FIN415 Class Web Page, Spring '18
Instructor: Maggie Foley
Weekly SCHEDULE, LINKS, FILES and Questions
Coverage, HW, Supplements
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Part I: Review of the global economy
GDP by PPP
Largest economies by PPP GDP in 2018. According to International Monetary Fund estimates.
Largest economies by PPP GDP in 2019. The economy of the U.S.will be larger than that of the EU’s after Brexit
. According to International Monetary Fund estimates.
Global Outlook for Growth of Gross Domestic Product, 2014-2025
Part II: Chapter 2 International Flow of Funds
Chapter 2 (PPT)
· What is BOP? What is current account?
Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's export and imports of goods, services, financial capital, and financial transfers.
A country's current account is one of the two components of its balance of payments, the other being the capital account. The current account consists of the balance of trade, net factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers
A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse.
A country's balance of trade is the net or difference between the country's export of goods and services and its imports of goods and services, ignoring all financial transfers, investments and other components. A country is said to have a trade surplus if its exports exceed its imports, and a trade deficit if its imports exceed its exports.
The 20 largest trade partners of the United States represent 76.6% of U.S. exports, and 81.0% of U.S. imports as of December 2014. These figures do not include services or foreign direct investment.
The largest US partners with their total trade (sum of imports and exports) in millions of $ for calendar year 2016 are as follows
Source: indexmundi.com and world bank (2015)
For Class Discussion:
1. Can President Trump’s policy help improve US economy? Who will benefit most from his reforms?
2. Can US devaluate currency to eliminate current account deficit? Why does US raise interest rate? Can tax cut help boosting US economy?
· $ devalued, then export become cheaper and increased; imports more expensive and decreased; seems like current account deficit could disappear.
· However, in short run, demand is not so flexible and thereby current account might get worsen.
· Demand will improve with time, so current account improves with time, but not immediately.
· $ depreciated, it becomes less attractive to foreign government and investors. The borrowing cost to cover the deficit will increase.
· $ depreciated, living standard might drop.
· Competitor can drop price; Countries can devalue their currencies.
· Your idea?
3. Evolution of international monetary system
· Bimetallism: Before 1875
· Classical Gold Standard: 1875-1914
§ International value of currency was determined by its fixed relationship to gold.
§ Gold was used to settle international accounts, so the risk of trading with other countries could be reduced.
· Interwar Period: 1915-1944
§ Countries suspended gold standard during the WWI, to increase money supply and pay for the war.
§ Countries relied on a partial gold standard and partly other countries’ currencies during the WWII
· Bretton Woods System: 1945-1972
§ All currencies were pegged to US$.
§ US$ was the only currency that was backed by gold.
§ US$ was world currency at that time.
· The Flexible Exchange Rate Regime: 1973-Present
FLOATING AND FIXED EXCHANGE RATE (video)
If the dollar is pegged to gold at U.S. $30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold. What should be the exchange rate between U.S. $ and British £? What will happen if this exchange rate does not hold, such as £1 = $4?
For class discussion:
4. What is European union? What is Euro zone? Who is ECB? You think EU will collapse? What about British exit from EU?
EU: free movement of goods, people, services, and capital.
EU: an economic and political union of 28 member states in Europe.
Euro zone: or euro area, is an economic and monetary union of 18 EU member states that have adopted euro.
ECB: in charge of monetary policy of euro zone.
HW II – Chapter 2 (Due on 1/16)
1. If the dollar is pegged to gold at U.S. $30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold. What should be the exchange rate between U.S. $ and British £?
How much can you make without any risk, if this exchange rate is £1 = $6? Assume that your initial investment is $1,200. (Answer: $240)
2. What is your opinion about Trump’s tax cut plan? His policy reform to bring jobs back to US? Will that work?
3. What is your opinion about US monetary policy? Shall Fed continue increasing interest rate to make $ stronger and other currencies weaker? Why or why not?
4. Internet exercises (not required, for interested students only)
a. IMF, world bank and UN are only a few of the major organizations that track, report and aid international economic and financial development. Using these website, you can summarize the economic outlook for each country.
World bank: www.worldbank.org’
Bank of international settlement: www.bis.org/index.htm
b. St. Louis Federal Reserve provides a large amount of recent open economy macroeconomic data online. You can track down BOP and GDP data for the major industrial countries.
