Economics

Finance: Problem Set 1
Question 1.
An ANZ Bank currency trader working out of Wellington New Zealand wonders if she can make an intermarket arbitrage profit using Solomon Islands dollars (SBD) and Singapore dollars (SGD). If she has 10 million New Zealand dollars to work with and gathers the following quotes, calculate if she can make a profit (show your workings):
National Australia Bank quotes NZD/SBD 5.7796 – 5.8241
Citibank quotes NZD/SGD 1.0148 – 1.0156
Commonwealth Bank quotes SGD/SBD 5.6928 – 5.7371

S(NZD/SBD) 5.8241
S(NZD/SGD) 1.0156
S(SGD/SBD) 5.7371

#1: Start with NZD to SGD
Step 1: NZD/SGD = 9,846,396
Step 2: SGD/SBD = 56,489,759
Step 3: SBD/NZD = 9,699,311

In this scenario there is no arbitrage profit made as there is a loss.

#2: Start with NZD to SBD
Step 1: NZD/SBD = 58,241,000
Step 2: SBD/SGD = 10,151,644
Step 3: SGD/NZD = 10,310,000

In scenario 2 a profit was made.

Question 2.
Assume your firm is based in the US and has a subsidiary in Australia. The subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from local banks. Your subsidiary purchases all of its materials from Hong Kong. The Hong Kong dollar is tied to the U.S. dollar. Your subsidiary borrowed funds from the U.S. parent, and must pay the parent $100,000 in interest each month. Australia has just raised its interest rate in order to boost the value of its currency (A$). The Australian dollar appreciates against the US dollar as a result. Briefly explain whether these actions would increase, reduce, or have no effect on: a) The volume of your subsidiary’s sales in Australia (measured in A$) b) The cost to your subsidiary of purchasing materials (measured in A$) c) The cost to your subsidiary of making the interest payments to the U.S. parent (measured in A$).
Briefly explain each answer.

a) The volume is not going to change directly as we are dealing in Australian Dollars to Australian clients. Fluctuations of the dollar don’t result in terms of purchases. However, indirectly the cost of goods will drop and a consequence the cost of production will drop, then there is a possibility of increased volume of sales due to a drop in price. b) The cost of goods will drop will drop, the cost of HKD/USD will not change, but due to a change in stronger Australian dollar, then the cost of raw goods in Australian dollars will fall. c) The subsidiary in Australia is conducting business in Australian dollars, therefore due to a stronger Australian dollar the number of Australian dollars to make the interest payments will decrease. This will have a direct impact of the profitability to the subsidiary. As will the lower cost of goods, assuming that the consumers sell price remains the same.

Question 3. If the government of Mexico officially changed the value of the Mexican peso from 3.2 pesos per US dollar to 5.5 pesos per US dollar. What was the percentage change in its value? Was this a depreciation, devaluation, appreciation, or revaluation? Briefly explain. The Percentage change = S1-S2/S2 x100 = 3.2-5.5/5.5 x100 = -41.81% devaluation in the Mexican Peso Generally depreciation applies to currencies that are from floating, market sensitive conditions that have little to no government intervention. As the government changed the rate from 3.2 to 5.5 Pesos to USD then this change is considered a devaluation of currency. Also as that you can now get 5.5 pesos to the USD from the previous rate at 3.2 it can be said that the currency has become weaker, therefore it is a devaluation rather than a revaluation.