FIN4802 Assignment 1 ALL SOLUTION SPRING FALL-2022 LATEST 100% CORRECT GUARANTEED GRADE A+

Question 1 James Clark is a foreign exchange trader with Citibank. He notices the following quotes. Spot exchange rate SFr1.2051/US$ 1 year forward exchange rate SFr1.1922/US$ 1 year US$ interest rate 1.25% per year 1 year SFr interest rate 3.75% per year 1.1 Is the interest rate parity holding? You may ignore transaction costs. [2] 1.2 Is there an arbitrage opportunity? If yes, show what steps need to be taken to make arbitrage profit. Assuming that James Clark is authorized to work with US$1 000 000, compute the arbitrage profit in dollars. [10] Question 2 2.1 A call option allows the holder to buy US$100 000 at an exercise exchange rate of 1.8000 (AUD/US$). If the premium paid is 0.5 Australian cents for each US$, calculate the net payoff at the following spot exchange rates: (a) 1.8040 [1] (b) 1.8260 [1] (c) 1.7870 [1] (d) At what exchange rate will the holder break even? [2] 2.2 A put option allows the holder to sell NOK250 000 at an exercise exchange rate of 0.190 (AUD/NOK). If the premium paid is 0.4 Australian cents for each NOK, calculate the net payoff at the following spot exchange rates: (a) 0.200 [1] (b) 0.192 [1] (c) 0.180 [1] (d) At what exchange rate will the holder break even? [2] Question 3 Omega Industries, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR10 000. The annual cash flows over the five year economic life of the project in ZAR are estimated to be 3 000, 4 000, 5 000, 6 000, and 7 000. The parent firm’s cost of capital in dollars is 9.5 percent. Long-run inflation is forecasted to be 3 percent per annum in the U.S. and 7 percent in South Africa. The current spot foreign exchange rate is ZAR/US$ = 3.75. Determine the NPV for the project in US$ by: 3.1 Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher Effect and then converting to US$ at the current spot rate. [9] 3.2 Converting all cash flows from ZAR to US$ at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the dollar cost of capital. [12] 3.3 What is the NPV in US dollars if the actual pattern of ZAR/US$ exchange rates is: S(0) = 3.75, S(1) = 5.7, S(2) = 6.7, S(3) = 7.2, S(4) = 7.7, and S(5) = 8.2? [7]