International-Financial-Management---Bekaert-2e---

©2012PearsonEducation,Inc.Chapter2TheForeignExchangeMarketQUESTIONS1.Whatisanexchangerate?Answer:Anexchangerateistherelativepriceoftwocurrencies,liketheU.S.dollarpriceoftheeuro,theThaibahtpriceoftheMalaysianringgit,ortheMexicanpesopriceoftheCanadiandollar.2.Whatisthestructureoftheforeignexchangemarket?IsitliketheNewYorkStockExchange?Answer:Theinterbankforeignexchangemarketisaverylarge,diverse,over-the-countermarket,notaphysicaltradingplacewherebuyersandsellersgathertoagreeonapricetoexchangecurrencies.Traders,whoareemployeesoffinancialinstitutionsinthemajorfinancialcitiesaroundtheworld,dealwitheachotherprimarilyoverthephoneorviacomputer,withwrittenorformalelectronicconfirmationsoftransactionsoccurringonlylater.3.Whatisaspotexchangeratecontract?Whendoesdeliveryoccuronaspotcontract?Answer:Whencurrenciesintheinterbankspotmarketaretraded,certainbusinessconventionsarefollowed.Forexample,whenthetradeinvolvestheU.S.dollar,businessconventiondictatesthatspotcontractsaresettledin2businessdays—thatis,thepaymentofonecurrencyandreceiptoftheothercurrencyoccursin2businessdays.Onebusinessdayisnecessarybecauseoftheback-officepaperworkinvolvedinanyfinancialtransaction.Theseconddayisneededbecauseofthetimezonedifferencesaroundtheworld.Severalexceptionstothe2-business-dayrulearenoteworthy.First,forexchangesbetweentheU.S.dollarandtheCanadiandollarortheMexicanpeso,theruleis1businessday.Second,ifthetransactioninvolvesthedollarandthefirstofthe2daysisaholidayintheUnitedStatesbutnotintheothersettlementcenter,thefirstdayiscountedasabusinessdayforsettlementpurposes.Third,FridaysarenotpartofthebusinessweekinmostMiddleEasterncountries,althoughSaturdaysandSundaysare.Hence,non–MiddleEasterncurrenciessettleonFridays,andMiddleEasterncurrenciessettleonSaturdays.4.WhatwastheJapaneseyenspotpriceoftheU.S.dollaronDecember21,2010?2Chapter2TheForeignExchangeMarket©2012PearsonEducation,Inc.Answer:ExaminingExhibit2.5forDecember21,2010wefindthattheJapaneseyenspotpriceoftheU.S.dollarwas¥84.12/$.5.WhatwastheU.S.dollarspotpriceoftheSwissfranconDecember21,2010?Answer:ExaminingExhibit2.5forDecember21,2010,wefindthattheU.S.dollarspotpriceoftheSwissfrancwas$1.0289/CHF.6.Howlargearethebid–askspreadsintheinterbankspotmarket?Whatistheirpurpose?Answer:Thepurposeofthebid-askspreadistoallowtraderstoprofitbybuyingacurrencyatalowbidpriceandsellingthatcurrencyatahigheraskprice.Bid–askspreadsinthespotforeignexchangemarketarequitesmall,oftenonlytwoorthreebasispoints.Forexample,ayen–dollartradermightquoteabidpriceofyenperdollaratwhichsheiswillingtobuydollarsinexchangeforyenof,say,¥83.74/$.Thetraderwouldthenquoteahigheraskpriceatwhichsheiswillingtoselldollarsforyen,say,atanexchangerateof¥83.76/$.Thispercentagebid-askspreadis?3.76/$-?3.74/$1000.02%?3.76/$+?3.74/$/27.WhatwastheeuropriceoftheBritishpoundonDecember21,2010?Why?Answer:Wecanfindthisinformationtwoways.Thecross-ratequotefromExhibit2.6is€1.1818/£.TheexchangeratesofeurosperdollaranddollarsperpoundfromExhibit2.5are€0.7636/$and$1.5477/£.Weknowthattherewouldbeatriangulararbitragepossibilityifthecross-ratediffersfromtheindirectrateusingthedollarasanintermediary.Thus,wefindthesamevalueifwecalculate€0.7636/$$1.5477/?=€1.1818/?8.IfthedirecteuropriceoftheBritishpoundishigherthantheindirecteuropriceoftheBritishpoundusingthedollarasavehiclecurrency,howcouldyoumakeaprofitbytradingthesecurrencies?Answer:IfthedirecteuropriceoftheBritishpoundishigherthantheindirecteuropriceoftheBritishpoundusingthedollarasavehiclecurrency,therewouldbeatriangulararbitrage.Wewouldwanttobuypoundsattheindirectlowpriceandsellpoundsatthedirecthighprice.SupposeinQuestion7thatthedirectpriceeurosperpoundwere€1.2115/£andtheexchangeratesversusthedollarare€0.7636/$and$1.5477/£.Theindirecteuropriceofthepoundistherefore€0.7636/$$1.5477/?=€1.1818/?Chapter2:TheForeignExchangeMarket3©2012PearsonEducation,Inc.Ifwestartwith€10,000,000,wecanconverteurostodollarsandget€10,000,000/€0.7636/$=$13,095,862Convertingthesedollarsintopoundsgives$13,095,862/$1.5477/£=£8,461,499Convertingthesepoundsintoeurosgives€1.2115/££8,461,499=€10,251,106Thus,wemakeaprofitof€251,106or2.51%.9.Whatisanappreciationofthedollarrelativetothepound?Whathappenstothedollarpriceofthepoundinthissituation?Answer:Anappreciationofthedollarrelativetothepoundmeansthatittakesfewerdollarstobuyapound,sothedollarpriceofthepoundfalls.Thissituationisalsodescribedasthedollarisstrongerintheforeignexchangemarket,thepoundhasdepreciatedversusthedollar,andthepoundisweakerintheforeignexchangemarket.10.WhatisadepreciationoftheThaibahtrelativetotheMalaysianringgit?Whathappenstothebahtpriceoftheringgitinthissituation?Answer:AdepreciationoftheThaibahtrelativetotheMalaysianringgitmeansthatitwilltakemorebahttobuyoneringgit.Thus,thebahtpriceoftheringgitisnowhigherafterthedepreciationofthebaht.PROBLEMS1.MississippiMudPies,Inc.needstobuy1,000,000Swissfrancs(CHF)topayitsSwisschocolatesupplier.Itsbankerquotesbid–askratesofCHF1.3990–1.4000/USD.WhatwillbethedollarcostoftheCHF1,000,000?Answer:Thebank’sbidrateisCHF1.3990/$.Th