International Currency and Banking Interest

International Currency and Banking Interest Rate Parity. Two countries, Cambria and Nubira, have nominal interest rates of 5% and 10%, respectively (assume annual compounding). These interest rates are inferred from the yields of government debt instruments and are applicable over the next four years. The currencies of these two countries, the CAB and NUB are freely traded in markets without any governmental restrictions. The current exchange rate is NUB/CAB=2 from the perspective of NUB.

Estimate the exchange rate path of the NUB / CAB over the next four years? The current exchange rate path of the NUB / CAB over the next four years will be with continuing upward momentum. What is the annual rate of change of NUB/CAB? The annual rate of change for the NUB / CAB is 10%. What is the annual rate of change of CAB/NUB? The annual rate of change for the CAB / NUB is 5%. Question 2 You have the following information: The 180-day USD LIBOR rate is 2.5%.

The 90-day EUR EURIBOR rate is 4%. Exchange-traded futures contract on a EUR-denominated money market contract (reference rate is EURIBOR) maturing in 90-days trades at 96.20 (Assume pricing convention of Eurodollar futures). (Hint: Note: the 91-180 EUR rate of 3.80% is inferred from MM futures price of 96.2 and equals '100-96.2') Current USD/EUR equals 1.40. 180-day forward USD/EUR equals 1.39. a. What is the equilibrium forward rate? b. Calculate the per unit profit from covered interest arbitrage.

Question 4 An Australian farmer has just sold a shipment of live sheep worth KWD100 000 to Kuwait, with the payment due in three months. The company wishes to hedge this exposure, since the Kuwaiti dinar is expected to depreciate against the Australian dollar in the next three months. Australian banks are unwilling to offer forward contracts on the Kuwaiti currency. However, Kuwaiti banks offer forward contracts to trade the currency against the U.S. dollar.

The following information is available: Current spot rate (AUD/KWD) 5.46 Expected spot rate (AUD/KWD) 5.20 Current spot rate (KWD/USD) 0.340 Expected spot rate (KWD/USD) 0.324 Three-month forward rate (KWD/USD) 0.322 Current spot rate (AUD/USD) 1.8564 Expected spot rate (AUD/USD) 1.6848 (a) Explain how cross hedging can be implemented. Cross hedging can occur in several different areas to include: the current spot rate (AUD / KWD) and the current spot rate (KWD / USD).

A second strategy that could be used includes: the expected spot rate (AUD / USD) and the three-month forward rate (KWD / USD). (b) Supposing that all expectations are fulfilled, calculate the Australian dollar value of the KWD receivables under the hedge and no-hedge decisions. (c) Recent surveys of corporate exchange risk management practices indicate that many U.S. firms simply do not hedge.

How would you explain this result? There are two possible reasons why a firm will not utilize hedging to include: a lack of understanding the risks / rewards and fears surrounding possible losses. These factors are important, because they are showing how many businesses are sometimes more conservative in practices they are using as a part of their strategy. (d) Should a firm hedge? Why or why not? A firm should be hedging if their business model requires the use of this kind strategy.

This means those companies that are in industries that are exposed to tremendous amounts of volatility should be engaging in these activities. Some of the different areas they will become involved in are: currencies, stocks, futures, options and commodities. The reason why, is because these kinds of companies are often exposed to large swings that could happen at any point in time (due to adverse changes in the economy or the markets).

This will have a negative effect on earnings and it will become difficult from them to make accurate projections. When a company begins using hedging, this will provide more consistent earnings stability to their business model. This is point that they can provide more stable returns to shareholders. However, not all firms should be hedging. In some cases, this activity could be considered to be speculation. As, the hedge may not provide any kind significant benefit to the business by: addressing a challenge that they are facing.

Instead, it is executives using the company's funds to make risky trades. As their business, will see no benefit from: the position other than to receive a financial gain. When this happens, it is a sign that a firm should not be involved in these activities. This is due to the fact that it is: increasing their risks and not supporting the long-term viability of the company. Question 5 Trident is a multinational corporation that has operations in several countries. Although Trident is based in the U.S.

And its profits are reported in USD, its revenues are denominated in various currencies including the AUD. Recently, Trident took out a 3-year USD loan at a fixed interest rate of 3.5% per annum. Since Trident has AUD revenues, it has decided to enter in a three-year swap to receive USD and pay AUD. The quoted currency.