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Ejercicios resueltos Mecanica de fluidos
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Assignment: IFM Submitted By: Rana Ahtasham Anwar Q 1: What does interest rate parity say about international borrowing costs? Ans: Interest Rate Parity (IRP) is an equilibrium condition where in covered interest arbitrage will provide a return that is no higher that a domestic return. According to IRP, spot price and the forward price of a currency incorporate any interest rate differentials between the two currencies assuming there are no transaction costs or taxes. IRP theory regarding borrowing says that if the forward rate is lower than what the interest rate parity indicates, the appropriate strategy would be to borrow home currency, convert to foreign currency at the spot rate, and lend/invest into foreign currency.If the forward rate is higher than what interest rate parity indicates, the appropriate strategy would be to borrow forei gn currency, convert to home currency at the spot rate, and lend/invest the home currency. To summarize, if forward rate is lower that what IRP indicates, borrowing at home is more feasible/cost effective that of foreign borrowings. Q2: Assume that the bonds are issued at par what is the cost in Euros of each e ach of the bond alternatives? Assume annual coupon payments. Ans: Total Bond value:
Euro 750 M
Bond Period:
10 years
Currency
Bond Value
Coupon Rate
Bond coupon per year
Euro UK Pound Swiss Francs US Dollars
750M 1194.75M 516M
5.25 5.375 3.625
39.375 M 64.218 M 18.705 M
Bond Coupon per Year (Euros) 39.375 M 40.329 M 27.178M
765M
5.50
42.075 M
41.234 M
Q3: Which bond is the most attractive option for Carre four to borrow foreign currency? Ans: As per above data calculation in Question 2 above and assuming Interest Rate Parity holds, Swiss Francs Bond will be most attractive option and is most cost effective. Q4. What can the firm do to manage the exchange rate risk of the foreign currency? Ans: Following options can be utilized:
1. By hedging the exchange rate risk through purchasing of forward contract for that foreign currency. Hedging exchange risk is a strategy that should be considered during periods of unusual currency volatility. A Forward contract will lock in an exchange rate at which the
transaction will occur in the future. An option sets a rate at which the c ompany may choose to exchange currencies. If thecurrent exchange rate is more favorable, then the company will not exercise this option. Hedging can be achieved through Forward exchange contract for currencies, Currency future contracts, Money Market Operations for currencies, Forward Exchange Contract for interest (FRA), Money Market Operations for interest or Future contracts for interest. 2. By investing/issuing bonds in that foreign currency which have minimal fluctuation in the inflation. Q5: Calculate Parity Forward Rates from ye ar through year 10 for each bond in each currency? Ans:
Maturity
Euro RF Rate(%)
British Pound RF Rate(%)
F-S/S = I(Euro) I(Pound)
S
F = S {I(Euro)I(Pound)} + S
1
3.514
4.258
-0.00744
0.628
0.62332768
2
3.816
4.622
-0.00806
0.628
0.62293832
3
4.11
4.91
-0.008
0.628
0.622976
4
4.342
5.088
-0.00746
0.628
0.62331512
5
4.53
5.19
-0.0066
0.628
0.6238552
6
4.688
5.249
-0.00561
0.628
0.62447692
7
4.819
5.292
-0.00473
0.628
0.62502956
8
4.928
5.331
-0.00403
0.628
0.62546916
9
5.017
5.358
-0.00341
0.628
0.62585852
10
5.087
5.374
-0.00287
0.628
0.62619764
Maturity
Euro RF Rate(%)
CHF RF Rate(%)
F-S/S = I(Euro) I(CHF)
S
F = S {I(Euro)I(CHF)} + S
1
3.514
1.125
0.02389
1.453
1.48771217
2
3.816
1.713
0.02103
1.453
1.48355659
3
4.11
2.172
0.01938
1.453
1.48115914
4
4.342
2.498
0.01844
1.453
1.47979332
5
4.53
2.743
0.01787
1.453
1.47896511
6
4.688
2.948
0.0174
1.453
1.4782822
7
4.819
3.12
0.01699
1.453
1.47768647
8
4.928
3.267
0.01661
1.453
1.47713433
9
5.017
3.394
0.01623
1.453
1.47658219
10
5.087
3.499
0.01588
1.453
1.47607364
Maturity
Euro RF Rate(%)
US$ RF Rate(%)
F-S/S = I(Euro) I(USD)
S
F = S {I(Euro)I(USD)} + S
1
3.514
2.099
0.01415
0.98
0.993867
2
3.816
2.767
0.01049
0.98
0.9902802
3
4.11
3.432
0.00678
0.98
0.9866444
4
4.342
3.922
0.0042
0.98
0.984116
5
4.53
4.308
0.00222
0.98
0.9821756
6
4.688
4.619
0.00069
0.98
0.9806762
7
4.819
4.873
-0.00054
0.98
0.9794708
8
4.928
5.081
-0.00153
0.98
0.9785006
9
5.017
5.264
-0.00247
0.98
0.9775794
10
5.087
5.413
-0.00326
0.98
0.9768052
PS: Assignment may seem copied cause we have solved it together in a group.
