Use the table below to answer the following questions:
|American Terms||European Terms|
|Bank A’s Quotations||Bid||Ask||Bid||Ask|
- What is ?
- What is ?
- Suppose Bank B provides a quote of GBP 0.7462-68 for the EUR. Demonstrate whether and how an arbitrage profit can be made.
You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.50 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.25, is there an arbitrage opportunity? If so, how much money would you make? Show all workings.
A bank is quoting the following exchange rates against the dollar for the Swiss franc and the Australian dollar:
SFr/$ = 1.5958–70
A$/$ = 1.7249–58
An Australian firm asks the bank for an A$/SFr quote. What cross-rate would the bank quote?
Explain the differences between a long forward position and a short forward position. In your answer, illustrate the pay-off functions of these positions with graphs. Fully label your graphs. (note: you are welcome to draw them by hand, take a photo and attach it here)
Suppose IBM has a liability of £1,000,000, payable in three months. The company wants to hedge foreign exchange risk using forward contracts. The current spot rate for the £ is $1.2415/£, and the three-month forward rate is $1.2492/£.
- What forward position should IBM enter into?
- Suppose the spot exchange rate in three months’ time is either $1.2342/£ or $1.2547/£. Using this example, demonstrate how the forward contract in part i helps IBM eliminates foreign exchange risk exposure.
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