Internation Economic - Essay Example

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Geographical Arbitrage occurs when one currency sells for two prices in two different markets. Does Geographical arbitrage exit between NY and Japan given the following exchange rates. How would you gain from this arbitrage (hint: which currency would you buy and sell in…
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International Economics Suppose the following exchange rate are published  New York 529/£ pound  = USD/GBP Frankfurt: $0.876/€ Euro  = USD/EURLondon: 0.639/£ 
a. Calculate the cross exchange rate between the euro and pound 
EUR/GBP = (1.529/£)/(0.876/€) = €1.745/£ = EUR/GBP

b. If there is triangular arbitrage opportunity how much profit will you make by buying and selling these currencies with $1,000,000? 
$ to € = 100000/0.876 =1141552
€ to £ = 1141552/1.745=654184
£ to $ = 654184*1.529 =1000248
c. How much would you loose if you go the wrong direction in the triangular arbitrage calculations?
$ to £ = 100000/1.529 = 654022
£ to € = 654022*1.745=1141268
€ to $ = 1141268*0.876 = 999751
2. Geographical Arbitrage occurs when one currency sells for two prices in two different markets. Does Geographical arbitrage exit between NY and Japan given the following exchange rates. How would you gain from this arbitrage (hint: which currency would you buy and sell in which market) 
New york: $0.0086/Yen 
Japan: Yen131/$ 
Multiplying the two exchange rates, the value is 1.1266, which not being 1 shows indicates that there is a price difference in the two markets for the same set of currencies.
The difference in rates can be exploited from both markets either by selling USD in Japan or Yen in NY.
For instance, 100 USD in japan  13100 Yen. Selling this in NY would give 112.6 USD. Profit=$12.6
100 Yen in NY  0.86 USD. Selling this in Japan would yield the same profit of $12.6
3. IBM will need 1,000,000 Euros in 90 days to purchase German Goods(import). The spot rate is$1.29 per euro. If in 90 days IBM thinks that the sport rate may be $1.20 per Euro. How can IBM avoid exposure or take advantage of this spot rate? What would you do if you believe the spot rate will be $1.35 per Euro?
If IBM were to raise 100000 EUR now, it would require $129000
When the USD/EUR = 1.20 after 90 days, dollars required=$120000
As such, IBM can end up saving close to $9000 if it chooses to exchange at the end of the 90 day period.
If the spot rate is USD/EUR=1.35, IBM would need to pay $135000 for the same. As such, it can save $6000 if it exchanges at the current spot rate.
4.The United states has experienced a Balance of payment Trade deficit since 1982. You are a member of the Council of economic advisers to President and you role is to advise the President, who is very concerned about the rising EURO and the Trade Deficit, on how he can reduce or correct the Trade deficit respond to the Euro. What actions would you recommend and why?
The US trade deficit shows that the country is importing more than its exports. Any act of balancing the trade deficit through increased exports that match with the imports will take years to yield the desired results. One of the easiest ways to ease out is through favorable changes in the currency exchange rates such as the Euro. A rising euro means that the United States is able to export more than previous levels. As such, the trade deficit has come down since 1996 compared to previous years. Therefore, it is advised to maintain the favorable variations in currency by looking into the factors that affect these exchange rates and utilizing them for the benefit of the state. Read More
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