Home Work 3 Global Finance

Slide 14/Chapter 5

S($/£) = $2.0/£

I$ = 3.0 %

I£ = 2.49 %

a) If F360($/£) = $2.05/£ (> 2.01 %)

- Exchange $1000 for £500 at spot rate

- Invest £500 for one year at I£ = 2.29 % earned £512.45

- Translate £ 512.45 back into dollars at F360($/£) = $2.05/£. It will be worth $1050.52.

b) If F360($/£) = $1.95/£ (< 2.01 %)

- Exchange £500 for $1000 at spot rate.

- Invest $1000 for one year at 3.0 % earn $1030

- Translate $1030 back into pounds at F360($/£) = $1.95/£. It will be worth £528.21.

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Problem 1

Amount: $100,000

I$: 8%

I€: 7%

S(€/$) = €1.01/$

F360 (€/$) = €0.99/$

Alternative 1: Investing $100,000 at 8% will be worth $108,000.

Alternative 2: Exchanging to euros become €101,000, investing at 7% in Germany become $108,700 and then exchanging back to dollars are worth $109,161.62.

The treasurer should follow alternative 2 to maximize return.

Problem 2

Example amount: $35,000

Alternative 1:

Keeping $35,000 at bank, investing at 0.35% compounded monthly for 3 month become: $35368.79 and buying at F3month($/£) = $1.40/£ becomes £25,263.42

Alternative 2:

Exchange $35,000 for £ 24,137.93 at spot rate. Invest it at 2% becomes $24,620.69

Taking the investing amount $35,000 as an example we get to the conclusion that the first alternative give us a best return. It is better to keep money at US bank and buy £35,000 at forward rate.

Problem 4

S(€/$) = €0.80/$

F360 (€/$) = €0.7813/$

I$ = 5.6%

I€ = 5.4%

a) Assume want to realize profits in terms of US dollars

Alternative 1:

Borrow $1,000,000 at %5.6 becomes $1,056,000

Alternative 2:

Borrow $1,000,000 and exchange it for €800,000 at spot rate, invest it for three month at %5.4 per annum becomes €843,200 and exchange it to dollars back at forward rate becomes $1,079,226.93.

Using the alternative 2 an investor can take an arbitrage profit of $23,226.93.

b) Assume want to realize profits in terms of Euros...