Recent international economic data: research.stlouisfed.org/publications
Balance of Payments statistics: research.stlouisfed.org/fred2/categories/125
Reference of useful websites for global economy
Current Account (BOP) Data – World Bank
IMF, world bank and UN are only a few of the major organizations that track, report and aid international economic and financial development. Using these website, you can summarize the economic outlook for each country.
World bank: www.worldbank.org
Bank of international settlement: www.bis.org/index.htm
St. Louis Federal Reserve provides a large amount of recent open economy macroeconomic data online. You can track down BOP and GDP data for the major industrial countries.
Recent international economic data: research.stlouisfed.org/publicaitons/iet
** Euro Crisis for reference***
ECB Time Line of Financial Crisis
The great Euro crisis 2012
Brexit, Briefly (well explained)
1. A trade war with China would crush multinationals like Apple and Walmart
Published 10:42 AM ET Tue, 7 Nov 2017 Updated 11:52 AM ET Tue, 7 Nov 2017CNBC.com
As Donald Trump prepares to meet China's president Xi Jingping, a lightning rod of 2017 is on his agenda: trade.
Populist politicians have long opined on how U.S. trade policies with China have hurt certain American constituencies – namely, small businesses and factory workers. While these accusations largely ring true, the current protectionist policies under consideration risk generating blowback for another important economic faction: large American multinational corporations, which play a significant role in driving the U.S. economy.
If a trade war unfolded, this constituency would stand to lose the most. Many of America's biggest brands have considerable investment footprints in China: Nike, Walmart, Apple - thee list goes on. These companies would stand at the front of the firing line if China reciprocated against any major trade actions by the U.S. Depending on the nature of the retaliation, expect revenues, profits, and share prices to suffer. Collateral impacts would include company workers in America, local economies where the companies reside, and the pension and retirement fund holdings invested in them.
The risks involved run deeper than reciprocal tariffs and trade restrictions. At the heart of corporate America's concern is future access to the Chinese market. Already, China is heading in the wrong direction here, as its policy environment has become increasingly hostile to the private sector and the foreign investors within it. A trade war could be the final straw that leads Beijing to severely contain American corporate interests in China, if not close off the market altogether. For many U.S. companies, China is their No.2 market and revenue-generator in the world. For some, it is already No.1. Therefore, any new barriers that emerge from a trade war domino effect would devastate American business.
"A trade war could be the final straw that leads Beijing to severely contain American corporate interests in China, if not close off the market altogether."
On both sides, economic hostility has been driven recently by accusations, counter-accusations, and ongoing investigations into China's practice of coercing American companies to hand over advanced technology and other intellectual property as a price for doing business. The U.S. Trade Representative's ongoing investigation into these shenanigans has illuminated the ways China's regulators railroad U.S. corporations. During open hearings in October, voice after voice recounted examples of American firms essentially forced into disadvantageous commercial arrangements with Chinese partners – the localization of customer data, software source codes, core intellectual property rights – because Chinese law often requires such provisions before regulators will grant operating rights.
Why do major American companies allow themselves to be perennially manipulated by the Chinese government into forgoing their hard-earned innovations? Because Beijing is masterful at playing one company against the other, and Chinese leaders know multinational corporations cannot resist the lure of China's consumers. Thus, companies compromise to gain access, for fear if they don't play ball someone else will.
China's government will only change its tune if all the private players team up to reject unfair market-access offers – and withhold their investments en masse. But U.S. firms are legally prohibited from and instinctively disinclined to collaborate with one another in their own defense. Private sector players will almost always seek to steal a march on their competitors, particularly if they can do so in such a way that blocks out rivals.
Back at home in the U.S., multinational corporations are concerned about the U.S. government's ability to address these and other challenges. The Trump administration and many in Congress appear increasingly determined to do something to change the status quo. But Washington pushing too hard could worsen the situation by triggering Chinese retaliation.
Adding to the complications, American multinationals also find themselves dealing with an administration focused more on investments inside the U.S. and less on supporting U.S. industry abroad. For example, negotiations over a U.S.-China Bilateral Investment Treaty (BIT) have gone moribund, despite a U.S.-China BIT arguably ranking as corporate America's top policy priority in the relationship. Moreover, many multinational corporations thought the Trans-Pacific Partnership would be a strong bulwark to help normalize China's trade and investment practices.
