Finance 475

Solutions to Problem Set #1

1) Suppose that a BMW costs E 45,000 in Germany and that the current USD/EUR exchange rate is 

    .7624.  Calculate the dollar price of the BMW.

    Note that the exchange rate is in terms of Euros per dollar (E/$).  Therefore, to get the dollar price, divide by the exchange rate.  

    45,000 / .7624 = $59,024.  Notice the units.....(E/BMW)/(E/$) = (1/BMW)/(1/$) = ($/BMW)

2)  Consider the following exchange rates: 

        EUR/USD  = 1.2500 ($/Euro)

        USD/CAD = 1.1000 (CAD/$)

        EUR/CAD =  1.3550 (CAD/Euro)

      How could you use this information to make money in the currency markets?

      First, calculate the implied cross rate between USD and Euros.    1.355 (CAD/Euro) / 1.10 (CAD/$) = 1.23 ($/Euro).  Therefore, the Euro is overpriced  

       in the market (relative to dollars).  Any profitable  trade will involve selling Euros and buying dollars.  For example: 

        Start with $1.  Now convert to Canadian Dollars $1 x 1.10 (CAD/$) = CAD 1.10.  Now convert to Euro...

        CAD 1.10 / 1.3550 (CAD/Euro) = .812 Euros.  Now Convert to Dollars .812 Euros * 1.25 ($/Euro) = $1.014 (1A 1.4% return). 

3) Suppose that you took a short position on 12,500,000 Japanese Yen future (remember, a short 

    position involves selling Yen) at a price of 104.5 Yen/$.  If the spot rate on the contract's expiration date 

    was 103.45 Yen/$, calculate your profit/loss from the futures contract. 

    Your short position allows you to sell Yen at a price of 104.5 Yen/$.  At a spot rate of 103.45 (Yen/$), you would need to spend 

    Y12,500,000/103.45(Y/$) = $120,831 to acquire 12,500,000 Yen.  Then you would turn around and sell them for 104.5(Y/$) which leaves you with 

    12,500,000/104.5 = $119,617.  This is a loss of $1,214.


4)   Consider the following balance of payments data. (in billions of dollars)

    Merchandise Exports

    $100 (+)

    Merchandise Imports

    $125 (-)

    Service Imports

    $90 (-)

    Service Exports

    $80 (+)

    Income received from abroad

    $110 (+)

    Income payments to foreigners

    $150 (-) 

    Increase in US ownership of private assets abroad

    $160 (-) 

    Increase in foreign ownership of private US assets

    $200 (+) 

    Increase in home official reserve assets

    $30 (-) 

    Increase in foreign official assets in US

    $35 (+) 

    Assuming that unilateral transfers are zero, find the trade balance, the current account balance, 

    the capital and financial accounts balance, the Balance of Payments, and the statistical discrepancy.

    Trade Balance = Sum of first 4 lines = -$35

    Current Account = Sum  of first 6 lines = -$75

    Balance of Payments = Sum of all 10 Lines = -$30 

    Statistical Discrepancy = -(BOP) = $30. 

5) .  Suppose that the U.S. sells F-16 fighter planes to the Israeli government.  Explain how this transaction creates 

        offsetting credits and debits in the Balance of Payments accounts.

        The sale of the F-16 will create a (+) in the current account under merchandise exports.  This corresponding (-) will be in the capital/financial account.  The exact entry will depend on how Israel pays for the plane, but it will be under the heading "Increase in US assets help abroad".