Question

Question 1 a) Assume the following information: Quoted Price Value of one Euro in U.S. dollars = 1.12 Value of one New Zealand dollar in U.S. dollars = 0.64 Value of one New Zealand in Euro - 0.55 Given this information, is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy if you had $2,000,000 to use. What market forces would occur to eliminate any further possibilities of triangular arbitrage. (5 marks) b) Define functional currency with appropriate example. (3 marks) c) In managing transaction exposure, suggest other methods of reducing exchange rate risk when hedging techniques (forward, futures, money market and currency options) are not available. (3 marks) d) As for today, assume the following information is available for the Canada and United States: 7% 5% Canada United States Expected inflation 3% 2% Annualized nominal interest rate The direct quotation of spot rate: TUSD is equivalent to C$1.42 and one-year forward rate is equivalent C$1.48 i. Does Interest Rate Parity (IRP) hold? Justify. (2 marks) ii. Explain the difference between exchange rate adjustment according to IFE and IRP concept (2 mark) [Total: 15 marks)