Despite the uncertainty on the U.S. side, America has more opportunity to push back on China's leaders than it did a decade ago. The days of China's double-digit growth figures are gone, permanently, making the risk of heightened tensions less dangerous for business than in the past. China is no longer a wonderland of easy growth and easy profits, so some leverage has shifted back to American negotiators. Additionally, China's investments abroad have skyrocketed – particularly in the U.S. – creating a mutual incentive for keeping doors open.
This week in Beijing, some pushing from the Trump side could help in cajoling China into improving market-access conditions for foreign companies. However, if threats and heated rhetoric turn into painful protectionist U.S. policies down the road, "face issues" for China would likely come into play and lead Beijing to institute retaliatory actions – step one towards a trade war. It behooves American business to ensure its voice is heard now and heard clearly, without the mixed messages of the past. In this way, the populist proposals kicking around Washington can be handled moderately, to help bring about positive change rather than a downward spiral.
2. Trump readies tougher ‘America first’ line for China trade in 2018
By David Lynch December 27, 2017
Several corporate officials and analysts closely tracking trade policy said that President Trump is expected to take concrete actions on a range of disputes involving China within weeks.
Trump is due by the end of January to render his first decision in response to petitions from U.S. companies seeking tariffs or import quotas on Chinese solar panels and washing machines manufactured in China and its neighbors.
U.S. trade officials in both cases already have determined that domestic manufacturers have been injured by surging imports and have recommended that he erect new trade barriers.
Trump could also order new limits on Chinese investment in the United States or raise tariffs unilaterally — a likely violation of U.S. commitments to the World Trade Organization — pending the outcome of a broader investigation into Beijing’s alleged failure to protect foreign companies’ intellectual property rights, analysts say.
And White House action is due on a separate Commerce Department probe triggered by worries about the national security impact of rising imports of Chinese steel and aluminum.
“Their intent is to bring shock and awe,” said Scott Kennedy, an expert on Chinese trade at the Center for Strategic and International Studies. “They’re not kidding around.”
On Dec. 6, Robert Lighthizer, the president’s chief trade negotiator, had a contentious discussion of administration trade policy with members of the US-China Business Council’s board of directors, which includes the chief executives of companies such as Chubb Insurance and General Motors, according to three executives familiar with the session who asked for anonymity to describe a confidential meeting.
During the closed-door Washington briefing for chief executives with business in China, Lighthizer said that U.S. complaints about Chinese trade practices could not be resolved simply by additional talks with Beijing, and he appeared indifferent to concerns that the administration’s hard line risked rupturing a $600 billion annual trade relationship.
“It did not go well,” said one person familiar with the exchange.
A spokeswoman for Lighthizer did not reply to a request for comment. The business group declined to comment on what it said was an off-the-record discussion.
It’s not yet clear how extensive the administration actions will be. Trump’s repeated campaign vows to retaliate against China for policies that he says contributed to the loss of millions of U.S. jobs have yet to translate into concrete action. During a visit to Beijing at last month, the president blamed his White House predecessors rather than Chinese President Xi Jinping for the yawning bilateral trade deficit.
That gap has only grown since Trump became president, despite his “America first” rhetoric. Through the first 10 months of this year, the United States incurred a $309 billion trade deficit with China, up from $289 billion during the same period one year earlier.
“So far, it’s been the Teddy Roosevelt philosophy turned on its head: Speak loudly and carry a small stick,” said Scott Paul, president of the Alliance for American Manufacturing, a nonprofit established by the United Steelworkers union and major steel makers.
Still, in recent weeks, there have been mounting signs of the president's intention to act. In a new national security strategy, the president earlier this month described China a strategic competitor and said that when it comes to trade, the United States “will no longer turn a blind eye to violations, cheating or economic aggression.”
The White House document was issued less than a month after the United States formally told the WTO that China did not qualify as a “market economy” under the trade body’s rules.
In a dispute with the European Union, China insists that it was promised the designation by now under the terms of its 2001 membership in the WTO. The European Union and the United States insist that the Chinese state’s role in the economy remains too large to justify granting China market economy treatment. As a nonmarket economy, China is subject to higher anti-dumping duties under U.S. trade law, making the issue more than a matter of bragging rights.
The president also previewed the tougher line in a speech last month in Danangm, Vietnam, saying that the U.S. now expects its trade “partners will faithfully follow the rules just like we do.”
