Finance 475 Solutions to Problem Set #1 PDF

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Finance 475 Solutions to Problem Set #1 1) Suppose that a BMW costs E 45,000 in Germany and that the current USD/EUR exchange rate is .7624. Calculate the dollar price of the BMW. Note that the exchange rate is in terms of Euros per dollar (E/$). Therefore, to get the dollar price, divide by the exchange rate. 45,000 / .7624 = $59,024. Notice the units.....(E/BMW)/(E/$) = (1/BMW)/(1/$) = ($/BMW) 2) Consider the following exchange rates: EUR/USD = 1.2500 ($/Euro) USD/CAD = 1.1000 (CAD/$) EUR/CAD = 1.3550 (CAD/Euro) How could you use this information to make money in the currency markets? First, calculate the implied cross rate between USD and Euros. 1.355 (CAD/Euro) / 1.10 (CAD/$) = 1.23 ($/Euro). Therefore, the Euro is overpriced in the market (relative to dollars). Any profitable trade will involve selling Euros and buying dollars. For example: Start with $1. Now convert to Canadian Dollars $1 x 1.10 (CAD/$) = CAD 1.10. Now convert to Euro... CAD 1.10 / 1.3550 (CAD/Euro) = .812 Euros. Now Convert to Dollars .812 Euros * 1.25 ($/Euro) = $1.014 (1A 1.4% return). 3) Suppose that you took a short position on 12,500,000 Japanese Yen future (remember, a short position involves selling Yen) at a price of 104.5 Yen/$. If the spot rate on the contract's expiration date was 103.45 Yen/$, calculate your profit/loss from the futures contract.

Your short position allows you to sell Yen at a price of 104.5 Yen/$. At a spot rate of 103.45 (Yen/$), you would need to spend Y12,500,000/103.45(Y/$) = $120,831 to acquire 12,500,000 Yen. Then you would turn around and sell them for 104.5(Y/$) which leaves you with 12,500,000/104.5 = $119,617. This is a loss of $1,214.

4) Consider the following balance of payments data. (in billions of dollars)

Merchandise Exports

$100 (+)

Merchandise Imports

$125 (-)

Service Imports

$90 (-)

Service Exports

$80 (+)

Income received from abroad

$110 (+)

Income payments to foreigners

$150 (-)

Increase in US ownership of private assets abroad

$160 (-)

Increase in foreign ownership of private US assets

$200 (+)

Increase in home official reserve assets

$30 (-)

Increase in foreign official assets in US

$35 (+)

Assuming that unilateral transfers are zero, find the trade balance, the current account balance, the capital and financial accounts balance, the Balance of Payments, and the statistical discrepancy. Trade Balance = Sum of first 4 lines = -$35 Current Account = Sum of first 6 lines = -$75 Balance of Payments = Sum of all 10 Lines = -$30 Statistical Discrepancy = -(BOP) = $30. 5) . Suppose that the U.S. sells F-16 fighter planes to the Israeli government. Explain how this transaction creates offsetting credits and debits in the Balance of Payments accounts. The sale of the F-16 will create a (+) in the current account under merchandise exports. This corresponding (-) will be in the capital/financial account. The exact entry will depend on how Israel pays for the plane, but it will be under the heading "Increase in US assets help abroad"....