International Financial Management FINA 4836
Rauli Susmel Spring 2017
Final Exam
No points will be given by simply writing down formulas, and writing down definitions or irrelevant statements from
the book, or saying "yes," will get you zero points. Justify all your answers. If you cannot prove something give
some intuition. Good luck. Reminder: this is an open book exam, but no open notes.
Estimated Time: 2 hrs 30 minutes.
I. Problems (10 points each).
1. Bilardo Inc. considers investing excess funds at home, in the U.S., at 1% for 180 days. Bilardo also considers
investing in Canada, in Japan and forming a portfolio with 80% invested in Euros (EUR) and 20% in Japanese
yen (JPY). The forecasts of appreciation in the EUR and JPY for the 180 days are as follows:
Currency ef,T Probability
EUR 1% 70%
EUR 3% 30%
JPY 0% 60%
JPY 1% 40%
The interest rate on the EUR is 3%, and the interest rate on the JPY is 1%. Where should Bilardo Inc invest: at
home, in Japan, in Europe, or in the 80-20 portfolio?
2. You work for Kempes Industries, U.S. MNC. Kempes gives you the following projections for next year:
Currency Total inflows Total outflows Current Exchange rate
NZD NZD 200,000 NZD 50,000 .70 USD/NZD
ARS (peso argentino) ARS 300,000 ARS 500,000 .05 USD/ARS
a.- What is Kempes's net transaction exposure (NTE)?
b.- Suppose the NZD and the ARS have a perfect negative correlation. The USD/NZD exchange rate increases to .77
USD/NZD. What is the change in net transaction exposure for Kempes Industries?
c.- Go back to part (a). Assume that changes in exchange rates (ef) follow a normal distribution. The NZD's mean and
standard deviation are 0 and .10, respectively; while the ARS’s mean and standard deviation are -0.2 and .20,
respectively. Determine the VAR (Value-at-Risk) for each currency using a 97.5% confidence level.
3. On May 5, a swap dealer wants to price a one-year fixed-for-floating interest rate swap against the 3-month LIBOR,
that starts on June 17. The fixed rate will be paid semiannually and is quoted bond basis. Find the swap coupon rate. Get
the appropriate rates from the attached quotes.
Price # days covered
Mar 17 98.64 92
Jun 98.69 92
Sep 98.64 91
Dec 98.49 90
Mar 18 98.22 92
4.- You have data on the SEK/USD and CPI indexes for Sweden and the US from January 1970 to November 2007.
You run the following regression: changes in the SEK/USD exchange rate against inflation rate differentials (ISwed-IUS).
Below, you have the excel regression output.
Coefficients Standard Error t -stat P-value
Intercept 0.00063769 0.001387156 0.459710491 0.645951097
ISwed-IUS 0.42083281 0.246676358 1.706011931 0.088711535
a) Let SSR(H0)= 0.37515. Test PPP, using individual t-tests and a joint F-test.
b) Let SNov = 6.326 SEK/USD, SDec = 6.3889 SEK/USD and SJan = 6.3521 SEK/USD.
Suppose that you have a forecast for the inflation rates:
ENov[ISwed,Dec] = .005; ENov[ISwed,Jan] = .001; ENov[IUS,Dec] = .001; ENov[IUS,Jan] = .002.
Forecast the SEK/USD exchange rate in December and January, conditional on November information.
c) Using the MSE as your metric, is your PPP model better than the Random Walk?
5. Bank A gives the following quotes: BOB/USD=8.00 - 8.02. The one-year interest rates for the BOB, iBOB, and for the
USD, iUSD, are 9.25% – 9.75% and 2.50% – 3.10%, respectively. Strongest Bank quotes FSBt,180 = 8.20 - 8.25 BOB/USD.
A. Is arbitrage possible? If so, design a covered arbitrage strategy to take advantage of Strongest Bank’s quote.
B. Determine an arbitraguer's profits.
C. Describe the international capital flows between Bolivia and the U.S.
6. It is May 3, 2017. Sabella, a U.S. company, exports baseball equipment to Taiwan. Sabella expects to receive a
payment of TWD 100 million in October 1, 2017 (TWD=Taiwanese Dollar). Sabella decides to hedge this exposure
using an October forward contract, which expires on October 1, 2017. The 3-month, 4-month and 5-month
Taiwanese interest rates are 3%, 3.2% and 3.4%, while the 3-month, 4-month and 5-month U.S. interest rates are 2%,
2.1% and 2.3%, respectively. On May3, the spot exchange rate is 28.90 TWD/USD and the October 1 forward trades
at 29.23 TWD/USD.
