INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 16
1. Suppose you are a U.S. bicycle dealer. You have signed a contract in which you agree
to import 1,000 bicycles from a U.K. manufacturer and to pay £100,000 for them 6
months from today. How exactly can you use the forward exchange market to protect
yourself against exchange rate risk?
2. What is the essential difference between an exporter and a speculator in the foreign
exchange market?
3. Cross exchange rates calculation. The spot exchange rate between the $ and the
Swiss franc is $0.7602/SF and the exchange rate between the dollar and the euro is
$1.17/euro. Calculate the exchange rate between the euro and the Swiss franc as
quoted in France.
4. The forward exchange rate (90-day) between the $ and the Swiss franc is $0.7613/SF
and the forward exchange rate (90-day) between the dollar and the euro is
$1.1659/euro. (Use the spot exchange rates quoted in question 3.)
a. Are the markets expecting the Swiss franc to depreciate or to appreciate with
respect to the dollar?
b. Are the markets expecting the euro to depreciate or to appreciate with respect to
the dollar?
5. Insuring against exchange rate risk, use the exchange rate data from the previous
questions.
a. Assume that Macy, a U.S. importer of Tissot Swiss watches, has to make a 1,000
SF payment in 90 days and wishes to use the forward market to insure against
foreign exchange risk. Explain carefully how they will do so and calculate how much
the transaction will cost in terms of $ (assume no other cost).
b. Now assume that Macy uses the spot market to address the currency risk. The rate
of interest on the dollar is 5 percent (annual basis) and the rate of interest on the
Swiss franc is 4 percent (annual basis). Calculate the total cost of buying the Swiss
francs on the spot market (assume no other costs).
c. Which alternative would you advise Macy to choose?
6. Speculation on the forward market. Use the data from earlier questions.
a. If a speculator believes that in 90 days the $/SF spot exchange rate is going to be
$0.7610/ SF, explain which actions he will take to speculate on the currencies.
b. Assuming that he plans to use $1,000,000 for his speculative activities, calculate his
potential gain if his prediction is correct.
c. It turns out that 3 months later the spot rate is $0.7615/SF. Will he actually realize a
gain or a loss from his speculative activities? Calculate it (show the sign).
7. Currency arbitrage. Assume that the exchange rate in New York is $1.1727/€ and in
Paris it is 0.852€/$.
a. What actions will the currency arbitrageurs in the various banks (U.S. or France)
take to realize a gain?
b. How much will they gain for each $1,000 traded? (assume no costs).
c. What will be the impact of their action on the $ price of the euro in New York? And
on the euro price of the dollar in Paris? How long will this process continue?
INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 16: Answers
1.
You fear an appreciation of the pound by the time you have to make the pound payment.
3.
5.
a. Macy enters into a forward contract to buy SF1,000 on the 90-day forward market at
b. On the spot market, Macy borrows dollars ($760.2) to buy the 1,000 Swiss francs at
the spot rate. They pay 1.25 percent interest on the dollar (5%annual/4) i.e.
7.
a. The exchange rates are not consistent as, in Paris, the euro costs $1.1737. This is