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Arbitrage and Value of Money Problem

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Suppose your firm receives a $5 million order on the last day of the year. You fill the order with $2million worth of inventory. Customer picks up entire order the same day and pays $1million upfront in cash; you also issue a bill for the customer to pay the remaining balance of $4million within 30 days. Suppose your firm's tax rate is 0%(ignore taxes). Determine possible consequences of this transaction for each of the following:

Problem 2
Your firm has identified 3 potential investments. The projects and their cash flows are shown here:

Project Cash flow Today Cash flow in one year
A -10 20
B 5 5
C 20 -10

Suppose all cash flows are certain and risk-free interest rate is 10%
a)What is NPV of each project
b)If the firm can chose only 1, which should it choose?
c)If the firm can choose any 2, which should it choose?

Problem 3

Suppose Bank One offers a risk-free interest rate of 5.5% on both savings and loans, and Bank Enn offers a risk-free interest rate of 6% on both savings and loans.

a)what arbitrage opportunity is available?
b)which bank would experience a surge in the demand for loans?which bank would get a surge in deposits?
c)What would you expect to happen to the interest rates the two banks are offering?

Problem 4

The promised cash flows of three securities are listed below. If the cash flows are risk-free and risk-free interest rate is 5%, determine the no-arbitrage price of each security before the first cash flow is paid

Security Cash Flow today Cash flow in 1 Year
A 500 500
B 0 1000
C 1000 0

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The solution explains some questions relating to Arbitrage and Value of Money

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b. Assuming purchasing power parity holds, what should the exchange rate be at the end of the year?
c. Assuming 100% pass through of exchange rate changes, what should be the dollar price of a Nissan at the end of the Year?
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4. International fisher effect, Assume that one year interest rates ate 3% in the United States and 5% in the Euro Zone. The spot rate between the euro and the dollar is â?¬1.02/$. Assuming the international fisher effect holds, what should the â?¬/$ rate be one year in the future?

5. Covered interest arbitrage- Denmark A. James Change a foreign exchange trader at JP Morgan Chase, can invest $5 million or the foreign currency equivalent of the bank's short term funds in a covered interest arbitrage with Denmark. He has the following quotes:

sport exchange rate DKr7.5000/$
three month forward rate DKr7.5372/$
three month dollar interest 3% per year(.0.75% for 90 days)
three month krone interest 5% per year (1.25% for 90 days)

can James Cang make a covered interest arbitrage profit?

7. Covered interest arbitrage- Japan I, Yukiko Miyaki a foreign exchange trader at Credit Swiss first boston want to invest $800,000 or its yen equivalent in a covered interest arbitrage between US dollars and Japanese yen she has the following quotes:

Spot Exchange rate ¥124/$
Six month forward exchange rate ¥123/$
Six month dollar interest rate 3.00% per year 1.50% for 180 days)
Six month yen interest rate 1.00% per year .0.50% for 180 days)

The bank does not calculate transaction costs on any individual transaction because these costs are part of the overall operating budjet of the arbitrage department . Explain and diagram the specific steps Yukiko must take to make a covered interest arbitrage profit.

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Spot exchange rate SF.6000/$
Three month forward rate SF1.5800/$
Three month US interest rate 8.00% p.a. (2.00% per quarter)
Thee month swiss franc interest rate 6.00%p.a. (1.50% per quarter0

Where do you recommend Ms Smyth invest? Why?

14. Covered interest arbitrage against the Norwegian Krone A Foreign exchange trader sees the following prices on his computer screen
Spot rate NKr8.8181/$
3 month forward rate NKr8.9169/$
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Norweigan 3 month treasury bill rate 4.00% p.a.

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15. Frankfurt and New York Money and foreign exchange markets in Frankfurt and new york are very efficient the following information is available:

Frankfort New York
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Expected inflation rate unkown 2.00%

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b. Estimate today's one year forward exchange rate between the dollar and the euro

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