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Suggested answers to case study discussion questions
The World’s Greatest Investor: Because Mr. Bessent expected that the yen was going to lose
value during the next months, he wanted to establish positions in which he was short the yen.
Here are some possible actions he could have taken to establish yen liabilities. He could sell the
Eurocurrencies: Not (Just) Euros and Not Regulated: The beginning and early growth of the
Eurocurrency market included deposits from the government of the Soviet Union and the
governments of Arab oil-exporting countries. These governments did not trust the U.S.
government, but they still wanted to hold dollar bank deposits. So, they found banks outside the
Suggested answers to end of chapter questions and problems
1. Agree. As an investor, I think of my wealth and returns from investments
in terms of my own currency. When I invest in a
foreign-currency-denominated nancial asset, I am (actually or
eectively) buying both the foreign currency and the asset. Part of my
overall return comes from the return on the asset itself—for instance,
2. You will need data on four market rates: The current interest rate (or yield) on bonds
issued by the U.S. government that mature in one year, the current interest rate (or yield)
on bonds issued by the British government that mature in one year, the current spot
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
3. a. The U.S. rm has an asset position in yen—it has a long position in
yen. The risk is that the dollar exchange-rate value of the yen in 60
b. The student has an asset position in yen—a long position in yen. The
risk is that the dollar exchange-rate value of the yen in 60 days is
c. The U.S. rm has a liability position in yen—a short position in yen. The
risk is that the dollar exchange-rate value of the yen in 60 days is
4. a. The U.S. firm has an asset position in yen—it has a long position in yen. To hedge its
exposure to exchange rate risk, the firm should enter into a forward exchange contract
b. The student has an asset position in yen—a long position in yen. To hedge the exposure
to exchange rate risk, the student should enter into a forward exchange contract now in
c. The U.S. firm has a liability position in yen—a short position in yen. To hedge its
exposure to exchange rate risk, the firm should enter into a forward exchange contract
5. For forward speculation the relevant comparison is between the
current forward exchange rate and the expected future spot exchange
rate. Comparing these two rates, we hope to make a prot by buying
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
6. Relative to your expected spot value of the euro in 90 days ($1.22/euro), the current
forward rate of the euro ($1.18/euro) is low—the forward value of the euro is relatively
low. Using the principle of "buy low, sell high," you can speculate by entering into a
7. a. Invest in dollar-denominated asset:
b. Invest in dollar-denominated asset:
c. Invest in dollar-denominated asset:
8. a. The Swiss franc is at a forward premium. Its current forward value ($1.010/SFr) is
b. The covered interest differential "in favor of Switzerland" is ((1 + 0.005)(1.010) /
1.000) − (1 + 0.01) = 0.005. (Note that the interest rate used must match the time period
c. The lack of demand for dollar-denominated bonds (or the supply of these bonds as
investors sell them in order to shift into SFr-denominated bonds) puts downward pressure
137
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
9. a. From the point of view of the U.S.-based investor, the expected uncovered interest
differential is [(1 + 0.03) 1.77/1.80] – (1 + 0.02) = –0.0072. Because the differential is
b. From the point of view of the UK-based investor, the expected uncovered differential is
[(1 + 0.02) (1/1.77) 1.8] – (1 + 0.03) = 0.0073. (Note that the position of the interest
rates is reversed and that the exchange rates are inverted so that they are pricing
c. If there is substantial uncovered investment >owing from Britain to
the United States, this increases the supply of pounds in the spot
10. To evaluate the validity of the statement, one needs to examine two questions. First, what
speculative position would you establish if you expected that the future spot exchange
138
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
11. a. For the expected future value of the euro, the future spot exchange
rate expected in 90 days is U.S.$1.408/euro (= 1/0.71). This value is larger
b. With the United States as the home country of the investor, for each
dollar invested: Invest in the euro-denominated bond, expected in 90
days:
12. In testing covered interest parity, all of the interest rates and exchange rates that are
needed to calculate the covered interest differential are rates that can observed in the
bond and foreign exchange markets. Determining whether the covered interest
139
© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
Sample assignment
University of California—Davis
International Macroeconomics
Speculate!!
What will the yen, the Mexican peso, the pound sterling, the euro, and gold be worth a month
from now? Show your financial genius by filling in your forecasts below. Return this form to
lecture this Thursday, April 8.
For the purposes of this exercise, “a month from now” means the Wall Street Journal spot quotes
for late New York trading on Thursday, May 6. The winning guesses will be announced in class
on Tuesday, May 11. If you are the winner of any of these categories, yours is the satisfaction of
knowing that you could have made a bundle if your guess had been backed by millions of
dollars. There is an additional incentive: the best guessers in each category are my guests for a
free Winner Dinner on May 25 at 6:00 PM. In addition, there is a special prize for the individual
with the very best set of forecasts (smallest average percentage error, with percentage errors
calculated against the final actual values).
To guide your choice, here are some recent data on spot exchange rates and gold prices:
A month ago Yesterday
British pound sterling $1.6067 $1.5995
Japanese yen $0.008145 $0.008207
Mexican peso $0.1011 $0.1056
Euro $1.0833 $1.0710
Gold (London PM fixing) $1,287.90 $1,280.55
(ballot on the next page)
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
Sterling: I predict that the spot price of the British pound in late New York trading on May 6 will
be, in dollars with four decimal places:
$_ . _ _ _ _
Yen: I predict that the spot price of Japanese yen, same time and place, will be, with six decimal
places:
$_ . _ _ _ _ _ _
Peso: I predict that the spot price of the Mexican peso, same time and place, will be, with four
decimal places:
$_ . _ _ _ _
Euro: I predict that the spot price of the euro, same time and place, will be, with four decimal
places:
$_ . _ _ _ _
Gold: I predict that the London PM fixing price of gold, same date, will be, in dollars and cents
per ounce:
$_ , _ _ _ . _ _
My name
_____________________________
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