Administration officials say that China has not lived up to the bargain struck at the time of its accession to the WTO. Market liberalization has slowed or even reversed, especially since Xi became Communist Party general secretary in late 2012. State-owned enterprises, which enjoy preferential government financing and permit approvals, remain formidable competitors for multinational corporations.
In a US-China Business Council survey, 57 percent of U.S. companies operating in China say they have yet to see any impact from a sweeping package of economic reforms Xi unveiled four years ago.
The trade decisions facing Trump in the next several weeks encompass a range of U.S. complaints: the dumping in U.S. markets of Chinese products such as solar panels, the theft of intellectual property and trade secrets, and economic damage caused by excess Chinese production in key commodities such as steel.
“There needs to be a fundamental, systemic change and a real commitment to market opening by China,” said one senior administration official. “We want China to stop stealing our stuff, live up to its commitment, and don’t distort the international trading system.”
The president has discretion in choosing whether and how to respond to the specific issues reflected in each of the pending cases. Already, the administration has delayed action on its investigation of the national security impact of rising steel and aluminum imports from China, as it weighs the competing interests of companies that produce those materials and those that use them.
In the solar panel and washing machine cases, the president is being asked to impose sweeping "safeguard" tariffs, designed to protect American companies from foreign competition. Unlike anti-dumping or countervailing duty cases, the law does not require the administration to demonstrate that the import flood arises from an unfair trade practice. Safeguard remedies also are not limited to products from just one country, an important factor in the washing machine dispute, which has seen South Korean makers move production among their home market, China, Thailand and Vietnam to escape earlier U.S. trade penalties.
Potentially the most significant trade investigation examines China’s alleged theft of intellectual property and Beijing’s requirement that some foreign companies surrender their technology secrets in return for access to its 1.4 billion-person market. That probe, widely expected to conclude that China is treating U.S. companies unfairly, could lead to new restrictions on Chinese investment in high-tech U.S. industries, several analysts said.
Total financial flows into the United States from China topped $46 billion last year, almost 10 times the figure from five years earlier, according to the New York-based Rhodium Group consultancy.
In an interview, the senior administration official refused to rule out other potential remedies, such as an across-the-board tariff on Chinese imports, that would violate U.S. obligations to the WTO. Members of the Geneva-based global trade body agree to first bring complaints against their trading partners to its dispute settlement system, an essentially voluntary process that Lighthizer has criticized.
"The president will make a determination what’s the most effective way to ensure our industries are not being harmed by distorted practices,” the official said. “I don’t think the president would rule out any good option.”
China is sure to respond to any significant move by the United States with measures designed for political impact — such as reversing the recent opening of its markets to U.S. beef exports, Kennedy said.
That would hit states such as Montana that backed Trump last year.
U.S. multinationals operating in China also would be likely to suffer. Some companies might receive unexpected visits from government inspectors or encounter difficulties obtaining permits or licenses. Others could be hit with tax audits or antitrust investigations.
Chinese officials could “make American companies wear small shoes,” said Kennedy, alluding to a traditional Chinese saying that means causing pain or difficulty for another party.
For now, U.S. business leaders are bracing for impact. Though uncertain as to exactly what the president will do, they anticipate a difficult year ahead.
“Our sense,” said Jeremie Waterman, vice president for greater China at the U.S. Chamber of Commerce, “is that everything is on the table.”
Homework I: Based on the above articles, do you agree with President Trump? Why or why not? Can US win this trade war? (Due on 1/16/2018)
Go to www.forex.com and set up a practice account and you can trade with $50,000 virtue money.
Visit http://www.dailyfx.com/to get daily foreign exchange market news.
· US is using floating exchange rate system. What is the advantage and disadvantage of this system? DO we need Cheap $ or strong $?
· Chinese currency is pegged to US$. What is the advantage and disadvantage of this system? What about let it float, instead of holding its value at a fixed rate? Can Chinese government control its currency? How? Is cheap RMB always better than Strong RMB, to Chinese government?
· Germany is part of the Euro Zone. Can Germany manipulate Euro?
· Who are the major players in the FX market?
· As compared with stock market, FX market is more volatile or less? Why?
