Financial Management Case 2

There is no minimum of words required. Please just review the attached slides and answer all questions in question/answer format. 1. How are foreign exchange transactions between international banks settled? 2. What is triangular arbitrage? What is a condition that will give rise to a triangular arbitrage opportunity? 3. Over the past five years the exchange rate between British pound and U.S. dollar $/£ has changed from about 1.90 to about 1.45. Would you agree that over this five-year period that British goods have become cheaper for ers in the United States? 4. A foreign exchange trader with a U.S. bank took a short position of £5000000 when the $/£ exchange rate was 1.55. Subsequently the exchange rate has changed to 1.61. Is this movement in the exchange rate good from the point of view of the position taken by the trader? By how much has the bank’s liability changed because of the change in the exchange rate? 5. Doug Bernard specializes in cross-rate arbitrage. He notices the following quotes:Swiss franc/dollar = SFr1.5971/$Australian dollar/U.S. dollar = A$1.8215/$Australian dollar/Swiss franc = A$1.1440/SFrIgnoring transaction costs does Doug Bernard have an arbitrage opportunity based on these quotes? If there is an arbitrage opportunity what steps would he take to make an arbitrage profit and how would he profit if he has $1000000 available for this purpose. 6. Give a full definition of arbitrage. 7. Explain the following three concepts of purchasing power parity (PPP): a. The law of one price. b. Absolute PPP. c. Relative PPP. 8. Suppose that the current spot exchange rate is €0.80/$ and the three-month forward exchange rate is €0.7813/$. The three-month interest rate is 5.60 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to $1000000 or €800000. a. Show how to realize a certain profit via covered interest arbitrage assuming that you want to realize a profit in terms of U.S. dollars. Also determine the size of your arbitrage profit.b. Assume that you want to realize a profit in terms of euros. Show the covered arbitrage process and determine the arbitrage profit in euros. 9. In the October 23 1999 issue the Economist reports that the interest rate per annum is 5.93% in the United States and 70.0% in Turkey. Why do you think the interest rate is so high in Turkey? Based on the reported interest rates how would you predict the change of the exchange rate between the U.S. dollar and the Turkish lira? 10. James Clark is a foreign exchange trader with Citibank. He notices the following quotes.Spot exchange rate SFr1.2051/$Six-month forward exchange rate SFr1.1922/$Six-month $ interest rate 2.5% per yearSix-month SFr interest rate 2.0% per year. Is the interest rate parity holding? You may ignore transaction costs. b. Is there an arbitrage opportunity? If yes show what steps need to be taken to make arbitrage profit. Assuming that James Clark is authorized to work with $1000000 compute the arbitrage profit in dollars. Requirements: 400 words