about the long-term time horizon. However, there is likely to be a discount in the event the
forward exchange rate drops to a value that is lower than the spot exchange rate

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 Reference list

Janet nguyen, Why do we no longer use $1,000 bills?, marketplace, last updated December 23 2015
https://www.marketplace.org/2015/12/23/thousand-dollar-bills/

Jennifer Bradley franklin, Pictures of big bills: You probably won’t see them in circulation, but you can
see them here, bank rate, last updated January 6 2020
https://www.bankrate.com/financing/banking/pictures-of-big-bills-500-1000-5000-10000/

Joshua McMorrow-Hernandez, how paper currency changed in our lifetime, last updated October 23,
2018. https://coinweek.com/paper-money-2/paper-currency-changed-lifetimes/

laura green, federal reserve note, Investopedia, last updated September 29 2019,
https://www.investopedia.com/terms/f/federal-reserve-note.asp

Tommy Andres, Why are there so few $2 bills?, marketplace, last updated January 9 2015
https://www.marketplace.org/2015/01/09/why-are-there-so-few-2-bills/