- Daily Volatility (In Pips)
EUR/USD - Hourly Volatility (Pips/GMT Hours)
EUR/USD - Weekday Volatility (In Pips)
· Monday Tuesday Wednesday Thursday Friday
What is volatility? (https://www.investing.com/tools/forex-volatility-calculator)
Volatility is a term used to refer to the variation in a trading price over time. The broader the scope of the price variation, the higher the volatility is considered to be. For example, a security with sequential closing prices of 5, 20, 13, 7, and 17, is much more volatile than a similar security with sequential closing prices of 7, 9, 6, 8, and 10. Securities with higher volatility are deemed riskier, as the price movement--whether up or down--is expected to be larger when compared to similar, but less volatile, securities. The volatility of a pair is measured by calculating the standard deviation of its returns. The standard deviation is a measure of how widely values are dispersed from the average value (the mean).
The importance of volatility for traders
Being aware of a security's volatility is important for every trader, as different levels of volatility are better suited to certain strategies and psychologies. For example, a Forex trader looking to steadily grow his capital without taking on a lot of risk would be advised to choose a currency pair with lower volatility. On the other hand, a risk-seeking trader would look for a currency pair with higher volatility in order to cash in on the bigger price differentials that volatile pair offers. With the data from our tool, you will be able to determine which pairs are the most volatile; you can also see which are the most – and least – volatile days and hours of the week for specific pairs, thus allowing you to optimize your trading strategy.
What affects the volatility of currency pairs?
Economic and/or markets related events, such as a change in the interest rate of a country or a drop in commodity prices, often are the source of FX volatility. The degree of volatility is generated by different aspects of the paired currencies and their economies. A pair of currencies - one from an economy that’s primarily commodity-dependent, the other a services-based economy - will tend to be more volatile because of the inherent differences in each country’s economic drivers. Additionally, different interest rate levels will cause a currency pair to be more volatile than pairs from economies with similar interest rates. Finally, crosses (pairs which do not include the US dollar) and ‘exotic’ crosses (pairs that include a non-major currency), also tend to be more volatile and to have bigger ask/bid spreads. Additional drivers of volatility include inflation, government debt, and current account deficits; the political and economic stability of the country whose currency is in play will also influence FX volatility. As well, currencies not regulated by a central bank - such as Bitcoin and other cryptocurrencies - will be more volatile since they are inherently speculative.
· What is direct and indirect quote and cross rate
1. Direct quote is the local currency price of one unit of foreign currency. e.g. In New York City $1.38/€.
2. Indirect quote is the inverse of the direct quote. It is the quotations that represent the number of units of a foreign currency per dollar. e.g. In New York City €0.72/$.
3. Cross Exchange Rates: it is the quotations that represent the number of units of a foreign currency per another foreign currency. e.g. In New York City: €0.90/£.
4. You can get the cross exchange rates at www.forex.com
“The Forex Bid Price and Ask price”
The Forex bid is the price at which you can sell a certain Forex currency pair for (for base currency)..
Bid price represents what will be obtained in the quote currency when selling one unit of the base currency.
The ask price represents what has to be paid in the quote currency to obtain one unit of the base currency.
For instance, EUR/USD then EUR is the base and USD is the quote currency.
The bid price is seen on the left side of the Forex quote. For example, for the EUR/USD quote 1.2728/31, the bid price is 1.2728. This means you can sell one Euro for $1.2728. The ask price is 1.2731. It means you can buy 1 Euro for $1.2731.”
Assume you have $1000 and bid rate is $1.52/£ and ask rate is $1.60 /£. Meanwhile, the bid rate is quoted as 0.625 £/$ and the ask rate is quoted as 0.6579 £/$. If you convert it to £ and then convert it back to $, what will happen?
Answer: Sell at bid and buy at ask price (ask is always higher than bid so you buy high and sell low, since you are dealing with the bank). So here with $1000, you sell at bid 0.625 £/$ so you get 625£
($1000* 0.625 £/$ = 625£). With 625£, you sell at bid $1.52/£, so you get $950 (625£ * $1.52/£ = $950)
Or you can buy GBP at $1.60 /£ and buy $ at 0.6579 £/$. So $1000 / 1.6 $/£ * 0.6579 £/$ = $950
The impossible trinity
A country cannot be on all three sides of the triangle at once.
It must give up one of the three attributes if it is to achieve one of the states described by the corner of the triangle.
