college bowl final round. question #1 suppose that purchasing power parity holds. annual inflation...

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Final RoundFinal Round

Question #1Question #1

Suppose that Purchasing Power Parity holds. Annual inflation in the US is currently 7% annually (from the latest CPI numbers) while annualized inflation in Britain is 2%. If the current exchange rate is $1.90 per pound, what will the exchange rate be in 6 months?

$1.90 (1.025) = $1.9475


Suppose that the annual interest rate in the US is 3% while in Europe, a comparable asset pays 4%. The current spot rate is $1.35 per Euro, and the one year forward rate is $1.40. How could you make money off this information and what would your annual return be?

By borrowing the US and lending in Europe, you earn 1% (the interest differential), plus 3.7% (the pound appreciation)


US inflation is currently 7% annually while European inflation is 5%. The dollar depreciates by 4% against the Euro, what happens to the real exchange rate?

The real exchange rate depreciates by 4% + 5% - 7% = 2%


All else equal, if US economic growth outpaces European growth, what should happen to the value of the dollar?

It should appreciate relative to the Euro


The US is running a $600B trade deficit:

1) All else equal, what should happen to the dollar?

2) Changes is the exchange rate should correct the trade deficit unless this is true?

The trade deficit should cause the dollar to depreciate (making US goods cheaper and foreign goods more expensive). This will fix the deficit unless import/export elasticities are low.


Suppose that the price of services (a non-traded good) rises in the US. All else equal, what should happen to the nominal AND real exchange rate?

Nothing happens to the nominal exchange rate, the dollar, however, appreciates in real terms (US goods become more expensive relative to foreign goods.


What is a currency straddle and why is it useful?

A straddle combines a put option with a call option. It protects the buyer from both currency appreciations AND depreciations.


You have a L100,000 payable that will come due in one year. Currently the pound is trading at $1.80. Your point estimate for the pound one year from now is a 5% appreciation (5% depreciation of the dollar) with a standard error of 1%. What is the 95% confidence for you expected dollar costs?

A 5% depreciation implies a future exchange rate of $1.80(1.05) = $1.89($100,000) = $189,000 two standard deviations is 2% (+/- $3,780)

[$185,220, $192,780]


If you had a payable denominated in Yen, how would you hedge this in the option market?

You would buy a call option on Yen.


How does economic exposure differ from transaction exposure?

Transaction exposure deals with fixed cash flows while economic exposure deals with variable cash flows


Regression Results

VariableCoefficient

sStandard

Error t Stat

Intercept .05 1.5 .03

% Change e ($/E) -3.35 .97 -3.45

Given this regression of $ cash flows and the exchange rate, how could you hedge your risk in the futures market?

You are losing money when the Euro appreciates. Therefore, you could offset this loss by taking a long position in Euro.


Some people would argue that you shouldn’t have to hedge translation exposure. Why is this?

Translation exposure doesn’t involve actual cash flows. Only the conversion of financial statements into the company’s home currency.


China is currently pegging to the dollar. As the dollar continues to depreciate, what must the Peoples Bank of China do and why is it a bad policy in the long run?

China must buy up dollars in the world markets. This expands the Chinese money supply which will ultimately lead to inflation.


What is contagion and why does it occur?

Contagion describes the transmission of currency crises across neighboring countries. It is due to

•Common policies/shocks

•Trade linkages

•Financial linkages

•Information Problems


What are the costs/benefits of using an option hedge rather than a forward hedge?

An option hedge allows the holder to benefit from profitable exchange rate movements, but costs more up front (the premium)


If you knew that the Dollar/Euro exchange rate was going to fluctuate between $1.35 and $1.45, what would be the most efficient hedge?

An bullish spread (Buy a call option w/ a strike price of $1.35 and sell a call with a strike price of $1.45. The proceeds from the call sale should offset the purchase price of the other call.

“I'm the Dude so that's what you call me..ya know ah, that or his Dudeness or duder or El Dudereno if you're not into the whole brevity thing.”

The Big Lebowski (1998)

Lightning Round – Movie Lightning Round – Movie QuotesQuotes

Dirty Harry (1971)

I know what you're thinking. Did he fire six shots or only five? …..you've got to ask yourself one question: 'Do I feel lucky?' Well, do ya punk?"


Wall Street (1987)

"Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms."


Apocalypse Now (1979)

"I love the smell of napalm in the morning...smells like...victory."


The Graduate (1967)

"Mrs. Robinson, you're trying to seduce me. Aren't you?"


Airplane (1980)

- "Surely you can't be serious."- "I am serious, and don't call me Shirley."


Pride of the Yankees (1943)

"People all say that I've had a bad break, but today - today I consider myself the luckiest man on the face of the Earth."


Glengarry Glen Ross (1992)

"Only one thing counts in this life: Get them to sign on the line which is dotted...A. Always. B. Be. C. Closing. Always Be Closing."


The Godfather (1972)

"My father made him an offer he couldn't refuse."


Silence of the Lambs (1991)

"A census taker once tried to test me. I ate his liver with some fava beans and a nice Chianti."


Casablanca (1942)

"Of all the gin joints in all the towns in all the world, she walks into mine."


Jerry Maguire (1996)

"Show me the money!"


Forest Gump (1994)

"Mama says stupid is as stupid does."


Psycho (1960)

"We all go a little mad sometimes... Haven't you?"


Planet of the Apes (1968)

"Get your stinkin' paws off me, you damn dirty ape!"


2001: A Space Odyssey (1968)

"I'm sorry Dave, I'm afraid I can't do that."


Top Gun (1986)

"I feel the need - the need for speed!"


A Streetcar Named Desire (1951)

"Hey Stell - Lahhhhh!" "Hey, Stell - Lahhhh!"


Dr. Strangelove, or: How I learned to Stop Worrying and Love the Bomb (1964)

"Gentlemen. You can't fight in here. This is the War Room!"


Gone With the Wind (1939)

"As God is my witness, I'll never be hungry again."


college bowl final round. question #1 suppose that purchasing power parity holds. annual inflation...

Documents

real exchange rate

current exchange rate

nominal exchange rate

future exchange rate

us inflation

pound appreciation slide

current spot rate

us goods cheaper