Solutions Guide: Please reword the answers to essay type parts so as to guarantee that your answer is an original.

Do not submit as your own. p>2. Table 28.1 shows the 90-day forward rate on the South African rand. a. Is the dollar at a forward discount or premium on the rand? b. What is the annual percentage discount or premium? c. If you have no other information about the two currencies, what is your best guess about the spot rate on the rand three months hence? d. Suppose that you expect to receive 100,000 rand in three months. How many dollars is this likely to be worth Table 28.1 Percentage error 15 10 5 //// ////////////// 0 --//////////----///////////////////////////////------------/////////////////////////////////--------------------------------------------- -5 -10 -15 year 1984 1985 1986 ---------------------------------------------2003 Percentage error from using the one month forward rate swiss francs to forcast the next month spot rate. Note the forward rate overstimates and underestimates the spot rate with about equal frequency. a. The dollar is selling at a forward premium on the rand. b. c. d. 6.4662 4 1 = 0 .0762 = 7.62% 6.5917 Using the expectations theory of exchange rates, the forecast is: $1 = 6.5917 rand 100,000 rand = $(100,000/6.5917) = $15,170.59

10. In March 2004, an American investor buys 1,000 shares in a Mexican company at a price of 500 pesos each. The share does not pay any dividend. A year later she sells the shares for 550 pesos each. The exchange rates when she buys the stock are shown in Table 28.1. Suppose that the exchange rate at the time of sale is peso $12.0/$. a. How many dollars does she invest? b. What is her total return in pesos? In dollars? c. Do you think that she has made an exchange rate profit or loss? Explain. a. Pesos invested = 1,000 500 pesos = 500,000 pesos Dollars invested = 500,000/10.9815 = 45,531.12 b. Total return in pesos = (550 500) (1000) = 0.10 = 10.0% 500 1000

Dollars received = (550 1000)/12.0 = 45,833.33 Total return in dollars = 45,833.33 45,531.12 = 0.0066 = 0.66% 45,531.12

c.

There has been a return on the investment of 10% but a loss on the exchange rate.

11. Table 28.4 shows the annual interest rate (annually compounded) and exchange rates against the dollar for different currencies. Are there any arbitrage opportunities? If so, how would you secure a positive cash flow today, while zeroing out all future cash flows? Table 28.4 Average money market rate percent lasts 5 years to 2003 80 70 | 60 | 50 | 40 . | 30 . | . 20 | . 10 ....... | 0 | -10 0 10 20 30 2. Banks are not the only financial intermediary from which corporations can obtain financing. What are the other intermediaries? How much financing do they supply, relative to banks, in the United Kingdom, Germany, and Japan 3. Why is transparency important in a market-based financial system? Why is it less important in a bank-based system? 11. To determine whether arbitrage opportunities exist, we use the interest rate theory. For example, we check to see whether the following relationship between the U.S. and Costaguana holds: 1 + rpulgas 1 + r$ = fpulgas / $ spulgas / $ Ratio of Spot Rate to Forward Rate 1.194200 1.019231 1.064327 0.991304

For the different currencies, we have: Ratio of Interest Rates Costaguana Westonia Gloccamorra Anglosaxophonia 1.194175 1.019417 1.048544 1.010680

For Anglosaxophonia and Gloccamorra, there are arbitrage opportunities because interest rate parity does not hold. For example, one could borrow $1,019 at 3% today, convert $1,000 to 2,300 wasps, and invest at 4.1%. This yields 2,394.3 wasps in one year. With a forward contract to sell these for dollars, one receives (2,394.3/2.28) = $1,050 dollars in one year. This is just sufficient to repay the $1,019 loan: $1,019 1.03 = $1,049.57 The $19 difference between the amount borrowed ($1,019) and the amount converted to wasps ($1,000) is risk-free profit today. 7. What are some of the advantages and disadvantages of Japanese keiretsus? A Japanese keiretsu is a network of companies with cross-holdings and numerous interrelationships. These include long-standing relationships among the companies in the keiretsu, and between the companies and the bank that is often associated with the keiretsu. The advantages of this form of organization include the ability to obtain debt financing from the keiretsus bank or from other affiliated financial institutions. Financing can also

be obtained from other companies in the keiretsu, avoiding the need for external financing. Keiretsus tend to have relatively stable cash flows and are often able to resolve issues related to the financial distress of a company in the keiretsu. A disadvantage of this form of organization is the fact that outside shareholders have little, if any, influence on the companies in the keiretsu. As a result, dividends are relatively low and takeovers are extremely rare.