Assume that world interest rate is at 5%. If the home central bank tries to set domestic interest rate at a rate lower than 5%, for example at 2%, there will be a depreciation pressure on the home currency, because investors would want to sell their low yielding domestic currency and buy higher yielding foreign currency. If the central bank also wants to have free capital flows, the only way the central bank could prevent depreciation of the home currency is to sell its foreign currency reserves. Since foreign currency reserves of a central bank is limited, once the reserves are depleted, the domestic currency will depreciate.
Hence, the all three of the policy objectives mentioned above cannot be pursued simultaneously. A central bank has to forgo one of the three objectives. Therefore a central bank has three policy combination options.
· Option (a): A stable exchange rate and free capital flows (but not an independent monetary policy because setting a domestic interest rate that is different from the world interest rate would undermine a stable exchange rate due to appreciation or depreciation pressure on the domestic currency).
· Option (b): An independent monetary policy and free capital flows (but not a stable exchange rate).
· Option (c): A stable exchange rate and independent monetary policy (but no free capital flows, which would require the use of capital controls).
Currently, Eurozone members have chosen the first option (a) while most other countries have opted for the second one (b).
Class discussion: find your country’s exchange rate system and then discuss for the rational of that country’s adoption of the system based on the “impossible trinity”. (refer to the following paper)
Exchange Rate Regimes from http://www.imf.org/external/np/mfd/er/2004/eng/0604.htm (IMF)
Chicago bank expects the exchange rate of the NZ$ to appreciate from $0.50 to $0.52 in 30 days.
Chicago bank can borrow $20m on a short term basis.
Currency Lending Rate Borrowing rate
$ 6.72% 7.20%
NZ$ 6.48% 6.96%
Question: If Chicago bank anticipate NZ$ to appreciate, how shall it trade? (refer to ppt)
◦ NZ$ will appreciate, so you should buy NZ$ now and sell later. Borrow $à convert to NZ$ today à lend it for 30 days à convert to $ 30 days later àpayback the $ loan.
◦ Convert the borrowed $ to NZ$ today. So your NZ$ worth: $20m / 0.50 $/NZ$=40m NZ$.
◦ Lend NZ$ for 6.48% * 30/360=0.54% and get
40m NZ$ *(1+0.54%)=40,216,000 NZ$ 30 days later.
◦ Your borrowed $20m should be paid back for
20m *(1+7.2%* 30/360)=$20.12m. This equals to $20.12m / 0.52 $/NZ$=NZ$ 38,692,308.
◦ So the profit is:
40,206000-38,692,308 = NZ$1,523,692.
Your $ profit is: NZ$1,523,692 *0.52$/NZ$=$792,320.
Bank expects that the Mexican peso will depreciate against the dollar from its spot rate of $.15 to $.14 in 10 days. The following interbank lending and borrowing rates exist:2: Blue Demon
Lending Rate Borrowing Rate
U.S. dollar 8.0% 8.3%
Mexican peso 8.5% 8.7%
Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million pesos in the interbank market, depending on which currency it wants to borrow.
a. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.
b. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to appreciate from its present spot rate of $.15 to $.17 in 10 days. How could it attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.
