The document contains sample questions and problems from chapters in a textbook on international financial management. In the first section, it provides context about the US current account deficit and Japan's surplus. It then presents a cross-currency arbitrage problem and asks about opportunities. The second section describes an importer's options to hedge currency risk on a shipment from the UK, which is expected to appreciate. It asks about using forwards and calculates the no-arbitrage forward price. The document continues with additional practice problems covering topics like covered interest rate parity, currency option valuation, and hedging transaction exposure.

1. International Financial
Management
Mid-term Review

2. Chapter 3: BALANCE OF PAYMENTS
• The United States has experienced continuous current account
deficits since the early 1980s. What do you think are the main causes
for the deficits? What would be the consequences of continuous U.S.
current account deficits?
• In contrast to the United States, Japan has realized continuous
current account surpluses. What could be the main causes for these
surpluses? Is it desirable to have continuous current account
surpluses? Market imperfection – Having a surplus current account
would benefit the country. However, there does not exist a situation
that all countries export and no countries want to import.

3. Chapter 5: THE MARKET FOR FOREIGN
EXCHANGE
Doug Bernard specializes in cross-rate arbitrage. He notices the
following quotes:
Swiss franc/dollar = SFr1.5971/$ - 1.5980
Australian dollar/U.S. dollar = A$1.8215/$ - 1.8220
Australian dollar/Swiss franc = A$1.1440/SFr – 1.1550
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 much would he profit if he has $1,000,000 available for this
purpose?

4. AUD
USD
Swiss franc

5. Doug Bernard specializes in cross-rate arbitrage. He notices the
following quotes:
Swiss franc/dollar = SFr1.5871/$ - 1.5880
Australian dollar/U.S. dollar = A$1.8215/$ - 1.8220
Australian dollar/Swiss franc = A$1.1440/SFr – 1.1550
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 much would he profit if he has $1,000,000 available for this
purpose?

6. AUD
USD
Swiss franc

7. Chap 5
1. Japanese yen – UK pound:
Japanese yen: $0.009172/yen or 109.03yen/$
UK pound: $1.4402/pound or 0.6944pound/$
Japanese yen/pound = Japanese/$*$/pound
= 109.03yen/$*$1.4402/pound = 157.03yen/pound
UK pound/Japanese yen = UK pound/$*$/Japanese yen
= 0.6944*0.009172 = 0.006369pound/yen

8. Chapter 5
3. At spot rate = 1.55
5,000,000 pound = 5,000,000*1.55 = 7,750,000$
At spot rate = 1.61
5,000,000 pound = 5,000,000*1.61 = 8,050,000$
Arbitrage profit = 8,050,000 – 7,750,000 = 300,000 ($)
=> Bank’s liability

9. Chapter 6: INTERNATIONAL PARTITY
RELATIONSHIPS AND FORECASTING FOREIGN
EXCHANGE RATES
Suppose that the current spot exchange rate is €1.50/£ and the one-
year forward exchange rate is €1.60/£. The one-year interest rate is 5.4
percent in euros and 5.2 percent in pounds. You can borrow at most
€1,000,000 or the equivalent pound amount, that is, £666,667, at the
current spot exchange rate.
a. Show how you can realize a guaranteed profit from covered interest
arbitrage. Assume that you are a euro-based investor. Also
determine the size of the arbitrage profit.
b. Discuss how the interest rate parity may be restored as a result of
the above transactions.

10. Chapter 7: FUTURES AND OPTIONS ON
FOREIGN EXCHANGE
• Assume that the Japanese yen is trading at a spot price of 92.04 cents per
100 yen. Further assume that the premium of an American call (put) option
with a striking price of 93 is 2.10 (2.20) cents. Calculate the intrinsic value
and the time value of the call and put options.
S0 = 92.04cents/100yen
Premium = 2.10 cents (call option) – 2.20 cents (put option)
E = 93
C(a) = Max[S0 – E, 0] = Max[92.04 – 93; 0] = 0
Intrinsic value = 0 – 2.1 = -2.1 cents/yen; Time value = 2.1 – (-2.1) = 4.2
P(a) = Max [E – S0; 0] = Max[93 – 92.04;0] = 0.6
Intrinsic value = 0.6 – 2.2 = -1.6 cents/yen; Time value = 2.2 – (-1.6) = 3.8

