Scenario 1 [5 marks]
You have been asked to select one of the three market views developed by your group in stage 1. Using this market view, devise a speculation strategy that enables your organisation to take advantage of your predicted changes in the exchange rates. You should specify which currencies you will buy or sell. As part of your strategy you must create a portfolio as of 3rd of May 2021. This portfolio will comprise of the currency pair analysed in your market view.
The senior management has allocated you 400,000,000 units of currency as the initial balance for your speculation strategy if you are speculating on AUD, GBP, CAD, EUR, NZD, CHF or USD and 25,000,000,000 units if you are speculating on JPY. For instance, if you are speculating on AUD/EUR and decided to short the EUR then you have been allocated 400,000,000 EURs for this purpose. The corresponding long position should be calculated using bid/ask rates provided in Table 1. Please note that you must speculate on one currency pair only (two currencies). You must then take long and short positions as of 3rd of May 2021 in the respective currencies in accordance with your market view as a price taker [2.5 Marks]. These long and short positions will constitute your portfolio’s current opening position. Based on your initial position you must estimate the opening AUD value of your portfolio using the mid rates in Table 1 and update your position summary table below with your speculative position [2.5 Marks]. Mid rate = (bid rate + ask rate)/2
Comm / Terms Bid Ask Mid
AUD/USD 0.7161 0.7163 0.7162
AUD/EUR 0.6069 0.6073 0.6071
EUR/AUD 1.6471 1.6474 1.6473
AUD/GBP 0.5470 0.5473 0.5472
GBP/AUD 1.8275 1.8280 1.8278
AUD/JPY 75.75 75.78 75.77
EUR/USD 1.1795 1.1799 1.1797
GBP/USD 1.3087 1.3092 1.3090
USD/JPY 105.78 105.81 105.80
EUR/GBP 0.9010 0.9015 0.9013
EUR/JPY 124.79 124.83 124.81
GBP/JPY 138.45 138.50 138.48
AUD/CAD 0.9432 0.9440 0.9436
EUR/CHF 1.0750 1.0759 1.0755
GBP/CHF 1.1929 1.1938 1.1934
USD/CHF 0.9115 0.9117 0.9116
USD/CAD 1.3175 1.3179 1.3177
NZD/USD 0.6539 0.6542 0.6541
Table 1: Exchange rates on April 22, 2021. Mid rate = (bid rate + ask rate)/2
Currency Opening Position (current) Position in AUD (Current) Net
Trades Net Position (Expected) Net Position in AUD (Expected) Change in Position (AUD)
AUD
CAD
CHF
EUR
GBP
JPY
NZD
USD
Net Position (AUD)
Table 2: FX portfolio position summary
Note: Indicate long positions with a positive sign and short positions with a negative sign (e.g. a short position of 45,000,000 GBP should be indicated as –45,000,000). Mid rate = (bid rate + ask rate)/2
Question 2 [7 marks]
Senior management is concerned about the recent developments in the financial markets. There is a general belief that market volatility has been relatively high, yet it might climb even higher than expected in the near future due to the current global health crisis. You have been asked to conduct a thorough risk assessment of your speculative positions undertaken in question 1. For this purpose, the firm’s foreign currency analyst has provided you with the 2-month benchmark rates of these major currencies:
Currency Benchmark Interest Rates 2-Month Benchmark Rates
(%)
AUD 2-Month Bank Bill Swap Rates 0.095
GBP 2-Month GBP LIBOR 0.073
CAD 2-Month Treasury Bills 0.150
EUR 2-Month Euro LIBOR -0.495
NZD 2-Month Bank Bill Yields 0.270
CHF 2-Month CHF LIBOR -0.744
JPY 2-Month JPY LIBOR -0.059
USD 2-Month USD LIBOR 0.205
Table 3: Benchmark interest rates on April 23, 2021.
Using the interest rates above, calculate the implied forward bid, ask and mid rates for the currency pairs in Table 4 (next page) [3 Marks]. You must then calculate the value of your FX portfolio at the end of June using the calculated bid/ask rates. Report the expected value of your position in each currency in the position summary in Table 2 [2 Marks]. Finally, you must calculate expected profit/loss (gain or loss over the opening position) on your portfolio in AUD [1 Mark]. The AUD value of the net expected position must be calculated using the estimated mid rates.
Comm / Terms Bid Ask Mid
AUD/USD
AUD/EUR
EUR/AUD
AUD/GBP
GBP/AUD
AUD/JPY
EUR/USD
GBP/USD
USD/JPY
EUR/GBP
EUR/JPY
GBP/JPY
AUD/CAD
EUR/CHF
GBP/CHF
USD/CHF
USD/CAD
NZD/USD
Table 4: Implied forward rates at the end of June 2021. Mid rate = (bid rate + ask rate)/2
Explain your final portfolio position to the senior manager. Given the implied forward rates for June, discuss whether your speculative positions will generate profits for the company. You must explain ending positions for each currency (and it’s AUD value using mid rates) in your portfolio? Do your portfolio have any exposure to exchange rate risk? What recommendations, if any, will you make to the senior management? [1 Mark].
Question 3 [6 marks]
The firm’s senior management has taken note of your expertise in arbitrage trading. You have been asked to identify potential arbitrage opportunities based on the differences in exchange rates in table 4 and 5. Suppose that the actual forward rates for the end of June 2021 are as follows:
Comm / Terms Bid Ask Opinion
(over/under/ fairly valued) Suggested Strategy
AUD/CAD 0.9447 0.9455
GBP/USD 1.3100 1.3105
NZD/USD 0.6510 0.6513
Table 5: Actual forward FX rates for the end of June 2021.
Inform the company whether the commodity currencies listed in Table 5 are over-, under-, or fairly valued compared to the implied forward rates estimated in Table 4 [1.5 Marks], and what is your suggested strategy to the top management (buy or sell the commodity currency)? [1.5 Marks].
If there is any arbitrage opportunity available between the implied forward rates estimated in Table 4 and the actual forward rates listed in Table 5, how much profit can you generate for the company as a price taker with 50,000,000 units of currency (choose the most profitable option) [2 Marks]. To minimise the transaction costs involved you can only exploit arbitrage opportunities between two exchange rates (i.e., No Triangular Arbitrage opportunity allowed). Finally, you must convert profit, if any, to AUD using the mid rates estimated in Table 4 [1 Mark].
