Calculating the Exchange Rate - Assignment Example

Problem Part (a) In order to calculate the exchange rate between the Japanese Yen and the Chinese Yuan, we take the FX rate of the CNY for 2002 and divide it by the FX Rate for JPY. USD/CNY 0.125 USD/JPY 0.0075 JPY/CNY 16.66667 Part (b) From the year 2002 to the year 2003, the US Dollar experienced depreciation against the Mexican Peso, which came to exactly 12.5%. You had to pay more dollars to buy 1 Mexican Peso. Part C Taking into account the trade volumes, the net change in the US dollar with regard to the four currencies under consideration, was a depreciation of 2.64%. This decline can be attributed only to the Peso, as the USD had appreciated against the Yuan, Yen, and Canadian Dollar.

However, these appreciations were very minimal, but the depreciation against the Peso was substantial. Part (d) On a broader scale, depreciation in the US Dollar will make its exports appear cheaper as the country trading with the USA can get more dollars for their respective currency in 2003 as compared to 2002. On the split side, the USA importers will have to pay more dollars to obtain the required Foreign Exchange for their imports, and hence imports will become more costly. In a nutshell, the exports will get a boost and the imports will be hindered by a depreciating US Dollar.

However, if we look on an individual scale, the Yen, Yuan, and Canadian dollar all depreciated against the US Dollar, and hence USA’s export to these countries might marginally reduce and imports may marginally rise. In Mexico’s case, exports will strongly boost and imports will decline. Problem 2 Part (a) There are two ways an investor can take advantage of this arbitrage. In the first alternative, he can buy Euros in the New York FX Market at a rate of $1.25/Euro and then sell these Euros in the Tokyo FX Market at a rate of $1.

27/Euro to make a clean spread of 2 cents on each Euro he sells. The other way to make an arbitrage spread would be to buy dollars in Tokyo at a rate of $1.27/Euro (He is selling Euros) and then go to New York and sell those dollars (Buy Euros). In this case, he is also making an arbitrage spread. Part (b) Assuming you have $1 Million, an investor can make a decent spread using the arbitrage strategies mentioned above. He will buy $1 million worth of Euros in New York at a rate of $1.25, which would give him € 800,000.00. He will sell these Euros in the FX market in Tokyo at a rate of $1.27/Euro. This will give him $1,016,000.

The profit he will realize after deducting the initial investment will be $16,000. Part (c) In New York, investors will be lining up to buy the Euro and with this sudden spike in demand, the Euro will begin to appreciate against the US Dollar and the EUR/USD FX rate will rise. Conversely in Tokyo, there will be strong pressure to sell the Euro and this will attribute to depreciation against the US Dollar. This will trigger a decline in the EUR/USD FX rate. Eventually, both markets will reach the same exchange rate, thus eliminating the arbitrage opportunity.

Problem 3 Part (a) Since we have been given a direct quote for the Euro, we will divide the € 1,000,000 by the FX rate to determine the number of dollars to be received. It comes out to $13,157,895. Part (b) If the dollar appreciated against the Euro up to a rate of EUR 0.82/USD, then the exporter would receive $ 12,195,122. The amount is reduced because the exchange rate has risen, meaning that you have to pay more Euros to get dollars. Part (c) If I have gone long on a put option with a strike price of €0.

78/$ and the market prevailing at the time of exchange is €0.82/$, I would indeed exercise my option. At this strike price, my firm would receive $12,820,513 for the Euros. This would be a market gain of $625,390.90. I wouldn’t exercise my option if the price went below my strike price, that is, if the price of the USD/EUR were to go below €0.78/$. For example, if the price were to be €0.77/$, I would rather exchange my position in the FX market rather than exercise my option in the derivatives market.