INTERNATIONAL FINANCE
Homework Topic 7 + 9
International Arbitrage and Interest Rate Parity
+ Currency Derivatives
Topic 7:
1. Locational arbitrage. Assume the bid rate of NZ$ is $.635 while the ask rate is $.640 at North
Bank. Assume the bid rate of NZ$ is $.645 while the ask rate is $.650 at South Bank. Given this
information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is,
how much will you end up with over and above the $1,000,000 you started with?
2. Triangular arbitrage. Please identify a strategy to get profit by using the above exchange rates.
Assume that you can borrow $10.000.
3. Covered interest arbitrage. Suppose you observe a spot exchange rate of $1.65/€. If interest rates
are 4% APR in the U.S. and 2% APR in the eurozone, what is the no-arbitrage 1-year forward rate?
4. Covered interest arbitrage. Assume the following information:
You have $800,000 to invest.
The 90-day interest rate in the United States is 2 percent.
The 90-day interest rate in the United Kingdom is 4 percent.
The current spot rate of the pound is $1.60.
The 90-day forward rate of the pound is $1.60.
How can you earn a profit?
5. Covered interest arbitrage. Will an arbitrageur facing the following information be able to make
money?
Topic 9:
1. Futures contract. On Monday morning, an investor takes a long position in a pound futures contract
that matures on Wednesday afternoon. The agreed-upon price is $1.78 for £62,500.
At the close of trading on Monday, the futures price has risen to $1.79.
At Tuesday close, the price rises further to $1.80.
At Wednesday close, the price falls to $1.785, and the contract matures. The investor takes
delivery of the pounds at the prevailing price of $1.785.
Questions:
a. Identify the daily gain/loss. What will be the investor’s gain (loss)?
b. Assume that the initial performance bond is $1890 and the maintenance performance bond is $1400.
• Please identify the daily performance bond account balance.
• Will the investor receive the margin call?
2. Futures contract. On Monday morning, an investor takes a short position in a euro futures contract
that matures on Wednesday afternoon. The agreed-upon price is $0.9370 for €125,000.
At the close of trading on Monday, the futures price has fallen to $0.9315.
At Tuesday’s close, the price falls further to $0.9291.
At Wednesday's close, the price rises to $0.9420, and the contract matures.
The investor delivers the euros at the prevailing price of $0.9420.
Questions:
a. Identify the daily gain/loss. What will be the investor’s gain (loss)?
b. Assume that the initial performance bond is $1890 and the maintenance performance bond is $1400.
• Please identify the daily performance bond account balance.
• Will the investor receive the margin call?
3. Call option. You buy a one-month British pound call option:
Size: 5 million pounds.
Strike price: $1.50 per pound.
Premium: $.02 per pound.
Please calculate the gain or loss on the option within the range of expected future exchange rates at
three points: $1.45; 1.51; 1.53.
4. Call option. You sell a one-month British pound call option:
Size: 5 million pounds.
Strike price: $1.50 per pound.
Premium: $.02 per pound.
Please calculate the gain or loss on the option within the range of expected future exchange rates at
three points: $1.45; 1.51; 1.53.
5. Put option. You buy a one-month British pound put option:
• Size: 5 million pounds.
• Strike price: $1.50 per pound.
• Premium: $.03 per pound.
Please calculate the gain or loss on the option within the range of expected future exchange rates at
three points: $1.45; 1.48; 1.51.
6. Put option. You sell a one-month British pound put option:
• Size: 5 million pounds.
• Strike price: $1.50 per pound.
• Premium: $.03 per pound.
Please calculate the gain or loss on the option within the range of expected future exchange rates at
three points: $1.45; 1.48; 1.51.
7. Options and futures. A U.S. Company will make a payment totaling €10 million next month to
French suppliers. It can buy euro call options with a strike price of $1.30 at a premium of 3.0 cents per
euro. The spot price of the euro is currently $1.26, and the euro is expected to trade in the range of
$1.25 to $1.35. The US company also can take a long position in the euro futures contract with futures
price at $1.28.
Questions:
a. How many options and futures contracts will the company need to protect its payment? Each
contract size is €50,000 for options and €100,000 for futures and calculate the breakeven points?
b. Calculate what US company would gain or lose on the option and the future within the range of
expected future exchange rates at three points: $1.28, $1.31 & $1.34.
c. Diagram the company's profit and loss associated with the call option position and futures position
within its range of expected exchange rates. Ignore transaction costs and margins.
8. Options and futures. A U.S. Company will receive a payment totaling €10 million next month from
French customers. It can buy euro put options with a strike price of $1.30 at a premium of 3.0 cents per
euro. The spot price of the euro is currently $1.26, and the euro is expected to trade in the range of
$1.25 to $1.35. The US company also can take a short position in the euro futures contract with futures
price at $1.28.1i
Questions:
a. How many options and futures contracts will the company need to protect its payment? Each
contract size is €50,000 for options and €100,000 for futures and calculate the breakeven points?
b. Calculate what US company would gain or lose on the option and the future within the range of
expected future exchange rates at three points: $1.28, $1.31 & $1.34.
c. Diagram the company's profit and loss associated with the put option position and futures position
within its range of expected exchange rates. Ignore transaction costs and margins.
