Fin350- Questions and Applications

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Chapter 16: Questions and Applications 1 and 6; Problems 1, 2, and 4

1. Exchange Rate Systems Explain the exchange rate system that existed during the 1950s and 1960s. How did the Smithsonian Agreement in 1971 revise it? How does today’s exchange rate system differ?

6. Impact of Economic Conditions Assume that Switzerland has a very strong economy, putting upward pressure on both inflation and interest rates. Explain how these conditions could put pressure on the value of the Swiss franc, and determine whether the franc’s value will rise or fall.

1. Currency Futures Use the following information to determine the probability distribution of per unit gains from selling Mexican peso futures.

■  Spot rate of the peso is $0.10.

■  Price of peso futures is $0.102 per unit.

■  Your expectation of the peso spot rate at maturity of the futures contract is:

POSSIBLE OUTCOME FOR FUTURE  SPOT RATE 

PROBABILITY

$0.090

10%

0.095

70

0.110

20

 

2. Currency Call Options Use the following information to determine the probability distribution of net gains per unit from purchasing a call option on British pounds.

■  Spot rate of the British pound is $1.45.

■  Premium on the British pound option is $0.04 per unit.

■  Exercise price of a British pound option is $1.46.

■  Your expectation of the British pound spot rate prior to the expiration of the option is:

POSSIBLE OUTCOME FOR FUTURE  SPOT RATE 

PROBABILITY

$1.48

30%

1.49

40

1.52

30

4 .Covered Interest Arbitrage Assume the following information:

■ British pound spot rate = $1.58

■ British pound one-year forward rate = $1.58

■ British one-year interest rate = 11 percent

■ U.S. one-year interest rate = 9 percent

Explain how U.S. investors could use covered interest arbitrage to lock in a higher yield than 9 percent. What would be their yield? Explain how the spot and forward rates of the pound would change as covered interest arbitrage occurs.


Chapter 17: Questions and Applications 1, 2, 7, 11, and 13

1. Bank Balance Sheet Create a balance sheet for a typical bank, showing its main liabilities (sources of funds) and assets (uses of funds).

2. Bank Sources of Funds What are four major sources of funds for banks? What alternatives does a bank have if it needs temporary funds? What is the most common reason that banks issue bonds?

7. Borrowing from the Federal Reserve Describe the process of “borrowing at the Federal Reserve.” What rate is charged, and who sets it? Why do banks commonly borrow in the federal funds market rather than through the Federal Reserve?

11. Bank Capital Explain the dilemma faced by banks when determining the optimal amount of capital to hold. A bank’s capital is less than 10 percent of its assets. How do you think this percentage would com- pare to that of manufacturing corporations? How would you explain this difference?

13. Credit Crisis Explain how some mortgage operations by some commercial banks (along with other financial institutions) played a major role in instigating the credit crisis.


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