## Transcribed Text

1 Volusia, Inc. is: U.S. based exporting firm that expects to receive payments of €400,000 and
C$400,000, both five days. Today's spot rates are US$1 25/€ and C$1 25/US$ Based ondata for the
last five years, Volusia estimates the standard deviation of daily percentage changes to be 0.8% for the
euro and 0 3% for the Canadian dollar. The correlation coefficient between the euro and the Canadian
dollar 0.30.
a. What is the -day 99% VaR for the portfolio? Assume that returns are normally distributed withmean
zero.
Answer:
N 1 day
1 day
X 99%
X =99%
a day=0.8%
O'day=0.3%
S. $1.25/€
S. = $1.25/$
(€400,000)*($1 25/€) €500,000
($400,000)*($1.25/$) $500,000
(€500,000)*(0.008) €4,000
($500,000)*(0.003) = $1,500
1 day 99% VaF 2.33 * (€4,000) =
1-day 99% VaR (2.33) ($1,500)
$9,320
$3.495
5 -day 99% VaF SQRT (5) ($9,320)
5-day99% VaR=SQRT (5) *
$20,840.15
($3,495)=$7,815.058
(€4,000^2)+ ($1,500^2)+2*0.3*
€4,000* $1,500=$21,850,000
SQRT(5*(21850000)) = $10,452.27
2.33*10452.27 =$24,353.79
b What the benefit of diversification e., what the reduction in the 5-day 99% VaR for the portfolio
relative to the VaR of the individual cash flows?
2. Thespot Kr/¥ FX rate S0 KrO.10/¥. The annualized 9- month Kinterestratei 3.0% and the
annualized -month Kr interest rate is 5.0% Suppose that you observe S -month forward price of
KrO.09/¥. How would you make an arbitrage profit? Describe the steps and calculate the profit (9
months 0.75 years)
3 Baps Corporation considering the establishment of subsidiary in Norway. The initial investment
required by the parent is NOK40 million. Ifthe project i undertaken, Baps would terminate the project
after four years. Baps cost of capital is 13% and the project softhe same risk as Baps' existing
projects. All net cash flows generated from the project will be remitted to the parent at the end of each
year. Listed separately below are the estimated cash inflows and outflows the Norwegian subsidiary will
generate over the project's lifetime in millions of Norwegian kroner (NOK), and Baps forecast of future
exchange rates. The current exchange rate of the Norwegi. an kroneri $0 135/NOK.
Year
1
2
Inflow
NOK18
NOK25
NOK29
NOK40
Outflow
NOK8
NOK10
NOK12
NOK15
FX Rate
$0.13/NOK
.14/NOK
$0.12/NOK
$0.15/NOK
a. What is the NPV, in S,of the Norwegian project?
b
Assume that of the NOK40 million cash inflow in year NOK25 million is from operations and NOK15
millioni the assumed salvage value for the project. What the break even salvage value for the
project, i.e., the salvage value at which the project has zeroNPV?
Use the following information for problem 4.
Stewart & Stevenson, a Texas based retailer of power plants, has agreed to sell two gas turbines to
British utility INPOWER at price of £10million per turbine. Payment will be received upon delivery of
heturbines one (1) year from today. You are Stewart & Stevenson's Treasurer. You have obtained
the
following quotes.
Spot FX (Foreign eXchange)rate: $1.5000/£
One year forward FX rate: $1.5218/£
One year interest rate: 4.50%
One year interest rate: 3.00%
One year call option (on £) with strike price $1 500/£: $0.0691/£
One year put option (on £ withstrike price $1 500/£: $0.0474/£
You considering three possible strategies
i)
Hedgeusing the forward market.
ii)
ii) Hedge using the money market.
iii)
iii) Hedge using the options market
4. For ach hedging strategy, calculate the expected cash flows, both today and n° year, and di raw the
cash flow profile as : function ofthe future spot FX (rate. Based on your calculations choose the
strategy you think best. What reason will you give the CEO for choosing this particular strategy? (You
must include sound economic reason in order to get full credit!). Stewart & Stevenson's WACC= 11%.
Stockholm Bank S(¥/Kr) $19.00/SEK
Tokyo Bank s(¥/$) ¥167.0/$
New York Bank S(£/$)=E0.900/$
London Bank S(Kr/£) SEK9.50/£
5. Suppose you have ¥1 ,000. Given the FX rates above, can you earn an arbitrage profit? If yes show
the steps involved intaking advantage of the arbitrage opportunity and calculate your profit in yen.
Assume that there are no transactions costs.

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