Part a: Blue Demon Bank can capitalize on its expectations about pesos (MXP) as follows:
1. Borrow MXP70 million
2. Convert the MXP70 million to dollars:
MXP70,000,000 × $.15 = $10,500,000
3. Lend the dollars through the interbank market at 8.0% annualized over a 10‑day period. The amount accumulated in 10 days is:
$10,500,000 × [1 + (8% × 10/360)] = $10,500,000 × [1.002222] = $10,523,333
4. Repay the peso loan. The repayment amount on the peso loan is:
MXP70,000,000 × [1 + (8.7% × 10/360)] = 70,000,000 × [1.002417]=MXP70,169,167
5. Based on the expected spot rate of $.14, the amount of dollars needed to repay the peso loan is:
MXP70,169,167 × $.14 = $9,823,683
6. After repaying the loan, Blue Demon Bank will have a speculative profit (if its forecasted exchange rate is accurate) of:
$10,523,333 – $9,823,683 = $699,650
Part b: Blue Demon Bank can capitalize on its expectations as follows:
1. Borrow $10 million
2. Convert the $10 million to pesos (MXP):
$10,000,000/$.15 = MXP66,666,667
3. Lend the pesos through the interbank market at 8.5% annualized over a 30‑day period. The amount accumulated in 30 days is: MXP66,666,667 × [1 + (8.5% × 30/360)] = 66,666,667 × [1.007083] = MXP67,138,889
Repay the dollar loan. The repayment amount on the dollar loan is:
$10,000,000 × [1 + (8.3% × 30/360)] = $10,000,000 × [1.006917] = $10,069,170
4. Convert the pesos to dollars to repay the loan. The amount of dollars to be received in 30 days (based on the expected spot rate of $.17) is: MXP67,138,889 × $.17 = $11,413,611
5. The profits are determined by estimating the dollars available after repaying the loan:
$11,413,611 – $10,069,170 = $1,344,441
What is margin call
1. Bid/Ask Spread
Compute the bid/ask percentage spread for Mexican peso retail transactions in which the ask rate is $.11 and the bid rate is $.10. HINT: BID ASK SPREAD = (ASK-BID)/ASK (Answer: 9.09%)
2. Indirect Exchange Rate
If the direct exchange rate of the euro is worth $1.25, what is the indirect rate of the euro? That is, what is the value of a dollar in euros? (Answer: 0.8€)
3. Cross Exchange Rate
Assume Poland currency (the zloty) is worth $.17 and the Japanese yen is worth $.008. What is the cross rate of the zloty with respect to yen? That is, how many yen equal a zloty? (Answer: 21.25¥)
4. Foreign Exchange
You just came back from Canada, where the Canadian dollar was worth $.70.
You still have C$200 from your trip and could exchange them for dollars at the airport, but the airport foreign exchange desk will only buy them for $.60. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for $.10 per peso. You met a tourist at the airport who is from Mexico and is on his way to Canada. He is willing to buy your C$200 for 1,300 pesos. Should you accept the offer or cash the Canadian dollars in at the airport? Explain. (Answer: You can only get $1,200 peso if you accept the offer in the airport)
5. Do you anticipate China to adopt floating exchange system? Why or why not? Do you expect US to go back to fixed exchange rate system? Why or why not?
Question 1. Choose between increase / decrease.
US Inflation goes up, $ will ________increase / decrease____________in value__.
US Real interest rate goes up, $ will ________increase / decrease___________ in value__.
US Domestic resident’s income goes up, $ will ________increase / decrease________ in value__.
US Current account goes up, $ will ________increase / decrease________ in value__.
US Recession or crisis, $ will ________increase / decrease________ in value__.
Question 2: Suppose you observe the following exchange rates: €1 = $.7; £1 = $1.40; and €2.20 = £1.00. Starting with $1,000,000, how can you make money? (Answer: get £ first. Your profit is $100,000)
Question 3: If the dollar is pegged to gold at U.S. $1800 = 1 ounce of gold, and the British pound is pegged to gold at £1200= 1 ounce of gold. What should be the exchange rate between U.S. $ and British £ ? How much can you make without any risk, if this exchange rate is £1 = $1.6? Assume that your initial investment is $1,800. Hint: start from convert to gold from $ ($1800 = 1 ounce of gold) (Answer: £1 = $1.5; Your profit is $120)
Assume you have £1000 and bid rate is 1.60$/£ and ask rate is 1.66$/£. If you convert it to £ and then convert it back to $, what will happen? (Answer: $963.86 and lose $36.14. Sell low and buy high here. So sell £ at bid and buy £ at ask )
Suppose you start with $100 and buy stock for £50 when the exchange rate is £1 = $2. One year later, the stock rises to £60. You are happy with your 20 percent return on the stock, but when you sell the stock and exchange your £60 for dollars, you find that the pound has fallen to £1 = $1.75. What is your return to your initial investment of $100? (Answer: 5%)
Baylor Bank believes the New Zealand dollar will depreciate over the next five days from $.52 to $.5. The following annual interest rates apply:
Currency Lending Rate Borrowing Rate
Dollars 5.50% 5.80%
New Zealand dollar (NZ$) 4.80% 5.25%
Baylor Bank has the capacity to borrow either NZ$11 million or $5 million. If Baylor Bank’s forecast if correct, what will its dollar profit be from speculation over the five‑day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)? (Answer: 0.44 million NZ$ profit)
F = forward rate
S = spot rate
r1 = simple interest rate of the term currency
r2 = simple interest rate of the base currency
T = tenor (calculated to the appropriate day count conversion)
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