International Business Chapter 2 Suppose Question That The Direct Price Euros Per Pound Were And The

Chapter 2

The Foreign Exchange Market

QUESTIONS

1. What is an exchange rate?

2. What is the structure of the foreign exchange market? Is it like the New York Stock

Exchange?

3. What is a spot exchange rate contract? When does delivery occur on a spot contract?

Answer: When currencies in the interbank spot market are traded, certain business

conventions are followed. For example, when the trade involves the U.S. dollar, business

9. What is an appreciation of the dollar relative to the pound? What happens to the dollar

price of the pound in this situation?

10. What is a depreciation of the Thai baht relative to the Malaysian ringgit? What

happens to the baht price of the ringgit in this situation?

PROBLEMS

1. Mississippi Mud Pies, Inc. needs to buy 1,000,000 Swiss francs (CHF) to pay its Swiss

chocolate supplier. Its banker quotes bid–ask rates of CHF1.3990–1.4000/USD. What

will be the dollar cost of the CHF1,000,000?

2. If the Japanese yen–U.S. dollar exchange rate is ¥104.30/$, and it takes 25.15 Thai bahts

to purchase 1 dollar, what is the yen price of the baht?

4 Chapter 2 The Foreign Exchange Market

Answer: To prevent triangular arbitrage, the direct quote of the yen price of the baht (¥/THB)

must equal the yen price of the dollar times the dollar price of the baht (which is the

reciprocal of the baht price of the dollar):

¥104.30/$



1/(THB25.15/$) = ¥104.30/$



$0.03976/THB = ¥ 4.1471/THB

3. As a foreign exchange trader, you see the following quotes for Canadian dollars (CAD),

U.S. dollars (USD), and Mexican pesos (MXN):

USD0.7047/CAD MXN6.4390/CAD MXN8.7535/USD

Is there an arbitrage opportunity, and if so, how would you exploit it?

Answer: The direct quote for the cross-rate of MXN6.4390/CAD should equal the implied



4. The Mexican peso has weakened considerably relative to the dollar, and you are trying

to decide whether this is a good time to invest in Mexico. Suppose the current exchange

rate of the Mexican peso relative to the U.S. dollar is MXN9.5/USD. Your investment

advisor at Goldman Sachs argues that the peso will lose 15% of its value relative to the

dollar over the next year. What is Goldman Sachs’s forecast of the exchange rate in 1

year?

Answer: One way to think of this is to say that the investment advisor is referring to the fact

that the Mexican peso price of the dollar will be 15% higher next year. In this case, the

forecast of the MXN/USD exchange rate in year 1



Chapter 2: The Foreign Exchange Market 5

The difference arises because the simple percentage change in the exchange rate depends on

how the exchange rate is quoted.

5. Deutsche Bank quotes bid–ask rates of $1.3005/€ – $1.3007/€ and ¥104.30 – 104.40/$.

What would be Deutsche Bank’s direct asking price of yen per euro?

Answer: The direct asking price of yen per euro (¥/€) is the amount of yen that the bank

6. Alumina Limited of Australia has called Mitsubishi UFJ Financial Group to get its

opinion about the Japanese yen–Australian dollar exchange rate. The current rate is

¥67.72/A$, and Mitsubishi thinks the Australian dollar will weaken by 5% over the next

year. What is Mitsubishi UFJ’s forecast of the future exchange rate?

7. Go to www.fxstreet.com, find the “Live Charts Window,” and plot the exchange rate of

the dollar vs. the euro with a “candle stick” high-low chart at 5 minute intervals for one

day, daily intervals for one month, and weekly intervals for one year. Now, cover the

units and ask a classmate to identify the different graphs. Are you surprised?

8. Pick 3 currencies, and go to www.oanda.com to get their current bilateral exchange

rates. Is there an arbitrage opportunity?

9. Go to the CLS Bank web site, www.cls-group.com, and read about In/Out Swaps. How

do they help participants manage their risks?

6 Chapter 2 The Foreign Exchange Market

Answer: Here is the quote from the Web site:

How It Works

The In/Out Swap is designed to reduce the payment obligations to CLS and to mitigate liquidity

pressures. An In/Out Swap is an intraday swap consisting of two equal and opposite FX

Benefits

The combined effect of these two transactions is a reduction in the intraday funding requirements

of the two Settlement Members, while leaving the institutions’ overall FX positions unchanged.