Foreign Exchange Quotations and Interest Rates

Question 1

Suppose you are foreign exchange dealer/investor. You see on your Bloomberg’s screen that the euro is quoted as US$:€ = 0.84610–0.84650, and the Australian dollar is quoted as US$:A$ = 1.3875–1.3885. What is the implicit €:A$ quotation?

Question 2

The following are the bid–ask quotes for spot exchange rate and interest rates:

Spot exchange rate:

USD:CHF: 1.3300 –1.3340

Interest rates:

One-month CHF: 2¹/₂ – 2⁵/₈

One-year CHF: 3¹/₄ – 3¹/₂

One-month USD: 5¹/₈ –5¹/₄

One-year USD: 5¹/₂ – 5³/₄

What are the quotations for the one-month and one-year USD:CHF forward exchange rates?

Question 3 (5 marks)

The following table provides correlations of world stock markets. Explain the reasons for the observed correlations between the United States and other markets and indicate the motivations for diversifying a U.S stock portfolio into foreign stock markets.

 Table 1: Correlation stock markets, January 2010-July 2020.

Question 4

Consider two South African companies listed on the Johannesburg stock exchange:

· Company A is a mining company that exports a large part of its minerals production. Much larger competitors can be found in Latin and North America. The market price of its production is largely determined in US dollars in the world market.

· Company B imports various engine parts from Europe and the United States. The demand for its product is highly price elastic. A significant rise in South African rand prices lowers the demand.

(a) What will happen to the earnings and stock prices of the two companies if there is a sudden and large devaluation of the South African rand against major currencies?

(b) What can you say about the currency exposures of the two companies (g’s)

Question 5

A portfolio manager follows an active international asset allocation strategy. The average execution cost for a buy or a sell order is forecasted at 0.8%. On average, the manager turns over the portfolio once a year. Various administrative costs include a custodial cost amount of 0.5% per year of assets under management. The annual management fee is 1% of assets under management. The annual expected return before costs is 13% compared to an expected return of 8% on a passive global benchmark (some global index).

(a) What is the annual expected return net of execution costs?

(b) What is the net annual expected return for the client?

(c) Should the client expect the portfolio to outperform the global index used as a benchmark?

Question 6

A company without default risk can issue a five-year dollar FRN at LIBOR. The coupon is paid and reset semiannually. It is certain that the issuer will never have default risk and will always be able to borrow at LIBOR. The FRN is issued on November 1, 2005, when the six-month LIBOR is at 5%. Here are the dollar yield curves on two different dates:

a. What should the value of the FRN be on May 1?

b. What should the value and the clean price of the FRN be on August 1, 2006?

Question 7

An investor is thinking of investing in one-year zero-coupon bonds. He is considering investing in either a New Zealand dollar-denominated-bond with a yield 3.25 percent or US dollar-denominated bond with a yield of 2.5 percent. The current exchange rate is US$ 0.6546 per NZ$.

(a) What exchange rate one year later is the break-even exchange rate, which would make the NZ$ and US$ investments equally good?                                                 

(b) Which investment would have turned out to be better if the actual exchange rate one year later is US$ 0.6052 per NZ$?