PRACTICE

1. Using the American term quotes from Exhibit 5.7, calculate a cross-rate matrix for the euro,
Swiss franc, Japanese yen, and the British pound so that the resulting triangular matrix is similar
to the portion above the diagonal in Exhibit 5.8.

2. Using the American term quotes from Exhibit 5.7, calculate the one-, three-, and six-month
forward cross-exchange rates between the Australian dollar and the Swiss franc. State the
forward cross-rates in “Australian” terms.

3. A foreign exchange trader with a U.S. bank took a short position of £5,000,000 when the $/£
exchange rate was 1.55. Subsequently, the exchange rate has changed to 1.61. Is this
movement in the exchange rate good from the point of view of the position taken by the trader?
By how much has the bank’s liability changed because of the change in the exchange rate?

4. Restate the following one-, three-, and six-month outright forward European term bid-ask
quotes in forward points.
Spot 1.3431-1.3436

One-Month 1.3432-1.3442

Three-Month 1.3448-1.3463

Six-Month 1.3488-1.3508

5. Using the spot and outright forward quotes in problem 4, determine the corresponding bid-
ask spreads in points.

6. Using Exhibit 5.7, calculate the one-, three-, and six-month forward premium or discount for
the Japanese yen versus the U.S. dollar using American term quotations. For simplicity,
assume each month has 30 days. What is the interpretation of your results?

7. Using Exhibit 5.7, calculate the one-, three-, and six-month forward premium or discount for
the U.S. dollar versus the British pound using European term quotations. For simplicity, assume
each month has 30 days. What is the interpretation of your results?

8. A bank is quoting the following exchange rates against the dollar for the Swiss franc
and the Australian dollar:
 SFr/$ = 1.5960--70

A$/$ = 1.7225--35

An Australian firm asks the bank for an A$/SFr quote. What cross-rate would the bank
quote?

First, what the way the bank express its quote means?

The bank ask 1.5970 SFr to sell you 1 $; to bid for 1.5960 SFr you need to pay 1 $

The bank ask 1.7235 A$ to sell you 1 $; to bid for 1.7225 A$ you need to pay 1 $

If the Australian Firm want to sell SFr to buy A$ it has to:

- Buy US$ by selling SFr: for 1 SFr the bank will give 1/1.5970 $ = 0.6262 $

- With 0.6262 $, the Australian firm can buy 0.6262*1.7225 = 1.0786 A$

So the bid A$/SFr quote is 1.0786. The formula is A$/SFr bid is A$/$(bid)/ SFr/$(ask)

If the Australian Firm wants to sell ASr to buy SFr it has to:

- Buy US$ by selling AS$: each US$ will cost the firm 1.7235 AS$

- For each US$ bought the firm will receive 1.5960 SFr

The cost of each SFr is thus 1.7235/1.5960 = 1.0799. This is the ask A$/SFr quote.

The formula is AS$/$(ask)/SFr/$(bid)

The bid-ask quotation is thus 1.0786 - 1.0799 Conversely, the SFr/A$ quote is (1/1.0799) -
(1/1.0786) = 0.9260 - 0.9271

9. Given the following information, what are the NZD/SGD currency against currency
bid-ask quotations?
 American Terms European Terms

Bank Quotations Bid Ask Bid Ask

New Zealand dollar .7265 .7272 1.3751 1.3765

Singapore dollar .6135 .6140 1.6287 1.6300

New Zealand dollar

Bid = .6168*1.3828 = 0.8529

Ask = .6173*1.3842 = 0.8545

Singapore dollar

Bid = 1/0.8545 = 1.1703

Ask = 1/0.8529 = 1.1725 (SAI SO)

10. Doug Bernard specializes in cross-rate arbitrage. He notices the following quotes:

Swiss franc/dollar = SFr1.5971?$

Australian dollar/U.S. dollar = A$1.8215/$

Australian dollar/Swiss franc = A$1.1440/SFr

Ignoring transaction costs, does Doug Bernard have an arbitrage opportunity based
on these quotes? If there is an arbitrage opportunity, what steps would he take to make
an arbitrage profit, and how would he profit if he has $1,000,000 available for this
purpose.

An arbitrage opportunity is available when the implicit quote rate between 2 currencies diverge
from the explicit one.

Let's compute the implicit ASD/SFr rate: 1.8215/1.5971 = 1.1405 which is lower than the explicit
rate: the explicit rate overprice Swiss Franc over ASD.

