Managing International Risks: Solution to Chapter 27 Problems

1.
a. This is equal to the reciprocal of the direct spot rate = 1/47.81
b. 48.030
c. Singapore Dollar is at premium. (Indian Rupee is at discount).
d. Annualised Premium = (48.959/47.81 - 1) x (12/6) x 100%
e. From interest rate parity:
1+𝑟𝐼𝑛𝑑𝑖𝑎 𝑓𝐼𝑁𝑅/𝑆$
=
1+𝑟𝑆𝑖𝑛𝑔𝑎𝑝𝑜𝑟𝑒 𝑠𝐼𝑁𝑅/𝑆$
𝑠𝐼𝑁𝑅/𝑆$
𝑟𝑆𝑖𝑛𝑔𝑎𝑝𝑜𝑟𝑒 = (1 + 𝑟𝐼𝑛𝑑𝑖𝑎 ) × 𝑓 − 1 = (1.0325 x 47.81/48.959) -1
𝐼𝑁𝑅/𝑆$

f. Rs 48.419 = 1 S$
g. According to purchasing power parity & expectations theory
1 + 𝐸(𝑖𝐼𝑛𝑑𝑖𝑎 ) 𝐸(𝑠𝐼𝑁𝑅/𝑆$ ) 𝑓𝐼𝑁𝑅/𝑆$
= = = 48.959/47.810
1 + 𝐸(𝑖𝑆𝑖𝑛𝑔𝑎𝑝𝑜𝑟𝑒 ) 𝑠𝐼𝑁𝑅/𝑆$ 𝑠𝐼𝑁𝑅/$
Inflation Differential = 48.959/47.810 – 1

3.
a. According to purchasing power parity
𝐸(𝑆) 1 + 𝐸(𝑖𝐼𝑛𝑑𝑖𝑎 ) 1.06
= => 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑆𝑝𝑜𝑡 𝐸𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑅𝑎𝑡𝑒 = 16 × = 16.466
𝑆 1 + 𝐸(𝑖𝑈𝐴𝐸 ) 1.03
b. Change in real exchange rate = 17.33/16.466 – 1 = 5.25% depreciation in Indian
Rupee vs UAD Dirham
Alternatively, change in nominal exchange rate = 17.33/16 – 1 = 8.31%
Change due to inflation by PPP = 1.06/1.03 – 1 = 2.91%
Change in real exchange rate = (1+0.0831)/(1+0.0291)-1 = 5.25%

4. Based on Interest Rate Parity

For 1 month:
1+𝑟𝑁𝑎𝑛𝑜 𝑓𝑁𝑎𝑛𝑜/$ (1+0.082)1/12 𝑓𝑁𝑎𝑛𝑜/$
1+𝑟𝑈𝑆
=𝑆 => (1+0.04)1/12
= 15
=> 𝑓𝑁𝑎𝑛𝑜/$ = 15.049
𝑁𝑎𝑛𝑜/$
1
12
Forward discount on Nano (annualised) = ( 15.049
1 − 1) × 1
= −3.95%
15

For 3 months:
Forward discount on Nano (3 mth) = 4.8 x 3/12 = 1.2%
Forward dollars per Nano = 1/15 x (1-0.012)
Forward Nanos per dollar = 15/(1-0.012) = 15.1822
𝑓𝑁𝑎𝑛𝑜/$ 15.1822 1 4
(1 + 𝑟𝑁𝑎𝑛𝑜 )1/4 = × (1 + 𝑟𝑈𝑆 )1/4 = ( × (1 + 0.045)4 ) − 1 = 9.67%
𝑆𝑁𝑎𝑛𝑜/$ 15

For 12 months:
1
Forward discount on Nano = ( 15.6
1 − 1) = −3.85%
15
𝑆𝑁𝑎𝑛𝑜/$ 15
𝑟𝑈𝑆 = (1 + 𝑟𝑁𝑎𝑛𝑜 ) × − 1 = (1 + 0.098) × ( ) − 1 = 5.58%
𝑓𝑁𝑎𝑛𝑜/$ 15.6
 1 Month 3 Months 1 Year

Dollar interest rate (annually compounded) 4.00% 4.50% 5.58%

Nano interest rate (annually compounded) 8.20% 9.67% 9.80%

Forward nanos per dollar 15.05 15.18 15.60

Forward discount on nano (% per year) 3.95% 4.80% 3.85%

5. By buying pesos forward, the importer locks in the price today, thereby eliminating exchange
rate risk.

6. Zero. Buying HK Dollar in the forward market commits the Indian company, but does not require
an upfront expenditure.

7. It can borrow the present value of Euro 1 million, sell the Euros in the spot market, and invest
the proceeds in an eight-year dollar loan.