11. • Assume the spot Swiss franc is $0.7000 and the six-month forward rate is $0.6950. What is the
minimum price that a six-month American call option with a striking price (exercise price) of
$0.6800 should sell for in a rational market? Assume the annualized six-month Eurodollar rate is
3.5 percent.
S0 = 0.7, F = 0.695, E = 0.68, i = 3.5%
C >= Max[(F - E)/(1 + i); 0] = Max [(0.695 – 0.68)/(1+0.035);0] = 0.0145$ per Swiss franc
Min price = 0.0145$ per Swiss franc or 1.45 cents per Swiss franc
C >= Max[S0 – E; 0] = Max [0.7 – 0.68; 0] = 0.02
Min price = 0.02$ per Swiss franc or 2 cents per franc
Min price for American call option is 2 cents per franc
Call option/put option = striking price + premium

12. Swiss franc – USD call option striking price 0.68$ and premium 2 cents
An investor buy that call option in order to convert $100,000 to Swiss
franc in 2021. The amount of money he needs to pay for the call option
= ($100,000/0.68)*$0.02 = 147,059*$0.02 = 2,941$
In 2022, if the spot rate 0.65$, S(t) < E, use spot rate and let the call
option expires
If the spot rate S(t) = 0.7$, S(t) > E, use call option => $100,000/0.68 =
147,059 Swiss franc

13. • Use the European option-pricing models developed in the chapter to
value the call of problem above. Assume the annualized volatility of
the Swiss franc is 14.2 percent.
• S0 = 0.7, F = 0.695, E = 0.68, i = 0.035, volatility = std = 14.2%
Appreciating ratio u = e^(14.2%*sqrt(1/2)) = 1.1056
Depreciating ratio d = 1/u = 0.9045
Estimated appreciating exchange rate S(uT) = 0.7*1.1056 = 0.77$
Estimated depreciating exchange rate S(dT) = 0.7*0.9045 = 0.63$
Quotes q = (0.695 – 0.63)/(0.77-0.63) = 0.4643
Call option price at appreciating rate u:
C(uT) = Max[0.77 – 0.68; 0] = 0.09
C(dT) = Max[0.63 – 0.68; 0] = 0
C = [0.4643*0.09 + (1-0.4643)*0]/(1+0.035) = 0.04$ per Swiss franc
or 4 cents per Swiss franc

14. Chapter 8: MANAGEMENT ON TRANSATION
EXPOSURE
• Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy
Industry for 500 million yen payable in one year. The current spot rate is
¥124/$ and the one-year forward rate is 110/$. The annual interest rate is
5 percent in Japan and 8 percent in the United States. PCC can also buy a
one-year call option on yen at the strike price of $.0081 per yen for a
premium of .014 cents per yen.
a. Compute the future dollar costs of meeting this obligation using the
money market and forward hedges.
b. Assuming that the forward exchange rate is the best predictor of the
future spot rate, compute the expected future dollar cost of meeting this
obligation when the option hedge is used.
c. At what future spot rate do you think PCC may be indifferent between
the option and forward hedge?

15. Y500,000,000 payable after 1 year
S0 = Y124/$, F = Y110/$, i(J) = 5%, i(US) = 8%, E = $0.0081/yen or
Y123.46/$, premium – 0.014 cents/yen
a) Money market and future hedges
Sign a futures contract to hedge his amount of money at rate Y110/$
After 1 year, the company need to pay an amount of money equivalent
to 500,000,000/110 = 4,545,454.55 ($)
If the company borrows money from US bank
If the company converts US to yen and invest into J bank for 1 year, the
amount of money it needs to convert is 500,000,000/(1+5%) =
476,190,476 yens equivalent to 476,190,476/124 = 3,840,246$
Borrow that money from a US bank with the amount paid after 1 year is:
3,840,246$*(1+8%) = 4,147,465$

16. E = 0.0081$/yen, premium = 0.914 cents/yen, F = e = 0.00909$/yen, S0
= 0.00806, i(J) = 5%, i(US) = 8%
C = Max[S – E; S/(1+i(J)) – E/(1+i(US)); (F – E)/(1 + i(US)); 0]
Call option has exercise price + premium = forward rate

17. Chapter 8: MANAGEMENT ON TRANSATION
EXPOSURE (cont’d.)
• Suppose that you are a U.S.-based importer of goods from the United
Kingdom. You expect the value of the pound to increase against the U.S.
dollar over the next 30 days. You will be making payment on a shipment of
imported goods in 30 days and want to hedge your currency exposure. The
U.S. risk-free rate is 5.5 percent, and the U.K. risk-free rate is 4.5 percent.
These rates are expected to remain unchanged over the next month. The
current spot rate is $1.50.
a. Indicate whether you should use a long or short forward contract to
hedge the currency risk.
b. Calculate the no-arbitrage price at which you could enter into a forward
contract that expires in 30 days.
c. Move forward 10 days. The spot rate is $1.53. Interest rates are
unchanged. Calculate the value of your forward position.