# Currencies: Interest rate parity, Spot, Forward, Hedging

10. In the spot market $1 U.S. equals 1.85 Brazilian real, and in the 1-year forward market 1 U.S. dollar equals 1.98 real. Interest rates on 1-year, risk-free securities are 4.8 percent in the United States. If interest rate parity holds, what is the interest rate on 1-year, risk-free Brazilian securities?

a. 2.13%

b. 12.14%

c. 28.61%

d. 26.05%

e. 7.03%

11. Swenser Corporation arranged a 2-year, $1,000,000 loan to fund a foreign project. The loan is denominated in euros, carries a 10 percent nominal rate, and requires equal semiannual payments. The exchange rate at the time of the loan was 1.05 euros per dollar but immediately dropped to 0.95 euros per dollar before the first payment came due. The loan carried no exchange rate protection and was not hedged by Swenser in the foreign exchange market. Thus, Swenser must convert U.S. funds to euros to make its payments. If the exchange rate remains at 0.95 euros through the end of the loan period, what effective interest rate will Swenser end up paying on the foreign loan? Hint: the annuity formula can be used to determine payment amount and interest rate.

a. 10.36%

b. 17.44%

c. 19.78%

d. 11.50%

e. 20.00%

12. If the spot rate of the Swiss franc is 1.51 Swiss francs per dollar and the 180-day forward rate is 1.30 Swiss francs per dollar, then the forward rate for the Swiss franc is selling at a __________ to the spot rate.

a. Premium of 14%

b. Premium of 18%

c. Discount of 18%

d. Discount of 14%

e. Discount of 8%

13. Currently, 1 British pound (£) equals 1.569 U.S. dollars and 1 U.S. dollar equals 1.0279 euros. What is the cross exchange rate between the pound and the euro?

a. £1 = 0.8756 euro

b. £1 = 1.6128 euros

c. £1 = 1.2423 euros

d. £1 = 1.0000 euros

e. £1 = 0.6200 euro

14. Sunware Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Canada for 38,040 Canadian dollars or $24,000, at the spot rate of 1.585 Canadian dollars per U.S. dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.60 Canadian dollars. If the spot rate in 90 days is actually 1.55 Canadian dollars, how much will the U.S. firm have saved in U.S. dollars by hedging its exchange rate exposure?

a. -$396

b. -$243

c. $ 0

d. $243

e. $767

15. 90-day investments in Great Britain have a 6 percent annualized return. In the U.S., 90-day investments of similar risk have a 4 percent annualized return. In the 90-day forward market, 1 British pound (£) = $1.65. If interest rate parity holds, what is the spot exchange rate?

a. £1 = $1.6582

b. £1 = $1.8000

c. £1 = $0.6031

d. £1 = $1.0000

e. £1 = $0.8500

16. Currently, a U.S. trader notes that in the 6-month forward market, the Japanese yen is selling at a premium (that is, you receive more dollars per yen in the forward market than you do in the spot market), while the British pound is selling at a discount. Which of the following statements is most correct?

a. If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan.

b. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates.

c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates.

d. If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates.

e. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates.

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____ 10. In the spot market $1 U.S. equals 1.85 Brazilian real, and in the 1-year forward market 1 U.S. dollar equals 1.98 real. Interest rates on 1-year, risk-free securities are 4.8 percent in the United States. If interest rate parity holds, what is the interest rate on 1-year, risk-free Brazilian securities?

a. 2.13%

b. 12.14%

c. 28.61%

d. 26.05%

e. 7.03%

Forward rate / Spot rate = ( 1+ Brazilian interest rate ) / ( 1+ US interest rate )

(1.98 / 1.85) = ( 1+ Brazilian interest rate ) / ( 1+ 4.8% )

or ( 1+ Brazilian interest rate )= (1.98 / 1.85) x ( 1+ 4.8% ) = 1.1216

or Brazilian interest rate = 1.1216- 1 = 12.16%

Answer: b 12.14%

____ 11. Swenser Corporation arranged a 2-year, $1,000,000 loan to fund a foreign project. The loan is denominated in euros, carries a 10 percent nominal rate, and requires equal semiannual payments. The exchange rate at the time of the loan was 1.05 euros per dollar but immediately dropped to 0.95 euros per dollar before the first payment came due. The loan carried no exchange rate protection and was not hedged by Swenser in the foreign exchange market. Thus, Swenser must convert U.S. funds to euros to make its payments. If the exchange rate remains at 0.95 euros through the end of the loan period, what effective interest rate will Swenser end up paying on the foreign loan? Hint: the annuity formula can be used to determine payment amount and interest rate.

a. 10.36%

b. 17.44%

c. 19.78%

d. 11.50%

e. 20.00%

Principal amount in $ = $1,000,000

Principal amount in ...

#### Solution Summary

Answers and explanations have been provided to 6 Multiple choice Questions on currencies, interest rate parity, effective interest rate, premium/ discount, hedging its exchange rate exposure, spot exchange rate, forward market