Exam 13: Foreign Exchange Risk

A U.S. FI is raising all of its $20 million liabilities in dollars (one-year CDs) but investing 50 percent in U.S. dollar assets (one-year maturity loans) and 50 percent in U.K. pound sterling assets (one-year maturity loans). Suppose the promised one-year U.S. CD rate is 9 percent, to be paid in dollars at the end of the year, and that one-year, credit risk-free loans in the United States are yielding only 10 percent. Credit risk-free one-year loans are yielding 16 percent in the United Kingdom. -If the exchange rate had fallen from $1.60/≤1 at the beginning of the year to $1.50/≤1 at the end of the year, the net interest margin for the FI on its balance sheet investments is

Forward contracts in FX are typically written for periods exceeding 6 months.

How would you characterize the FI's risk exposure to fluctuations in the Swiss franc/dollar exchange rate?

Most profits or losses on foreign trading come from taking an open position in currencies.

Directly matching foreign asset and liability books in the same FX currency will allow an FI to hedge or lock in a profit spread regardless of future changes in exchange rates.

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C $1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US $0.78493 per Canadian dollar. -If in one year there is no change to either interest rates or exchange rates, what is the end-of-year profit or loss for the bank? (Hint: Annual interest is paid on both the Canadian bonds and the CD on the date of liquidation in exactly one year.)

The FI is acting as a speculator when it

According to purchasing power parity (PPP), foreign currency exchange rates between two countries adjust to reflect changes in each country's

How would you characterize the FI's risk exposure to fluctuations in the yen/dollar exchange rate?

The one-year CD rates for financial institutions with AA ratings are 5 percent in the U.S. and 8 percent in France. An AA-rated U.S. financial institution can borrow by issuing CDs or lend by purchasing CDs at these rates in either market. The current spot rate is $0.20/Euro. -What should be the one-year forward rate in order to prevent any arbitrage?

What is the end-of-year profit or loss to the bank if in one year Canadian bond rates increase to 7.538 percent? (Assume no change in either current U.S. interest rates or current exchange rates, US $0.78493/C $1.)

Suppose that the current spot exchange rate of U.S. dollars for Russian rubles is $0.15/1ruble. The price of Russian-produced goods increases by 8 percent, and the U.S. price index increases by 3 percent. -According to PPP, the new exchange rate of Russian rubles to U.S. dollars is

What is the end-of-year profit or loss to the bank if in one year the exchange rate falls to US $0.765 per Canadian dollar? (Assume that there is no change in interest rates.)

Your U.S. bank issues a one-year U.S. CD at 5 percent annual interest to finance a C $1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. You expect to liquidate your position in one year. Currently, spot exchange rates are US $0.78493 per Canadian dollar. -Your position is exposed to

Suppose that the current spot exchange rate of U.S. dollars for Russian rubles is $0.15/1ruble. The price of Russian-produced goods increases by 8 percent, and the U.S. price index increases by 3 percent. -According to PPP, the 8 percent rise in the price of Russian goods relative to the 3 percent rise in the price of U.S. goods results in a(n)

Assume that instead of investing in Euro bonds at a fixed rate of 6.5 percent, the FI invests them in variable rates of LIBOR + 1.5 percent, reset every six months. The current LIBOR rate is 5 percent. Assume both interest and principal will be reinvested in six months. Assume the exchange rate remains at €1.75/$ at the end of the year. What should be the LIBOR rates in six months in order for the bank to earn a 1 percent spread?

How would you characterize the FI's risk exposure to fluctuations in the Euro to dollar exchange rate?

Which of the following FX trading activities is used to hedge FX risk?

Long-term violations of the interest rate parity relationship may occur if imperfections in the international financial markets are allowed to exist.

The use of an exchange rate forward contract assures the FI of the opportunity to buy (or sell) the foreign currency at a future time at a known price.