Robert Williams is a junior analyst at Anderson Brothers, a large Wall Street brokerage firm. He reports to Will McDonald, the chief economist for Anderson Brothers. McDonald provides economic research, forecasts, and interpretation of economic data to all of Anderson's investment departments, as well as the firm's clients. McDonald has asked Williams to analyze economic trends in the country of Bundovia. The currency of Bundovia is the Bunco (BU).Williams first analyzes the effect of rising nominal Bundovian interest rates relative to U.S interest rates on the supply and demand for BU. He determines that the increase in Bundovian nominal interest rates would increase the demand for BU and, because the BU supply curve is upward sloping, the BU will appreciate and the equilibrium quantity of BU will increase proportionately.Bundovia has announced plans to impose either a tariff or a quota on semiconductor imports from the United States. McDonald also asks Williams to analyze the potential effect on Bundovian Semiconductors, the dominant semiconductor manufacturer located in Bundovia. Currently, Bundovian Semiconductors is not competitive in the global semiconductor market because its higher production costs make it unable to generate profits at the current world market price.Williams concludes that the imposition of either a tariff or quotas would benefit Bundovian Semiconductors. The company would become competitive with foreign producers in its domestic semiconductor market because imports would be reduced and domestic production would rise.Exhibit 1 shows the trend in the average BU/USD exchange rate over the past three years.Williams asks the bank for a GBP/SFr cross rate.From the same bank, Williams receives the following forward rate quotes in the USD/GBP market:• 30-day forward rate: USD/GBP = USD/GBP = 2.0045 - 55• 60-day forward rate: USD/GBP = USD/GBP = 2.0075 – 85Williams has uncovered a potential arbitrage opportunity in the foreign exchange markets. The current spot rate is $2.00 per BU. The Bundovian risk-free interest rate is 3%, and the one-year forward rate is $2.10 per BU. The U.S. risk-free rate is 5%.From 2006 to 2008, the Bunco has:
Answer(s): B
The BU/USD exchange rate is increasing over time, which means the USD has appreciated relative to the BU, and the BU has depreciated relative to the USD. Another way to see this is to recognize that it .takes more BU to buy one USD in 2008 than in 2006, which means the BU is depreciating relative to the U.S. dollar. Because the BU has depreciated, Bundovian residents will find U.S. goods more expensive. (Study Session 4, LOS 17.a)
Robert Williams is a junior analyst at Anderson Brothers, a large Wall Street brokerage firm. He reports to Will McDonald, the chief economist for Anderson Brothers. McDonald provides economic research, forecasts, and interpretation of economic data to all of Anderson's investment departments, as well as the firm's clients. McDonald has asked Williams to analyze economic trends in the country of Bundovia. The currency of Bundovia is the Bunco (BU).Williams first analyzes the effect of rising nominal Bundovian interest rates relative to U.S interest rates on the supply and demand for BU. He determines that the increase in Bundovian nominal interest rates would increase the demand for BU and, because the BU supply curve is upward sloping, the BU will appreciate and the equilibrium quantity of BU will increase proportionately.Bundovia has announced plans to impose either a tariff or a quota on semiconductor imports from the United States. McDonald also asks Williams to analyze the potential effect on Bundovian Semiconductors, the dominant semiconductor manufacturer located in Bundovia. Currently, Bundovian Semiconductors is not competitive in the global semiconductor market because its higher production costs make it unable to generate profits at the current world market price.Williams concludes that the imposition of either a tariff or quotas would benefit Bundovian Semiconductors. The company would become competitive with foreign producers in its domestic semiconductor market because imports would be reduced and domestic production would rise. Exhibit 1 shows the trend in the average BU/USD exchange rate over the past three years.Williams asks the bank for a GBP/SFr cross rate.From the same bank, Williams receives the following forward rate quotes in the USD/GBP market:• 30-day forward rate: USD/GBP = USD/GBP = 2.0045 - 55• 60-day forward rate: USD/GBP = USD/GBP = 2.0075 - 85Williams has uncovered a potential arbitrage opportunity in the foreign exchange markets. The current spot rate is $2.00 per BU. The Bundovian risk-free interest rate is 3%, and the one-year forward rate is $2.10 per BU. The U.S. risk-free rate is 5%.Based on the USD/GBP and USD/SFr quotes, in response to Williams's request, the bank would quote a cross rate closest to:
Answer(s): A
The bid rate in GBP/SFr is the rate a trader can convert SFr into GBP (remember "up- the-bid"). To do this indirectly through USD, convert SFr into USD at the bid rate of 0.8550 ("up-the- bid") and then convert USD to GBP at the ask rate of 2.0020 ("down-the-ask"). To arrive at GBP/SFr, divide the USD/SFr bid rate by the USD/GDP ask rate. The cross bid rate in GBP/SFr would be:The ask rate in GBP/SFr is the race a trader can convert GBP into SFr ("down-the-ask"). To do this indirectly through USD, convert GBP into USD at the bid rate of 2.0010 ("up-thc-bid") and then convert USD to SFr at the ask rate of 0.8560 ("down-the-ask"). To arrive at GBP/SFr, divide the USD/SFr ask rate by the USD/GDP bid rate. The cross ask rate in GBP/SFr would be:The GBP/SFr quote would be: GBP/SFr = 0.4271 – 78 (Study Session 4, LOS 18.c)
