This week’s homework assignment relates to Chapter 4, “Exchange Rate Determination” and Chapter 5, “Currency Derivatives.” InstructionsPlease respond to the following: 1. Interest Rate Effects on Exchange Rates Assume the U.S. interest rates fall relative to British interest rates. Other things being equal, how should this affect the (a) U.S. demand for British pounds, (b) supply of pounds for sale, and (c) equilibrium value of the pound? 2. Movements in Cross Exchange Rates Last year a dollar was equal to 7 Swedish kronor, and a Polish zloty was equal to $.40. Today, the dollar is equal to 8 Swedish kronor and a Polish zloty is equal to $.44. By what percentage did the cross exchange rate of the Polish zloty in Swedish kronor (that is, the number of kronor that can be purchased with one zloty) change over the last year? 3. Speculation on Expected Exchange Rates Kurnick Co. expects that the pound will depreciate from $1.70 to $1.68 in one year. It has no money to invest, but it could borrow money to invest. It has been approved by a bank to borrow either 1 million dollars or 1 million pounds for one year. It can borrow dollars at 6% or British pounds at 5% for one year. It can invest in a risk-free dollar deposit at 5% for one year or a risk-free British deposit at 4% for one year. Determine the expected profit or loss (in dollars) if Kurnick Co. pursues a strategy to capitalize on the expected depreciation of the pound. 4. Speculating with Currency Call Options Randy Rudecki purchased a call option on British pounds for $.02 per unit. The strike price was $1.45 and the spot rate at the time the option was exercised was $1.46. Assume there are 31,250 units in a British pound option. What was Randys net profit on this option?
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