(A) Use the information given in the attached Excel output (based on 15 years of monthly changes) to calculate:
i) The VAR associated with Sabella’s open position (use a 97.5% C.I.).
ii) The worst case scenario for Sabella.
(B) Calculate the amount to be received on October 1, using a forward hedge.
(C) Calculate the amount to be received on October 1, using a money market hedge.
● DATA (based on monthly percentage changes from 2001:1 to 2016:12).
1-mo % change TWD/USD
Mean -0.077%
Standard Error 0.1329%
Median -0.029%
Mode .....
Standard Deviation 1.4495%
Sample Variance 2.1
Kurtosis 0.561619
Skewness -0.26282
Range 8.2225
Minimum -4.365%
Maximum 3.8576%
Sum -9.202
Count 119
7. Laudrup F.C., a Danish fund, holds a British stock portfolio worth GBP 100M on which it earns a volatile equity
return which is highly correlated with the FT-100 index (the U.K. stock index). This return is in GBP. The manager
of Laudrup, Mr. Piazza, decides to have all foreign income in the form of fixed-rate DKK for one year, with
quarterly payments. You work for Mr. Piazza.
A. Present in an exhibit your proposed financial engineering solution with 2 swaps, where the equity swap is a
variable-variable equity swap, where one leg of the equity swap is 3-mo LIBOR + 2%.
B. At inception, 3-mo LIBOR was 2.5%. Suppose for the first cash flow exchange, the return on the FTSE-100 was -
1%. What was the net exchange between the parties on the equity swap?
8. Suppose Telefónica (TEF) is considering offering cellular phone service in Panamá, El Salvador, Guatemala,
Nicaragua and Honduras. The success of the investment, with a 10-year horizon, depends on the number of subscribers.
TEF determines two states for the numbers of subscribers: “high growth” or “low growth.” If the state is “high”, the
expected NPV of future cash flows is EUR 80M per market; if the state is “low,” the expected NPV of the future cash
flows is EUR 20M per market. Suppose, the probability of a high number of subscribers is 50% and after one year TEF
knows learns the state (high growth or low growth) for the whole investment. Suppose the upfront initial investment is
EUR 45M per market if investing in one market. A joint investment in all markets reduces the total upfront investment by
5%. Evaluate the investment under the 3 situations described in A, B & C, using a discount rate of k=15%:
A. TEF invests in one market only, say Panamá.
B. TEF decides to test one market, say Panamá, first. After one year, if successful in test market –i.e., number of
subscribers is high-, TEF enters the other 4 markets. TEF learns from the investment in Panamá: with this knowledge,
now, the upfront investment in additional markets is reduced by 10%, while the probability of high increases to 60% in
additional markets.
C. TEF decides to invest in all the markets simultaneously.
II. CASE (30 points)
These questions are based on the online article. Briefly answer the following questions:
Note: No points will be given by simply writing lines from the article.
1) Mr. Bennet, currency analyst at Banco Santander, believes the GBP is cheap. Do you agree with his statement?
Justify your answer.
2) According to the article, analysts worry about rising U.K inflation. What is the effect of higher U.K. inflation on
the USD/GBP exchange rate? Draw a graph.
3) Using the 10-year yields and IFE, forecast next year’s USD/GBP exchange rate.
4) Suppose, the European Central Bank (ECB) decides to intervene to stop the depreciation of the EUR against the
GBP. Draw two graphs showing the effect of ECB’s intervention on the FX market and on European money markets.
5) The U.S. economy has been doing very well, while analysts worry about a slowdown in consumer spending in the
U.K. What is the effect of both factors on the USD/GBP exchange rate? Be specific regarding the theory you use to
justify your answer.
6) According to the article, there is a lot uncertainty regarding Trump’s tax policies. What is the effect of this
uncertainty on the USD/GBP exchange rate? Draw a graph.