Robert Williams is a junior analyst at Anderson Brothers, a large Wall Street brokerage firm. He reports to Will McDonald, the chief economist for Anderson Brothers. McDonald provides economic research, forecasts, and interpretation of economic data to all of Anderson's investment departments, as well as the firm's clients. McDonald has asked Williams to analyze economic trends in the country of Bundovia. The currency of Bundovia is the Bunco (BU).Williams first analyzes the effect of rising nominal Bundovian interest rates relative to U.S interest rates on the supply and demand for BU. He determines that the increase in Bundovian nominal interest rates would increase the demand for BU and, because the BU supply curve is upward sloping, the BU will appreciate and the equilibrium quantity of BU will increase proportionately.Bundovia has announced plans to impose either a tariff or a quota on semiconductor imports from the United States. McDonald also asks Williams to analyze the potential effect on Bundovian Semiconductors, the dominant semiconductor manufacturer located in Bundovia. Currently, Bundovian Semiconductors is not competitive in the global semiconductor market because its higher production costs make it unable to generate profits at the current world market price.Williams concludes that the imposition of either a tariff or quotas would benefit Bundovian Semiconductors. The company would become competitive with foreign producers in its domestic semiconductor market because imports would be reduced and domestic production would rise.Exhibit 1 shows the trend in the average BU/USD exchange rate over the past three years.Williams asks the bank for a GBP/SFr cross rate.From the same bank, Williams receives the following forward rate quotes in the USD/GBP market:• 30-day forward rate: USD/GBP = USD/GBP = 2.0045 - 55• 60-day forward rate: USD/GBP = USD/GBP = 2.0075 – 85Williams has uncovered a potential arbitrage opportunity in the foreign exchange markets. The current spot rate is $2.00 per BU. The Bundovian risk-free interest rate is 3%, and the one-year forward rate is $2.10 per BU. The U.S. risk-free rate is 5%.Is the USD selling at a 30-day forward premium or discount to the GBP, and what is the size of the 30-day premium or discount in annualized percentage terms?Premium or discount Annualized percentage
Answer(s): C
Use the mid-points of the spot and forward bid-ask spreads {2.0015 and 2.0050, respectively) to calculate the premium or discount. Notice that the quotes are in USD/GBP with GBP as the reference currency, so to calculate the 30-day forward premium or discount on the USD, take the reciprocal of each mid-point.(Study Session 4, LOS 18.g)
Robert Williams is a junior analyst at Anderson Brothers, a large Wall Street brokerage firm. He reports to Will McDonald, the chief economist for Anderson Brothers. McDonald provides economic research, forecasts, and interpretation of economic data to all of Anderson's investment departments, as well as the firm's clients. McDonald has asked Williams to analyze economic trends in the country of Bundovia. The currency of Bundovia is the Bunco (BU).Williams first analyzes the effect of rising nominal Bundovian interest rates relative to U.S interest rates on the supply and demand for BU. He determines that the increase in Bundovian nominal interest rates would increase the demand for BU and, because the BU supply curve is upward sloping, the BU will appreciate and the equilibrium quantity of BU will increase proportionately.Bundovia has announced plans to impose either a tariff or a quota on semiconductor imports from the United States. McDonald also asks Williams to analyze the potential effect on Bundovian Semiconductors, the dominant semiconductor manufacturer located in Bundovia. Currently, Bundovian Semiconductors is not competitive in the global semiconductor market because its higher production costs make it unable to generate profits at the current world market price.Williams concludes that the imposition of either a tariff or quotas would benefit Bundovian Semiconductors. The company would become competitive with foreign producers in its domestic semiconductor market because imports would be reduced and domestic production would rise.Exhibit 1 shows the trend in the average BU/USD exchange rate over the past three years.Williams asks the bank for a GBP/SFr cross rate.From the same bank, Williams receives the following forward rate quotes in the USD/GBP market:• 30-day forward rate: USD/GBP = USD/GBP = 2.0045 - 55• 60-day forward rate: USD/GBP = USD/GBP = 2.0075 - 85Williams has uncovered a potential arbitrage opportunity in the foreign exchange markets. The current spot rate is $2.00 per BU. The Bundovian risk-free interest rate is 3%, and the one-year forward rate is $2.10 per BU. The U.S. risk-free rate is 5%.The maximum profit from covered interest arbitrage in the USD/BU market by borrowing $1,000 or the BU equivalent is closest to:
The covered interest differential is:Therefore the appropriate arbitrage strategy is to borrow dollars at the "low rate" of 5% and invest in BU at the "high" rate of 8.15%.1. Borrow $1,000 at 5%. At the end of one year, Williams will be obligated to repay $1,000(1.05) = $1,050.2. Convert the $1,000 to BU at the spot rate, which yields $l,000/($2/BU) = BU500.3. Simultaneously enter into a 1-year forward contract to convert BU to USD at the forward rate of $2.1000/BU.4. Invest BU500 at 3%. In one year, Williams will receive proceeds of BU5O0(1.03) = BU515.5. Convert the BU515 back to USD at the forward rate, which was locked in at the.($2.1/BU) beginning of the year and yields BU) = $ 1,081.50.6. Arbitrage profits = $1,081.50 - $1,050 = $31.50.Notice that the arbitrage profits are equal to the covered interest differential times the initial amount borrowed: $1,000(0.0315) = $31.50. (Study Session 4, LOS 18.h)
