2.7 The Parfumerie

• You work for Societe Generale, a French bank. One of your customers, a French perfume company that exports to Switzerland, would like to sell Swiss francs against French francs. Market rates are:
(i) FF 4.0340-4.0350/US$ and

(ii) SF 1.6010-1.6020/US$

Your customer would like a Swiss franc rate in FF.

• Since the parfumerie is French and has Swiss Franc receivables, it would like to sell SFR for FFR. This is equivalent to selling Swiss francs for U.S. dollars (at 1.6020) and then buying French francs (at 4.0340) with U.S. dollars. Thus the crossrate can be calculated as follows: (4.0340 FFr/$)/(1.6020 SFr/$) = 2.5181 FFr/SFr

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2.9 NatWest

• The Eurocurrency dealer at National Westminster Bank in London provides the following quotations for 6-month Eurosterling deposits to the Central Bank of Taiwan: 11 1/16-10 15/16 percent. What rate could Taiwan expect to receive on funds placed with Natwest?

• In money-market quotations, the lower rate is the bid rate and the higher rate is the offered rate. The bid rate is the one that the quoting bank is willing to pay on deposits. Hence Taiwan should expect to receive 10 15/16 % on funds placed with NatWest Bank.

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2.10 Mitsubishi Bank

• If the Treasury department at Mitsubishi Bank in London is quoting the yen/pound exchange rates at 234-235 spot, 2 1/8-2 three months forward, would you expect that same bank's Euroyen quotations to be above, below, or the same as its Eurosterling quotations?
• Forward quotes: 231.875-233 (subtract the forward points since the second quote is lower than the first)
• Since the forward quote indicates that the pound is trading at a discount, the Euroyen quotations should be below the Eurosterling quotes. The currency that is stronger in the forward-exchange market should have a lower interest rate to offset the investor's for the gain on the currency.

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2.12 AT&T's Swiss Liability

• AT&T has a known cash payment of SF 50,000,000 to be made to a Swiss supplier in 100 days. The company wishes to fix or lock in the nominal dollar price of this payment using currently available rates. The spot rate available to AT&T is SF 2.50/$, the forward rate for maturity in 100 days is SF 2.465/$, and the company faces a dollar interest rate of 12 percent and a SF interest rate of 6 percent.

• Given this information, what is the smallest dollar price on its SF 50,000,000 that AT&T can lock in with certainty? Explain the procedure the company will follow to obtain this price.

(a) Forward hedge. That is, at the 100-day forward rate of SF2.4651, AT&T will pay $20,283,976 in 100 days.

(b) Money-market hedge. Borrow U.S. $ today, convert into Swissies at spot (2.50/$) and reinvest Swiss francs (at 6 percent) in 100-day maturity securities. To have exactly SFr 50 million available in 100 days, calculate backwards:

50,000,000 = [2.50x] +[100/365*6%*2.50x]

Solving for x, $19,676,550 is needed today. So in 100 days, AT&T will have to repay the principal plus interest of (100/365*12%)*$19,676,550 = $646,900. The total is $20,323,450. The forward is cheaper.

The implication: covered-interest parity does not hold.

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3.7 Finding the Forward

• If the dollar is trading at 130 yen in the spot market, and the 6-month Eurodollar and Euroyen rates are 10% and 7.5% respectively, what is the 6-month yen/dollar forward exchange rate?

• (c)The interest-rate parity theorem can be applied to obtain the theoretical forward exchange rate. Note that interest rates quoted on an annual basis must be divided by 2.

F / S (Yen/$) = (1 + I_EuroYen) / (1 + I_Euro$)

F = S (1 +I_EuroYen) / (1 + I_Euro$)

= 130 (1 + 7.5%/2) / (1 + 10%/2)

= 128.452

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Try more worked-out problems
Return to the course outline, International Financial Management.

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Ian H. Giddy, Professor of Finance New York University Salomon Center • Stern School of Business 44 West 4th Street, New York 10012 Tel 212 998-0704 • Fax 212 995-4220

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Go to Giddy's Web Portal • Contact Ian Giddy at ian.giddy@nyu.edu

Copyright ©2001 Ian Giddy. All rights reserved.