BUS 330 International Finance PDF

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BUS 330 INTERNATIONAL FINANCE By Aidan Duggan

32619172 PART A:

Question 1) The table stipulates the before and after changes. Blades would like to use an exercise price that is no more than 5%. The call option of $0.00756 has a call option premium of now 2% of the exercise price. Thus, higher than what Blades usually pays. In inspecting the other option, it plays a lower premium by purchasing the call option with an exercise price of $0.00792, which has a 10% above the spot rate of which the company stipulated that they would pay, which is no more than 5%. Blades have two choices. The first is the one they are currently using where the premium is now at 2% or use the other which has a high exercise price and a low premium. The tradeoff is paying the premium of $1417.50 to limit the amount paid for yen payable to 99000 or paying the premium of $1890.00 and the payables to 94500.00. Therefore ultimately it is better to the extra of $472.50 at a higher premium would save more on payable for Blades. Question 2) Blades could remain unhedged, however, due to the volatility of the Yen’s future value, the reason to hedge is greater due to this uncertainty of the yen future value. Due to no change on the futures contract by the event, Blades should be more inclined to look more into the futures contract as a possible solution as an alternative to the options. Since the futures contract has remained unchanged, they can, therefore, lock in the same price before the event occurred. Question 3) The expected yen spot rate must equal the expected futures rate of $0.006912. This is created through yen being bought for 2 months at a futures rate and selling at a spot rate at the time. Through many speculators doing this same action will create a downward pressure on the expected spot rate and the futures rate facing upwards pressure from the market will ultimately make them equal out to where the expected spot rate is the same as the futures rate. Therefore, the expected yen spot rate on delivery date is $0.006912. Question 4) Blades, have three choices, options, futures contract or remain unhedged. Using the expected spot rate on the delivery date we can calculate which choice is best purely on a cost basis. Futures price/ Expected spot rate: $0.006192 Cost per options contract: 6,250,000 Yen each (Total= 12,500,000 for 2) Cost per Futures contract: 12, 500,000 Yen

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$0.00756 $0.0001512

$0.00792 $0.0001134

6,250,000

6,250,000

Total premium

Yen payable

Two option $0.00756

$1,890.00

Two option $0.00792

$1,417.50

One of Each option

(1890/2)+(1417.5/2)=$ 1,653.75

(12500000 x 0.006192)=$86,400.00 (12500000 x 0.006192)=$86,400.00 (12500000 x 0.006192)=$86,400.00

Futures Contract

Futures price Yen payable Cost in 2 months

$0.006192 12,500,000 (12500000 x 0.006192)=$86,400.00

Remain Unhedged

Expected spot rate Yen Payable Cost in 2 month

$0.006192 12,500,000 (12500000 x 0.006192)=$ 86,400.00

Two Options

Exercise price Option premium per yen Cost per contract

Total cost in 2 months $88,290.00 $87,817.50 $88,053.75

The optimal choice given the calculations above based solely on a cost basis can be either a futures contract or to remain unhedged. However, as we know that through remaining unhedged they can still be influenced to deviation of the yen from order date to delivery date. Therefore the best choice in regards to cost basis is, therefore, a futures contract with a cost of $86,400.00. Question 5) No, it is not due to the volatility of the yen. Therefore there is a potential for the yen change and therefore may have a lower cost than if they went with an options or remain unhedged rather than being locked into the futures contract. Question 6) Historical Std.dev: $0.0005 No more than 2 Std.Dev Futures price/ Expected spot rate: $0.006192

Maximum spot rate

Expected spot rate Std. Dev Spot rate 2 Std. Dev

$0.006192 $0.0005 (0.006192 +(2x0.0005))=$0.007192

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Two Options

Exercise price Option premium per yen Cost per contract

Two option $0.00756 Two option $0.00792 One of Each option

Futures Contract

Futures price Yen payable Cost in 2 months

Remain Expected spot rate Un-hedged Yen Payable Cost in 2 month

$0.00756 $0.0001512

$0.00792 $0.0001134

6,250,000

6,250,000

Total premium

Yen payable

$1,890.00

(12500000 x 0.00756)=$94,500.00 (12500000 x 0.007192)=$89,900.00 (12500000 x 0.00756)/2 +(12500000 x 0.007192)=$92200

$1,417.50 (1890/2)+(1417.5/2)=$ 1,653.75

Total cost in 2 months $113,400.00 $91,317.50 $93.853.75

$0.006192 12,500,000 (12500000 x 0.006192)=$86,400.00 $0.007192 12,500,000 (12500000 x 0.007192)=$ 98,900.00

This spreadsheet once again outlines that to proceed with a futures contract is still best. The increase of the exercise price for remaining unhedged means that is has gotten more expensive. The increase of exercise price has also lead to option choices also being more expensive in payable of which were already a poor choice for Blades thus outlining that future contracts are the optimal choice for the firm.

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PART B: Question 1) Locational Arbitrage is possible to gain a profit. Bid

Ask

Minzu Bank

$0.0224

$0.0227

Sobat Bank

$0.0228

$0.0229

Locational Arbitrage 1. Buy Thai Baht from Minzu bank

($100,000/$0.0227)= THB 4,405,286.34

2.Sell Thai baht to Sobat Bank

(THB4,405,286.34 × $0.0228)=$100,440.53

3. US Dollar profit

($100,440.53 – $100,000)= $440.53

Question 2) Triangular arbitrage is possible to gain a profit. Triangular Arbitrage 1. Exchange dollars for Thai baht

($100,000/$0.0227)= THB 4,405,286.34

2. Convert the Thai baht into Japanese yen

(THB4,405,286.34 × ¥2.69)= Yen 11,850,220.25

3. Convert the Japanese yen into dollars

(¥11,850,220.26 × $0.0085)= $100,726.87

3. US Dollar profit

($100,726.87 – $100,000) =$726.87

Question 3) 4

Spot rate: $0.0227 90-day forward rate: $0.0225 90-day maturity interest: THB 1.0375 or US 1.02 Covered interest arbitrage can be done. Covered Interest Arbitrage 1. Convert U.S. dollars to Thai baht and set up a 90-day deposit account at a Thai bank

($100,000/$0.0227)= THB 4,405,286.34

2. In 90 days, the Thai deposit will mature

(THB 4,405,286.34 × 1.0375)= THB 4,570,484.58

3. Upon maturity convert Thai baht to US dollars

(THB4,570,484.58 × $0.0225)= $102,835.90

3. US 90-day deposit comparison

($100,000 × 1.02) =$102,000.00

4. Compare for Overall Profit

(102,835.90 - 100,000.00) =$2835.90

Question 4) Arbitrage opportunities quickly disappear as soon as they are discovered due to market forces. These market forces are from arbitrageurs, where the supply and demand for the foreign currency will adjust till the mispricing disappears. To illustrate this, we can use the covered interest arbitrage of Thai baht with the immediate purchase and sale of forward sale of Baht. This buying and selling creates an upwards pressure on the market and therefore increase the spot rate of the Thai Baht. Thus, creating a downward pressure on the Thai forward rate until the opportunity no longer exists. This state of difference is called interest parity of which is usually balanced by forward premiums or discounts.

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