International finance
A) Compare and contrast the fixed, freely floating, and managed float exchange rate
systems. (6 marks)
B) Suppose you have £1,000,000 to invest and assume the following information:
Quoted Price
Value of Canadian dollar in British pounds £0.60
Value of New Zealand dollar in British pounds £0.20
Value of Canadian dollar in New Zealand dollars NZ$3.02
i) Explain the concept of triangular arbitrage (3 marks)
a) Given this information, is triangular arbitrage possible? If so, explain the steps
that would reflect triangular arbitrage, and compute the profit from this strategy
using the £1,000,000 you have. (6 marks)
b) What market forces would occur to eliminate any further possibilities of
triangular arbitrage? (3 marks)
C) Assume that the annual US interest rate (continuous compounded) is currently
8% and Germany’s annual interest rate (continuous compounded) is currently
9%. The euro’s one-year forward rate currently exhibits a discount of 2%.
a) Does interest rate parity exist in this case? (4 marks)
b) Can a US firm benefit from investing funds in Germany using covered interest
arbitrage? Explain. (3 marks)
c) Can a German subsidiary of a US firm benefit by investing funds in the United
States through covered interest arbitrage? (3 marks)
Question 6
A) Compare and contrast transaction exposure and economic exposure. (4 marks)
B) Remington ltd exports products from Australia to the US. It obtains supplies and
borrows funds in Australia. How would the appreciation of the dollar be likely to
affect its net cash flows? Explain. (6 marks)
C) Assume that Johnson ltd needs £3 million for a one-year period. Within one year,
it will generate enough Sterling Pounds to pay off the loan. It is considering three
options:
(1) borrowing Pounds at an annual interest rate (continuous compounded) of 6%,
(2) borrowing Japanese yen at an annual interest rate (continuous compounded)
of 3%, or
(3) borrowing Canadian dollars at an annual interest rate (continuous
compounded) of 4%.
Johnson expects that the Japanese yen will appreciate by 1% over the next year
and that the Canadian dollar will appreciate by 3%.
a) What is the expected “effective” financing rate for each of the three options?
(6 marks)
b) Which option appears to be most feasible? Explain. (4 marks)
c) Why might Johnson not necessarily choose the option reflecting the lowest
effective financing rate? Explain (5 marks)
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