Problem Set FINC405

International Financial Management FINC 405 Problem Set
1. Suppose that the one-year interest rate is 5.0% in the United States and 3.5% in
Germany, and that the spot exchange rate is $1.12/€ and the one-year forward
exchange rate, is $1.16/€. Can you find an arbitrage opportunity? Why?
2. Suppose the spot rates for the British pound, Deutschmark, and Swiss franc were
$1.50, $.42, and $.48, respectively. At the time, the associated 90-day interest rates
(annualized) were 12%, 6%, and 4%, while the U.S. 90-day interest rate
(annualized) was 8%. What was the 90-day forward rate on a DCU (DCU 1 = £1
+ DM1 + SFr1) if interest parity were to hold?
3. Suppose you observe the following exchange rates: 1 = $.85/€; 1 = $1.6/£; and
€2.00/£. Can you find an arbitrage opportunity? Why?
4. You go to a bank and are given these quotes:

a. You can buy a euro for 14 Mexican pesos.
b. The bank will pay you 13 pesos for a euro.
c. You can buy a U.S. dollar for .9 euros.
d. The bank will pay you .8 euros for a U.S. dollar.
e. You can buy a U.S. dollar for 10 pesos.
f. The bank will pay you 9 pesos for a U.S. dollar.
• You have $1,000. Can you use triangular arbitrage to generate a profit?
• If so, explain the order of the transactions that you would execute and the
profit that you would earn. If you cannot earn a profit from triangular
arbitrage, explain why.
5. The South African rand has a one-year forward premium of 2%. One-year interest
rates in the United States are 3 percentage points higher than in South Africa.
Based on this information, is covered interest arbitrage possible for a U.S. investor
if interest rate parity holds?
6. The following information is available:

• You have $500,000 to invest.
• The current spot rate of the Moroccan dirham is $.110.
• The 60-day forward rate of the Moroccan dirham is $.108.
• The 60-day interest rate in the United States is 1%.
• The 60-day interest rate in Morocco is 2%.
a. What is the yield to a U.S. investor who conducts covered interest
arbitrage? Did covered interest arbitrage work for the investor in this
case?
b. Would covered interest arbitrage be possible for a Moroccan investor
in this case?
7. The one-year Treasury (risk-free) interest rate in the United States is presently 6
percent, while the one-year Treasury interest rate in Switzerland is 13 percent.
The spot rate of the Swiss franc is $.80. Assume that you believe in the
international Fisher effect. You will receive 1 million Swiss francs in one year.
a. What is the estimated amount of dollars you will receive when
converting the francs to U.S. dollars in one year at the spot rate at that
time?
b. b. Assume that interest rate parity exists. If you hedged your future
receivables with a one-year forward contract, how many dollars will
you receive when converting the francs to U.S. dollars in one year?
8. Suppose that the one-year interest rate is 5.0 percent in the United States; the spot
exchange rate is $1.20/€; and the one-year forward exchange rate is $1.16/€. What
must one-year interest rate be in the euro zone to avoid arbitrage? 8.62%
9. Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5
percent in Germany, and that the spot exchange rate is $1.12/€ and the one-year
forward exchange rate, is $1.16/€. Assume that an arbitrageur can borrow up to
$1,000,000.
10. Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest
for six months. You are considering the purchase of U.S. T-bills that yield 1.810%
(that's a six month rate, not an annual rate by the way) and have a maturity of 26
weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is
$1.00 = ¥110. The interest rate in Japan (on an investment of comparable risk) is
13 percent. What is your strategy?
11. Suppose that the annual interest rate is 2.0 percent in the United States and 4
percent in Germany, and that the spot exchange rate is $1.60/€ and the forward
exchange rate, with one-year maturity, is $1.58/€. Assume that an arbitrager can
borrow up to $1,000,000 or €625,000. If an astute trader finds an arbitrage, what is
the net cash flow in one year?
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FINC 405 Problem set

Problem Set FINC405

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International Financial Management FINC 405 Problem Set

4. You go to a bank and are given these quotes:

6. The following information is available:

FINC 405 Problem set

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