To exploit the situation we thus have to do a trading involving sell SFr to buy ASD at the explicit
rate.
- Buy Sfr: 1 mln USD X 1.5971 = 1,597,100 SFr

- Sell them to buy ASD: 1,597,100 X 1.1440 = 1,827,082 ASD

- Sell ASD to buy back USD: 1,827,082/1.8215 = 1,003,065 USD

The arbitrage gain is 3,065 USD

11. Assume you are a trader with Deutsche Bank. From the quote screen on your
computer terminal, you notice that Dresdner Bank is quoting €0.7627/$1.00 and Credit
Suisse is offering SFr1.1806/$1.00. You learn that UBS is making a direct market
between the Swiss franc and the euro, with a current €/SFr quote of .6395. Show how
you can make a triangular arbitrage profit by trading at these prices. (Ignore bid-ask
spreads for this problem.) Assume you have $5,000,000 with which to conduct the
arbitrage. What happens if you initially sell dollars for Swiss francs? What €/SFr price
will eliminate triangular arbitrage?

To make a triangular arbitrage profit the Deutsche

Bank trader would sell $5,000,000 to Dresdner Bank

at €0.7627/$1.00. This trade would yield €3,813,500=

$5,000,000 x .7627. The Deutsche Bank trader would

then sell the euros for Swiss francs to Union Bank

of Switzerland at a price of €0.6395/SF1.00, yielding

SF5,963,253 = €3,813,500/.6395. The Deutsche Bank

trader will resell the Swiss francs to Credit Suisse for

$5,051,036 = SF5,963,253/1.1806, yielding a triangular arbitrage profit of $51,036. If the

Deutsche Bank trader initially sold $5,000,000 for Swiss francs, instead of euros, the trade
would yield SF5,903,000 = $5,000,000 x 1.1806. The Swiss francs would in turn be traded for
euros to UBS for €3,774,969= SF5,903,000 x .6395. The euros would be resold to Dresdner
Bank for $4,949,481 = €3,774,969/.7627, or a loss of $50,519. (conduct the triangular arbitrage
in the correct order.) The S(€/SF) cross exchange rate should be .7627/1.1806 = .6460. This is
an equilibrium rate at which a triangular arbitrage profit will not exist. A profit results from the
triangular arbitrage when dollars are first sold for euros because Swiss francs are purchased for
euros at too low a rate in comparison to the equilibrium cross-rate, i.e., Swiss francs are
purchased for only €0.6395/SF1.00 instead of the no-arbitrage rate of €0.6460/SF1.00.
Similarly, when dollars are first sold for Swiss francs, an arbitrage loss results because Swiss
francs are sold for euros at too low a rate, resulting in too few euros. That is, each

Swissfranc is sold for €0.6395/SF1.00 instead of the higher no-arbitrage rate of

€0.6460/SF1.00.

12. The current spot exchange rate is $1.95/£ and the three-month forward rate is $1.90/£.
Based on your analysis of the exchange rate, you are pretty confident that the spot exchange
rate will be $1.92/£ in three months. Assume that you would like to buy or sell £1,000,000.

a. What actions do you need to take to speculate in the forward market? What is the
expected dollar profit from speculation?

b. What would be your speculative profit in dollar terms if the spot exchange rate actually
turns out to be $1.86/£.

13. Omni Advisors, an international pension fund manager, plans to sell equities denominated
in Swiss Francs (CHF) and purchase an equivalent amount of equities denominated in South
African rands (ZAR).
Omni will realize net proceeds of 3 million CHF at the end of 30 days and wants to eliminate the
risk that the ZAR will appreciate relative to the CHF during this 30-day period. The following
exhibit shows current exchange rates between the ZAR, CHF, and the U.S. dollar (USD).
Currency Exchange Rates

ZAR/USD ZAR/USD CHF/USD CHF/USD

Maturity Bid Ask Bid Ask

Spot 6.2681 6.2789 1.5282 1.5343

30-day 6.2538 6.2641 1.5226 1.5285

90-day 6.2104 6.2200 1.5058 1.5115

a. Describe the currency transaction that Omni should undertake to eliminate

currency risk over the 30-day period.
b. Calculate the following:
• The CHF/ZAR cross-currency rate Omni would use in valuing the Swiss equity
portfolio.

• The current value of Omni’s Swiss equity portfolio in ZAR.

• The annualized forward premium or discount at which the ZAR is trading

versus the CHF.