Frank Hoskins and Paul Lanning are economists for a large U.S. investment advisory firm. Platinum Advisors. Hoskins and Lanning use their independent research on U.S. stocks and international stocks to provide advice for the firm's network of advisors. As the senior economist at Platinum, Hoskins is a partner in the firm and is Lanning's supervisor. Lanning has worked for Platinum for the past four years. At a lunch meeting, the two economists discuss the usefulness of economic theory, economic data, and the resulting forecasts of the global economic and stock market activity.Hoskins is investigating the growth prospects of the country of Maldavia. Maldavia is a formerly communist country with a population of 3 million located in Eastern Europe. The Maldavian government had been aggressive in instituting political reform and encouraging the growth of financial markets. However, due to a recent insider trading scandal and resulting stock market volatility, the Maldavian government is considering restrictions on further stock market growth and the establishment of a national securities regulator. Hoskins states that these developments are not encouraging for future economic growth.Lanning is examining the country of Petra. Petra is a country of 25 million located in South America and rich with natural resources including oil. The recently elected president of Petra, Carlos Basile, has announced that he would like to diversify the country's economy away from natural resources while nationalizing the oil industry. Lanning states that these changes would not be beneficial for the future growth of the Petrian economy.One of the many items they study when examining an economy or stock market is the economic information released by governments and private organizations. Hoskins and Lanning use this information to determine the effects on economic growth and the appropriate portfolio allocations to the bond and stock markets. Examining information for Maldavia, Hoskins has learned that the Maldavian private sector has embarked on an ambitious plan to increase labor productivity by purchasing more machinery for its factories. The private sector feels compelled to do this because Maldavia has historically relied too heavily on labor as the main input into production. Plotting the productivity curve for Maldavia, Hoskins states that labor productivity should increase because the productivity curve will shift upward and to the right.Lanning is examining the historical record of economic growth in Petra. He has gathered the data in Exhibit 1 to determine potential economic growth.Hoskins is also examining data for the country of Semeria. Semeria is an emerging country that has benefited from recent changes in the political environment as well as technological advances. Its economy is growing rapidly, and changes in the Semerian economy and society have resulted in more opportunities for women. The Semerian economy has experienced 17 consecutive quarters of positive growth in GDP, which is unprecedented in Semerian history. Interest rates have increased over time because businesses have been borrowing heavily to invest in new machinery and technologies. Most economists are forecasting further increases in interest rates in Semeria.It has long been Platinum's policy that its economists use long-term economic growth trends to forecast future economic growth, stock returns, and dividends in a country. Lanning is examining the economy of Tiberia. Tiberia has a population of 11 million and is located in northern Africa. Its economy is diversified, and its main exports are agricultural products and heavy machinery. The country's economy has been growing at an annual rate of 6.2% for the past ten years, in part because of technological advances in the manufacture of heavy equipment. These advances involve the use of computer-operated welding machines that have made the manufacture of heavy equipment less expensive. Lanning is worried, however, that the 6.2% GDP growth rate may not be sustainable and is considering advising Platinum's portfolio managers to decrease their portfolio allocations in the country. Before doing so, he will consult with Hoskins.Are the statements made by Hoskins and Lanning regarding the future growth of the Maldavian and Petrian economies likely to be correct or incorrect?
Hoskins statement is likely to be correct. If the Maldavian government is considering restrictions on further stock market growth, then this will limit future economic growth. Economic growth is dependent in part on markets, because markets facilitate business transactions between buyers and sellers. The establishment of a securities regulator may or may not be neutral for the economy, but this is not explicitly mentioned in the topic review as a factor influencing economic growth.Lanning's statement is also likely to be correct. If the president of Petria nationalizes the oil industry, then private property will be seized and property rights will not have been respected. Without property rights, firms and individuals have little incentive to make investments that could lead to future economic growth. The diversification of the economy, while perhaps good for the long-term health of the economy, is not explicitly mentioned in the topic review as a factor for economic growth. (Study Session 4, LOS 14.e)
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