Former President Suharto of Indonesian once famously dismissed the concern over his country’s corruption by saying: Well you come out here from Washington with these high ideas to tell us….
Compare the one-year forward premium or discount on the French franc to the one-year Eurodollar and Eurofranc interest rates shown in Exhibit 2. How can this situation be arbitraged?
Examine the spot rate and the six-month forward rate for the British pound. Suppose a speculator anticipates that the pound’s spot rate and the six-month Eurodollar deposit rates will be unchanged from their present levels in six months time. However, at that future date, the six-month Euro-sterling deposit rates will have changed to 10.0000-10.0625% per annum. What should be the new six-month forward rate for the pound if covered interest arbitrage opportunities are to be avoided half a year from now? How can the speculator profit from the expected change in the interest rate difference while remaining in a “square” position (i.e., offsetting foreign exchange purchase contracts with sales contracts) at all times? What will be the expected dollar profit per pound? How will this expected profit change if the spot rate six months later does not remain constant but changes to 1.5500 /10? To 1.4500 /10? What circumstances might cause the speculator to realize a loss rather than a gain?
6- A U.S. corporate treasurer will receive a £2 million payment in 30 days from a British customer. The treasurer has no strong opinion about the direction or magnitude of changes in the sterling spot rate, but would like to eliminate the uncertainty surrounding such movements. Within the context of the rates shown in Exhibits 1 and 3, what options are available to the treasurer for hedging the foreign exchange risk associated with the sterling payment? What is the expected cost (expressed as an annualized percentage) of each alternative? Which alternative should the treasurer pursue? How would your answers to the above questions change if the treasurer believed very strongly that sterling would trade at $1.45?
7- Compare the one-year forward premium or discount on the French franc to the one-year Eurodollar and Eurofranc interest rates shown in Exhibit 2. How can this situation be arbitraged?