Problem 1: John works at the Arbitrage department of a bank in NY. He has access to $1,000,000 or its equivalent in euro to do business deal. At the end of each day, he must record his gains or losses.
1- John observes that the spot rate to be 1.255/euro and one year forward rate to be 1.45/euro. He further notes that interest rate in U.S. is 3% and that of euro 4%. Calculate how much can he makes and please show your steps clearly.
2- Next day he sees some changes in the market. While spot rate remains the same, the forward rate has change to1.25/euro. The interest rate of euro and dollar have also remained the same. Can he make profit from this situation and how much. Again, please show the steps clearly
Problem2 Price of a barrel of oil in the U.S. is $60 and in Japan yen 8400. What is the exchange rate between dollar and yen if a barrel of oil represents all the goods in the economy.
Using the above information, if the inflation in U.S. is 8% and in Japan 3%, using relative purchasing power parity (PPP) what would be your forecast of the exchange rate in one year between $ and Yen? If the interest rate in the U.S. is 10% what should be the interest rate in Japan to prevent capital flow between the two countries (according to Fisher effect)?
What happens it the Japanese interest rate was above the rate you have calculated?
Problem3 A person has bought $1,000,000 call option on euro strike price $1.1/euro with premium of $0.001. Calculate her
1- Breakeven point
2- Profit and loss at $1/euro and $1.2/euro
