| INTERNATINAL FINANCE | LECTURER: M.YOBE | | 2010/1/021 | |

MPHATSO T KAMLANJE

ASSIGNMENT 1

DISTANCE LEANER

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Question 1 (a) If a company forecast the exchange rate, the probability distribution of the currency’s percentage change over the upcoming period will be as follows: Forecast of Forecast of the Interest Rate Percentage Change Differential Probability 0% .9(0%) + .8(3%) = 2.4% 30% 1% .9(1%) + .8(3%) = 3.3% 60% 2% .9(2%) + .8(3%) = 4.2% 10%

Question 2

Yes triangular arbitrage is possible.

The appropriate cross exchange rate should be 1 Canadian dollar = 3 New Zealand dollars.
Thus, the actual value of the Canadian dollars in terms of New Zealand dollars is more than what it should be.

One could obtain Canadian dollars with U.S. dollars, sell the Canadian dollars for New Zealand dollars and then exchange New Zealand dollars for U.S. dollars.

With $1,000,000, this strategy would generate $1,006,667 thereby representing a profit of $6,667.

[$1,000,000/$.90 = C$1,111,111 × 3.02 = NZ$3,355,556 × $.30 = $1,006,667]

Question 3

If the firm uses a forward hedge, it will receive 400,000($1.50) = $600,000 in 180 days.
If the firm uses a money market hedge, it will borrow (400,000/$1.09) = 366,972 pounds, to be converted to U.S. dollars and invested in the U.S.

The 400,000 pounds received in 180 days will pay off this loan.

The 366,972 pounds borrowed convert to about $543,119 (computed as 366,972 × $1.48), which when invested at 8% interest will accumulate to be worth about $586,569.

In comparison, the firm