a. Calculate to 4 decimal places the new exchange rate after a 2% increase in the value of the dollar given a current exchange rate of EURUSD 1.1

Notes:

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Answers that make unreasonable assumptions will be penalized

Part A Please answer ALL questions in this section

Note that this paper uses the standard notation for exchange rates, for example

EURUSD 1.1 means “$1.1 for 1 euro”

1.

a. Calculate to 4 decimal places the new exchange rate after a 2% increase in the value of the dollar given a current exchange rate of EURUSD 1.1

(6 marks)

b. Given the following exchange rates calculate the GBPEUR rate to 4 decimal places.

EURUSD 1.1043

GBPUSD 1.2970

(6 marks)

c. Explain the relationship between your answer to part b of this question and triangular arbitrage.

(6 marks)

2. Consider the following data:

DateExchange rate
January 2017EURUSD 1.100
December 2017EURUSD 1.144

Take the US dollar as the home currency

a. According to Purchasing Power Parity which currency area should have had the

higher rate of inflation in 2017 and by how much?

(6 marks)

b. If inflation in the US were 3% higher than in the euro area, calculate the change

in the real value of the dollar. What are the implications of this change?

(6 marks)

c. What are the implications of a change in the real exchange rate of a currency?

(6 marks)

d. Explain why you would expect interest rates in the US to be higher than in the

euro area.

(6 marks)

e. Explain why you would expect there to be no difference in the interest rates of

government bonds of any two countries in the euro area and also explain why in

practice there are differences.

(8 marks)

Part B please answer TWO questions only from this section

3. Compare and contrast country risk analysis with exchange rate volatility.

(25 marks)

4. MNCs promote globalization. Is this a force for good or bad? Discuss.

(25 marks)

5. XYZ plc has been offered the following quotes for options on the dollar given a

current market price of 60 pence:

Strike price of dollar in penceCall premiumPut premium
 1 Year1 Year
626.93
645.93.8
664.84.5
674.55.1

a. Calculate the net payout from a purchased call option at a strike price of

67 pence for the following possible maturity prices 55p, 60p,65p,70p,75p.

(6 marks)

b. Calculate the net payout for a written put option at 66p for the following possible

maturity prices: 55p, 60p,65p,70p,75p.

(6 marks)

c. Calculate the total cost of the dollar if the MNC were to implement part a and part

b of this question for the following maturity prices: 55p, 60p,65p,70p,75p .

(6 marks)

d. Outline the advantages and disadvantages of purchasing a call at 67p and

writing a put at 66p for a MNC importing from the US.

(7 marks)

6. Pico plc has borrowed heavily in euros and is worried about increasing

interest rates in the eurozone. The Finance Director suggests that Pico

plc should sell futures on French bonds (known as OATs or Obligations

Assimilables du Trésor).

a. Explain why selling a futures contract on French bonds would

reduce the effect of an increase in euro interest rates.

(3 marks)

b. Pico sells a futures contract on bonds for €1,010 calculate the daily

payments and receipts on the futures contract given the following

bond prices: (4 marks)

Day 1Day 2Day 3Day 4Day 5
€1,010€1,005€1,001€1,006€1,009

c. Explain why the market insists on daily settlement.

(3 marks)

The Finance Director also offers two alternatives:

d. One alternative is to engage in an interest rate swap. Explain how

this might work.

(4 marks)

e. The other alternative is to purchase a PUT contract on euro

denominated bonds.

Calculate the net profit or loss per unit on a put option contract with

a strike price of €1,008 with a premium of €4.00 for the following

maturity prices:

€985, €1,000, €1,015 and €1,020

(8 marks)

f. Explain how the option contract in part e protects against interest

rate rises and how this form of protection differs from the futures

contract.

(3 marks)

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