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Assignment 1 (20%)   Why do Central Banks exist? Give examples of at least three central banks

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Assignment 1 (20%)

 

1. Why do Central Banks exist? Give examples of at least three central banks. Explain their rational for founding, working mechanism and objectives.
2. Explain what an exchange rate is. How does it affect your everyday life?
3. Compare and contrast the following exchange rate systems; fixed exchange rate system, freely floating exchange rates, managed floating and pegged exchange rate. How are they controlled and what are their advantages and disadvantages?
4. Explain the working mechanism of Purchasing Power Parity. Does it always hold?
5. Explain the working mechanism behind locational arbitrage. Calculate and explain if locational arbitrage is possible in the following situation.

 

Bank A	Bank B
Bid                       Ask $0.4                    $0.45	Bid                        Ask $0.5                      $0.55

 

 

 

1. Assume that the forward rate was used to forecast the future spot rate. Determine whether US Dollar or Japanese Yen was forecasted with more accuracy.

 

	90-day forward rate	Actual spot rate after 90 days
US Dollar	$ 0.9	$0.94
Japanese Yen	$0.17	$0.20

 

2 (a)The interest rate in United States is 7% and in Germany it is 4%. What will likely happen to the exchange rates in the future, in relation to each other? Explain by applying the theories of International Fisher Effect (IFE) and Interest Rate Parity (IPR).

(b)Let us assume that IRP (interest rate parity) theory applies. The one-year nominal interest rate in Germany is 4%, whereas in United States it is 7%. The spot rate for the US dollar is €0.77. If you purchase a one-year forward contract today with 10 000 US dollars, how many euros will you need in one year to fulfill your forward contract?

 

1. Is triangular arbitrage possible? -

You can buy a euro for 14 Mexican pesos. The bank will pay you 13 pesos for a euro. You can buy a U.S. dollar for 0.9 euros.

The bank will pay you .8 euros for a U.S. dollar. You can buy a U.S. dollar for 10 pesos.

 

The bank will pay you 9 pesos for a U.S. dollar.

 

3. What is the difference between direct and indirect intervention? Why would a central banks' indirect intervention have a stronger impact than its direct intervention? How would the European Central Bank use direct intervention to prevent economic recession in the whole Europe?

 

4. You purchase a put option of US dollar with a strike price of $0.9, for a premium of $0.02. At the expiration date US dollar's spot rate is $0.84. Should you exercise the option at this date or let it expire? Did you gain profit and how much? Did the seller gain profit, and how much?

The deadline of submission is 15 April 2022 by 11 pm via' Assignment Return 2'. Assignment 3 (25%)

 

5. Two companies want to establish a swap contract with each other. What is a realistic option to form the contract using an intermediary bank? Borrower A gains 0.4%,borrower B gains0.2% and bank gains 0.2%.

 

Borrower	FixedRate	Floating rate
Counterparty A: BBB-rated	5.50 %	6- month LIBOR + 0.5 %
Couterparty B: AAA- rated	4.20 %	6-month LIBOR

 

Calculations must be clearly shown. You must interpret calculations and draw conclusions based on them. 

 

1. You are the chief financial officer of an MNC based in United States. Your production facilities are located in China, and you also have sales operations both in China and USA. What type of exposure would the following events cause to your company and what types of measures could you take to (a.) prevent them (b.) mitigate their negative effects?
   • USA increases tariffs to Chinese imports.
   • The company's debt is tied to 6-monthLIBOR, which increases suddenly.

 

1. A company in the USA needs a loan of 10 million Euros to finance its upcoming operations in Germany. However, it cannot take a loan from a German bank because it is not yet established in Europe. The company issues US Dollar -denominated debt (at par value) in USA, with an annual coupon rate of 10%. After it will convert the dollar proceeds from the debt issue into Euros at the current spot rate $1.12. The company plans to use the revenue in euros from the business transactions for loan repayments during the next three years. Hence, the company engages in a currency swap contract to exchange euros to dollars for an exchange rate of $1.12 at the end of each of the next 3 years. How many dollars must be borrowed initially to operate the business in Germany? How many euros should the company specify in the swap agreement that it will swap over each of the next three years in exchange for dollars, in order to make its annual coupon payments to the U.S. creditors?

 

 

 

 

 

Assignment 4 - (30%)

Choose a Multinational Corporation (MNC) that is listed at least in one of the stock exchanges in Europe/ the USA/ Canada. Do not choose a bank, financial institution, or company currently or recently involved in merger and takeover. Find the company's annual reports with financial statements (balance sheet, income statement etc.) covering a period of at least 4 years. Incorporating the effects of the change sin the global/regional economic environment (i.e. financial crises, recessions, economic booms) during the period, you are required to prepare an individual assignment analyzing the following key issues:

MNC's operations, management structure, industry, competitors, business related characteristics and its motivation to operate as a MNC ). You are supposed to find out why the firm you have chosen is an MNC?

b. The nature of the MNC's foreign currency risk exposure. Analyze those activities of the chosen MNC which expose it to the foreign currency risk exposure, for example, Transaction Exposure, Translation Exposure and Economic Exposure.

c. The strategies used by the MNC to manage the exchange rate risk . How a firm, as a strategy and actions, is protecting itself from exchange rate fluctuations?