International FinanceFin435.101Fall 2010Exam #2Prof. M. Rhee1. You took a long position in three contracts of Euro futures (125,000 Euros for one contract) at 10am CST on 11/9 for 2010 December delivery at $0.923/€. What is the initial margin requirement at a 2% initial margin? Given that you put down $200 more than the 2% initial margin requirement, what is the ending balance of your account at the end of 11/9 if the settlement price of 11/9 is $0.917/€? What is your new margin ratio at the end of the day of 11/9? Do you get a margin call, if the minimum maintenance marginis1.5%? If so, how much is the variation margin? Assuming that you are going to add $300 more than the variation margin, if you get the margin call, what would be the ending balance of 11/9? If the futures rate becomes $0.909/€ on 11/10, do you get a margin call? What is the variation margin? What will be the ending balance if you add $300 more than the variation margin?2. Given the currency rates below, determine the three-month forward bid-asked outrightquotation rates and the forward premium APR rates.S0($/£): 1.9712 – 1.9717Three-month 54-57(1) Bid-Asked Outright RatesSince the first number is smaller than the second number, the forward rates are at a premium.For Bid, 1.9712 + 0.0054 = $1.9766/£For Asked, 1.9717 + 0.0057 = $1.9774/£(2) Forward Premium APR Rates- For Bid, [(F – S0)/S0] * [360/91] = [(1.9766 – 1.9712)/1.9712] * [360/91] = [0.0054/1.9712]*[360/91]= 1.084% - For Asked, [(F – S0)/S0] * [360/91] = [(1.9774 - 1.9717)/1.9717] * [360/91] = [0.057/1.9717]*[360/91]= 1.144% 3. James Clark is a currency trader with Wachovia. He notices the following quotes:1/S0 = SF 1.2051/$, Six month forward rate (1/F6mo) = SF 1.1922/$Six-month $ interest rate 2.5% APR, Six-month Swiss franc interest rate 2.0% APRa) Does the CIRP hold?b) Determine the implied forward rate.c) Show steps needed to make arbitrage profits assuming that Clark is authorized to work with $1 million or equivalent amount in SFs.a) 1 + (0.025/2) vs. (1.2051) * {1 + (0.02/2)} *(1/1.1922)$1.0125 < $1.02092854Borrow Low Invest High ⇨ CIRP does not hold. Borrow low in the U.S. and invest high in Switzerlandb)1.0125 = (1.2051) * (1.01) * F ⇨ F = {1.0125 / (1.2051 * 1.01)} = $0.831861/SF ⇨ Since actual F > implied F, RHS will be greater than LHS indicating “Borrow low in the U.S. and invest high in Switzerland”c)i. Borrow $1M in the U.S.ii. Convert $1M to SFs at S0 = $(1/1.2051)/SF$1M * SF(1.2051)/$ = SF 1,205,100iii. Invest SF 1,205,100 in Switzerland at iCHF = 2% APRSF 1,205,100 * (1 + interest rate) = SF 1,205,100 *{1 + (0.02/2)} = SF 1,217,151iv. Convert SFs into $s to realize revenue at F6mo = $(1/1.1922)/SFSF 1,217,151 * $(1/1.1922)/SF = $1,020,928.54v. Calculate the debt$1M * (1 + interest rate) = $1M * {1 + (0.025/2)} = $1,012,500vi. Realize profit$1,020,928.54 - $1,012,500 = $8,428.54Comment: In reality, there exist bid – asked spread for the exchange rates, the forward rates, and the interest rates. Due to the bid – asked spread, the arbitrage opportunity may not necessarily lead to the arbitrage gain. 4. Jim Smith specializes in cross-rate arbitrage. He notices the following quotes: SF 1.5971/$, A$ 1.8215/$, A$ 1.1440/SF. Is there an arbitrage opportunity? What steps would he take to make an arbitrage profit based onH and L? How much would he profit if he as $1 million available for this purpose?Location A: SF/$ = 1.5971Location B: A$/$ = 1.8215Location C: A$/SF = 1.1440Investment fund: $1,000,000(1) Triangular Arbitrage Opportunity?Location A: $/SF = 1/1.5917 = 0.62613 Sell HighLocation B & C: another $/SF= $/A$*A$/SF = (1/1.8215)*1.1440 = 0.62805 Buy Low ⇨ Yes, there exists a triangular arbitrage opportunity(2) Realizing Triangular Arbitrage (Buy from B & C and sell to A, Since C does not have $s, you need to start at B first)i. Buy A$ using $1,000,000 in location B$1,000,000 * A$1.8215/$ = A$1,821,500ii. Sell A$ for SF in location CA$1,821,500 *SF (1/1.1440)/A$€ = SF1,592,220.28iii. Sell SF to get $ revenue in location ASF1,592,220.28 * $(1/1.5917)/SF = $1,000,326.87iv. Profitπ = $1,000,326.87 - $1,000,000 = $326.875. a) Differentiate between futures and forward contractsb) Given the following information, determine the forecasting error using the formula, (|F-R|/R). Which forecast between the British pound and the Mexican peso is more accurate? (Hint: F=forecast, R=actual, realized). F = $2.0/£, R = $1.95/£ F = $ 0.10/MP, R = S0.095/MP$1MSF 1,205,100S0 = $(1/1.2051)/SFSF 1,217,151$1,012,500F6mo = $(1/1.1922)/SFiCHF 6mo = 2% APRi$ 6mo = 2.5% APR$1,020,928.54π = $8,428.54a) Forward vs. FuturesThe forward and future are conceptually the same with the differences shown in the chart below.Forward FutureSelf-regulated Regulated by Commodities Futures Trade CommissionContract can be made for any currency Available in a few major currenciesBid-asked spread commissionNo margin Must satisfy margin requirementsCustomized Contractual agreement between two parties StandardizedDelivery based on contract terms Delivery 3rd Weds. Of March, June, Sept., Dec.Traded over the counter (OTC) Traded on futures exchange floor (CME, SIMEX, etc)No daily settlements Daily settlements (marking to market)b) Forecasting Errori. $/£Forecasting Error = │F – R│ / R = │2.0 – 1.95│ / 1.95 = 2.564%ii. $/MPForecasting Error = │F – R│ / R = │0.10 – 0.095│ / 0.095 = 5.263%⇨ $/£ forecast is more accurate than