MGMT 4670
Foreign Exchange Problems

1)  Given the following spot exchange quotes:

 Bid Ask British Pound in United States Dollars \$1.99 \$2.00 French Franc in United States Dollars \$0.200 \$0.201 British Pound in French Francs FF10.8 FF11.0

If you start out with \$10,000 are there any triangular arbitrage opportunities?  That is to say, are there any possible profit opportunities? Describe in detail exactly how you would exploit the temporary imperfection in the spot quotes.  What profit could you achieve?

2)
a)  You have \$1,000,000 to invest.  The current spot rate of the Pound is \$2.00.  The 90-day forward rate of the Pound is \$2.00.  The 90-day interest rate in the United States is 2 percent.  The 90-day interest rate in Great Britain is 4 percent.  Are there any possible profit opportunities?  Describe in detail exactly what you would do.  What profit would you achieve?

b)  Market forces have adjusted the rates above to the following:   The current spot rate of the Pound is \$2.01; the 90-day forward rate of the Pound is \$1.99; the 90-day interest rate in the United States is 2.47 percent; the 90-day interest rate in Great Britain is 3.5 percent.  Retrace your previous steps to see if there are any possible profit opportunities.
3)  Assume that France and the United States trade extensively with each other.  Assume that initially the equilibrium value of the French franc is \$.20.  Then, assume that the United States experiences 1% inflation while France experiences 6% inflation.  According to the PPP theory what will be the spot rate of the franc?

4)  The following applies to a United States subsidiary in London:

BALANCE SHEET
As of December 31, 200x

 Assets Liabilities & Equity Cash £ 10,000 Accounts Payable £ 12,000 Receivables 5,000 Accrued Expenses 5,000 Inventory 15,000 Long Term Debt 13,000 Fixed Assets 20,000 Equity 20,000 £ 50,000 £ 50,000

The value of the Pound depreciated by 25% during the course of the year from \$2.00.  Use the current-rate method to translate the balance sheet into home currency.