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9. Given the following information, what are the NZD/SGD currency against currency bid-ask
quotations?
American Terms European Terms
Bank Quotations Bid Ask Bid Ask
Solution: Equation 5.12 from the text implies Sb(NZD/SGD) = Sb($/SGD) x Sb(NZD/$) = .6135 x
1.3751 = .8436. The reciprocal, 1/Sb(NZD/SGD) = Sa(SGD/NZD) = 1.1854. Analogously, it is
10. 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/SFr
Ignoring 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 $1,000,000 available for this purpose.
CFA Guideline Answer:
A. The implicit cross-rate between Australian dollars and Swiss franc is A$/SFr = A$/$ x $/SFr =
B. In the quoted cross-rate of A$1.1440/SFr, one Swiss franc is worth A$1.1440, whereas the
cross-rate based on the direct rates implies that one Swiss franc is worth A$1.1405. Thus, the
i. Sell dollars to get Swiss francs: Sell $1,000,000 to get $1,000,000 x SFr1.5971/$ =
ii. Sell Swiss francs to buy Australian dollars: Sell SFr1,597,100 to buy SFr1,597,100 x
iii. Sell Australian dollars for dollars: Sell A$1,827,082.40 for
11. Assume you are a trader with Deutsche Bank. From the quote screen on your computer
terminal, you notice that Dresdner Bank is quoting €0.7627/$1.00 and Credit Suisse is offering
SF1.1806/$1.00. You learn that UBS is making a direct market between the Swiss franc and the
euro, with a current €/SF quote of .6395. Show how you can make a triangular arbitrage profit by
trading at these prices. (Ignore bid-ask spreads for this problem.) Assume you have $5,000,000
with which to conduct the arbitrage. What happens if you initially sell dollars for Swiss francs?
What €/SF price will eliminate triangular arbitrage?
Solution: To make a triangular arbitrage profit the Deutsche Bank trader would sell $5,000,000 to
Dresdner Bank at €0.7627/$1.00. This trade would yield €3,813,500= $5,000,000 x .7627. The
Deutsche Bank trader would then sell the euros for Swiss francs to Union Bank of Switzerland at
If the Deutsche Bank trader initially sold $5,000,000 for Swiss francs, instead of euros, the
trade would yield SF5,903,000 = $5,000,000 x 1.1806. The Swiss francs would in turn be traded
The S(€/SF) cross exchange rate should be .7627/1.1806 = .6460. This is an equilibrium
rate at which a triangular arbitrage profit will not exist. (The student can determine this for
himself.) A profit results from the triangular arbitrage when dollars are first sold for euros
because Swiss francs are purchased for euros at too low a rate in comparison to the equilibrium
12. The current spot exchange rate is $1.95/£ and the three-month forward rate is $1.90/£.
Based on your analysis of the exchange rate, you are pretty confident that the spot exchange
rate will be $1.92/£ in three months. Assume that you would like to buy or sell £1,000,000.
a. What actions do you need to take to speculate in the forward market? What is the expected
dollar profit from speculation?
b. What would be your speculative profit in dollar terms if the spot exchange rate actually turns
out to be $1.86/£.
Solution:
a. If you believe the spot exchange rate will be $1.92/£ in three months, you should buy
b. If the spot exchange rate actually turns out to be $1.86/£ in three months, your loss from the
long position will be:
13. Omni Advisors, an international pension fund manager, plans to sell equities denominated in
Omni will realize net proceeds of 3 million CHF at the end of 30 days and wants to eliminate the
Currency Exchange Rates
ZAR/US
D
ZAR/US
D
CHF/US
D
CHF/US
D
Maturit
y
Bid Ask Bid Ask
a. Describe the currency transaction that Omni should undertake to eliminate
currency risk over the 30-day period.
b. Calculate the following:
• The CHF/ZAR cross-currency rate Omni would use in valuing the Swiss equity
portfolio.
• The current value of Omni’s Swiss equity portfolio in ZAR.
• The annualized forward premium or discount at which the ZAR is trading versus
the CHF.
CFA Guideline Answer:
a. To eliminate the currency risk arising from the possibility that ZAR will appreciate
against the CHF over the next 30-day period, Omni should sell 30-day forward
b. The calculations are as follows:
• Using the currency cross rates of two forward foreign currencies and three currencies
(CHF, ZAR, USD), the exchange would be as follows:
--30 day forward ZAR are purchased for USD. Dollars are simultaneously sold to
purchase ZAR at the rate of 6.2538 = $1 (done at the bid side because going from
• At the time of execution of the forward contracts, the value of the 3 million CHF equity
• To calculate the annualized premium or discount of the ZAR against the CHF requires
Spot rate = 1.5343 CHF/6.2681 ZAR = 0.244779120
30 day forward ask rate 1.5285 CHF/6.2538 ZAR = 0.244411398
The premium/discount formula is:
MINI CASE: SHREWSBURY HERBAL PRODUCTS, LTD.
Shrewsbury Herbal Products, located in central England close to the Welsh border, is an old-
line producer of herbal teas, seasonings, and medicines. Its products are marketed all over the
United Kingdom and in many parts of continental Europe as well.
Shrewsbury Herbal generally invoices in British pound sterling when it sells to foreign
customers in order to guard against adverse exchange rate changes. Nevertheless, it has just
received an order from a large wholesaler in central France for £320,000 of its products,
conditional upon delivery being made in three months’ time and the order invoiced in euros.
Shrewsbury’s controller, Elton Peters, is concerned with whether the pound will appreciate
versus the euro over the next three months, thus eliminating all or most of the profit when the
euro receivable is paid. He thinks this is an unlikely possibility, but he decides to contact the
firm’s banker for suggestions about hedging the exchange rate exposure.
Mr. Peters learns from the banker that the current spot exchange rate is €/£ is €1.4537, thus
the invoice amount should be €465,184. Mr. Peters also learns that the three-month forward
rates for the pound and the euro versus the U.S. dollar are $1.8990/£1.00 and $1.3154/€1.00,
respectively. The banker offers to set up a forward hedge for selling the euro receivable for
pound sterling based on the €/£ forward cross-exchange rate implicit in the forward rates against
the dollar.
What would you do if you were Mr. Peters?
Suggested Solution to Shrewsbury Herbal Products, Ltd.
(Note to Instructor: This elementary case provides an intuitive look at hedging exchange
rate exposure. Students should not have difficulty with it even though hedging will not be
formally discussed until Chapter 8. The case is consistent with the discussion that accompanies
Exhibit 5.9 of the text. Professor of Finance, Banikanta Mishra, of Xavier Institute of
Management – Bhubaneswar, India contributed to this solution.)
Suppose Shrewsbury sells at a twenty percent markup. Thus the cost to the firm of the
£320,000 order is £256,000. Thus, the pound could appreciate to €465,184/£256,000 =
€1.8171/1.00 before all profit was eliminated. This seems rather unlikely. Nevertheless, a ten
percent appreciation of the pound (€1.4537 x 1.10) to €1.5991/£1.00 would only yield a profit of
If the euro was trading at a forward discount, Shrewsbury would end up locking-in an
amount less than £320,000. Whether that would lead to a loss for the company would depend
Obviously, Shrewsbury could ensure that it receives exactly £320,000 at the end of three-
month accounts receivable period if it could invoice in £. That, however, is not acceptable to the
French wholesaler. When invoicing in euros, Shrewsbury could establish the euro invoice
