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# Exchange rate, futures, and option

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1. Bank USA recently purchased \$10 million worth of euro-denominated one-year CDs that pay 10 percent interest annually. The current spot rate was 1.30/\$.
b. Is Bank USA exposed to an appreciation or depreciation of the dollar relative to the euro?
c. What will be the return on the one-year CD if the dollar appreciates relative to the euro such that the spot rate at the end of the year is 1.20/\$?
d. What will be the return on the one-year CD if the dollar depreciates relative to the euro such that the spot rate at the end of the year is 1.40/\$?

2. Citibank holds \$23 million foreign exchange assets and \$18 million in foreign in foreign exchange liabilities. Citibank also conducted foreign currency trading activity in which it bought \$5 million in foreign exchange contracts and sold \$12 million in foreign exchange contracts.
a. What is Citibank's net foreign assets?
b. What is Citibank's net foreign exchange bought?
c. What is Citibank's net foreign exposure?

3. If the interest rate in the United Kingdom is 8 percent, the interest rate in the United States is 10 percent, the spot exchange rate is \$1.75/L, and interest parity holds, what must be the one-year forward exchange rate?

4. Suppose all of the conditions in Question 12 hold except that the forward rate of exchange is also \$1.75/L. How could an investor take advantage of this situation?

5. If a bundle of goods in Japan costs 400,000 yen while the same goods and services cost \$40,000 in the US, what is the current exchange rate of US dollars for yen? If, over the next year, inflation is 6% in Japan and 10% in the US, what will the goods cost next year? Will the dollar depreciate or appreciate relative to the yen over this time period?

6. When is a futures or options trader in a long versus a short position in the derivative contract?

7. What is the meaning of a T-bond futures price quote of 103-13?

8. Suppose you purchase a T-bond futures contract at a price of 95 percent of the face value, \$100,000.
b. Assume that the T-Bond futures price falls to 94%. What is your gain or loss?
c. Assume that the T-bond futures price rises to 97. What is your gain or loss?
9. You have taken a long position in a call option on IBM common stock. The option has an exercise price of \$136 and IBM's stock currently trades at \$140. The option premium is \$5 per contract.
a. What is your net profit on the option if IBM's stock price increases to \$150 at expiration f the option and you exercise the option?
b. What is your net profit if IBM's stock price decreases to \$130?

#### Solution Preview

1. Bank USA recently purchased \$10 million worth of euro-denominated one-year CDs that pay 10 percent interest annually. The current spot rate was 1.30/\$.
b. Is Bank USA exposed to an appreciation or depreciation of the dollar relative to the euro?

Yes, Bank USA is exposed to an appreciation or depreciation of the dollar relative to the euro. If dollar is depreciated against the euro, then Bank USA will receive more dollar back. On the other hand, if the dollar appreciate against the euro, Bank USA will receive less dollar back.

c. What will be the return on the one-year CD if the dollar appreciates relative to the euro such that the spot rate at the end of the year is 1.20/\$?

First, we have to convert \$10 million to euro at the current spot rate.

\$10,000,000/\$1.30 = euro 7,692,307.69

At the end of 1 year, total received in euro will be

7,692,307.69 x 1.10 = euro 8,461,538.46

Then, you have to convert it back to US\$.

8,461,538.46 x \$1.20 = \$10,153,846.15

Annual return = (\$10,153,846.15 - \$10,000,000)/\$10,000,000 = 1.5%

d. What will be the return on the one-year CD if the dollar depreciates relative to the ...

#### Solution Summary

This solution is comprised of a detailed explanation to answer the result of exchange rate on euro-denominated CDs, Citibank's net foreign exposure, forward exchange rate, appreciation and depreciation of Japanese yen, and what is the meaning of T-bond futures price quote.

\$2.19