Risk management sol. John Hull
INSTRUCTOR’S MANUAL: MULTINATIONAL FINANCIAL MANAGEMENT, 9TH ED.
CHAPTER 7
SUGGESTED ANSWERS TO CHAPTER 7 QUESTIONS
1.
Answer the following questions based on data in Exhibit 7.5.
a.
How many Swiss francs can you get for one dollar?
ANSWER. The indirect quote is $1 = SFr 1.0534.
b.
How many dollars can you get for one Swiss franc?
ANSWER. The direct quote is SFr1 = $0.9493.
c.
What is the three-month forward rate for the Swiss franc?
ANSWER. The three-month forward rate is SFr1 = $0.9498.
d.
Is the Swiss franc selling at a forward premium or discount?
ANSWER. At a forward premium.
e.
What is the 90-day forward discount or premium on the Swiss franc?
ANSWER. The 90-day forward premium is 5 points (pips), which translates into an annualized forward premium of
0.21% (4 x (0.9498 – 0.9493)/0.9493).
2.
What risks confront dealers in the foreign exchange market? How can they cope with these risks?
ANSWER. Foreign exchange dealers must cope with exchange risk, because of the foreign currency positions they take. They also bear credit risks since the counterparties to the trades they enter into may not honor their obligations.
They can cope with currency risk by using forward contracts and currency options (see Chapter 10), widening their bid-ask quotes, and limiting the position they are willing to take in any one currency. They can limit credit risk by restricting the position they are willing to take with any one customer and by setting margin requirements that vary with the riskiness of their customers (banks will generally not do this).
3.
Suppose a currency increases in volatility. What is likely to happen to its bid-ask spread? Why?
ANSWER. As a currency's volatility increases, it becomes riskier for traders to take positions in that currency. To compensate for the added risks, traders quote wider bid-ask spreads.
4.
Who are the principal users of the forward market? What are their motives?
CHAPTER 7
SUGGESTED ANSWERS TO CHAPTER 7 QUESTIONS
1.
Answer the following questions based on data in Exhibit 7.5.
a.
How many Swiss francs can you get for one dollar?
ANSWER. The indirect quote is $1 = SFr 1.0534.
b.
How many dollars can you get for one Swiss franc?
ANSWER. The direct quote is SFr1 = $0.9493.
c.
What is the three-month forward rate for the Swiss franc?
ANSWER. The three-month forward rate is SFr1 = $0.9498.
d.
Is the Swiss franc selling at a forward premium or discount?
ANSWER. At a forward premium.
e.
What is the 90-day forward discount or premium on the Swiss franc?
ANSWER. The 90-day forward premium is 5 points (pips), which translates into an annualized forward premium of
0.21% (4 x (0.9498 – 0.9493)/0.9493).
2.
What risks confront dealers in the foreign exchange market? How can they cope with these risks?
ANSWER. Foreign exchange dealers must cope with exchange risk, because of the foreign currency positions they take. They also bear credit risks since the counterparties to the trades they enter into may not honor their obligations.
They can cope with currency risk by using forward contracts and currency options (see Chapter 10), widening their bid-ask quotes, and limiting the position they are willing to take in any one currency. They can limit credit risk by restricting the position they are willing to take with any one customer and by setting margin requirements that vary with the riskiness of their customers (banks will generally not do this).
3.
Suppose a currency increases in volatility. What is likely to happen to its bid-ask spread? Why?
ANSWER. As a currency's volatility increases, it becomes riskier for traders to take positions in that currency. To compensate for the added risks, traders quote wider bid-ask spreads.
4.
Who are the principal users of the forward market? What are their motives?