FIN3106 Take Home Exam

Students must comply with USQ mandatory examination conditions.

Special Instructions:

• This examination contains seven (7) questions and you are required to answer ALL questions.
• This examination is worth a total of fifty (50) marks.
• You will not be assessed on referencing in this exam. No List of References is required for this Take Home Exam.
• It is acceptable to use dot points to answer any question.
• Students will have twenty four (24) hours to download, complete and upload their answers back to the study desk from when the exam paper is available. After completing the exam, students must upload their exam answers in a document file no later than 24 hours after the exam was available. Please note that there is no provision for an “extension” on an exam.
• The study desk will be closed to forum discussions in line with University directives once the exam is available and course leaders will not be available by email to answer questions during this period.
• You are required to submit your responses to the exam by uploading a document file with your answers in any of the following formats: .doc .docx .epub .gdoc .odt .oth .ott .pdf .rtf. Please note that you are only allowed to submit ONE such document file electronically. The file size of your document must not exceed 10MB. If you wish, you can use this take home exam document as a template and simply insert your answers beneath the questions asked. It is recommended you use the following file naming protocol when submitting your file (the example shown is based on a Word file submission): FIN3106_T2_final exam_2025_FamilyName_StudentNumber.docx.
• Some questions in this take home exam will have word limits which must be adhered to. Please ensure that you adhere to any word limits stipulated when answering the exam questions.
• Finally, there is no restriction on what you can cut and paste into your word file provided you do not exceed the 10 MB document size in total i.e. you can cut and paste diagrams, tables etc. if you wish into your document file.

Question 1 (8 marks total)

a) Given the following call option on Apple Inc. (AAPL).

• Current Stock Price (Spot rate): $150
• Strike Price: $140
• Time to Expiration: 30 days
• Option Premium: $12

1.  What is the Intrinsic value of this call option in dollars. Briefly explain in no more than 1-2 sentences the meaning of this value you calculated. (1 mark)
2.  What is the time value of this call option in dollars. Briefly explain in no more than 1-2 sentences the meaning of this value you calculated. (1 mark)

b) One year ago, you wrote (sold) a put option on 100,000 euros with an expiration date of 1 year. The premium received was AUD 0.05 per unit. The exercise price was AUD 1.22 / 1 Euro. The spot rate of the euro one year ago was AUD 1.20 / 1 Euro. From one year ago to today, the euro has depreciated against the Australian dollar by 4 percent. Determine the total dollar amount (in Australian dollars) of your profit or loss from your position in the put option? (3 marks)

c) A trader sells (writes) an American-style EUR put option on the EUR/USD exchange rate with the following terms:

• Strike price: 1.0800
• Time to maturity: 2 months
• Premium received: 0.0100 USD per EUR
• Option contract amount: 1 million EUR

Under the following scenarios, outline whether the seller (writer) made a profit or loss and the amount of that profit or loss:

1. the EUR/USD exchange rate fell to 1.0780 (1 mark)
2. the EUR/USD exchange rate stayed at 1.0800 throughout (1 mark)
3. the EUR/USD exchange rate rose to 1.09 (1 mark)

Question 2 (8 marks total)

a) A basket of goods costs $100 USD in the United States and $150 AUD in Australia. What should the exchange rate be according to absolute PPP? If the actual exchange rate is 0.70 USD/AUD, is the AUD overvalued or undervalued? (2 marks)

b) Inflation in the US is expected to be 3%, and in Australia 5% over the next year. The current exchange rate is 0.68 USD/AUD. What is the expected exchange rate in one year according to relative PPP? (2 marks)

c) The nominal interest rate in the US is 4%, and in Australia it's 6%. The current exchange rate is 0.6750 USD/AUD. What is the expected exchange rate in one year according to the International Fisher Effect? (2 marks)

d) The current US Treasury bill rate is 0.19% per annum and the Australian Treasury bill rate is 3.1% per annum. The spot rate in Australia is USD 0.8299 per 1AUD i.e. AUD/USD 0.8299. The 3-month forward rate is currently USD 0.8319 per 1AUD i.e. AUD/USD 0.8319.

1. i. If the forward rate is an unbiased predictor, what is the expected future spot rate in 3 months’ time? (1 mark)
2. ii. If the international Fisher effect holds, what is the expected future spot rate in 3 months’ time? Show your workings. (1 mark)

Question 3 (8 marks total)

a) The following exchange rates are forecast for one-year hence (€0.90/$, $1.60/£ and €1.46/£) where € represents the Euro, $ represents the United States Dollar and £ represents the British Pound. Are they in equilibrium? If not, can you make a profit using triangular arbitrage? Explain your answers in 2-3 sentences using any calculations to support your answer. (3 marks)

b) A finance manager has been tasked with investing 1,000,000 Australian Dollars AUD (or Chinese Renminbi CNY equivalent) for a period of three (3) months. Facing the rates shown in the table below, should the finance manager enter into a covered interest arbitrage (CIA) investment? If yes, show all relevant calculations to support your answer and show which currency the finance manager should invest in. If no, provide an explanation in no more than 4-5 sentences as to the reason why the finance manager should not enter into a covered interest arbitrage (CIA) investment.

Spot exchange rateS90 (CNY/AUD)5.048/AUD90-day forward rateF90 (CNY/AUD)4.8733/AUDAUD discount rateiAUD6.00% p.a.Chinese discount rateiCNY4.00% p.a.

QUESTION 4 (8 marks total)

a) XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of $0.0012 cent per yen. Would the firm be better off with a forward hedge, money market hedge or option hedge. Show workings for each. (3 marks)

b) A company expects to receive €10 million in 3 months. It wants to hedge against exchange rate risk using one of the following strategies:

• i) No hedge
• ii) Forward Hedge
• iii) Money market hedge
• iv) Option hedge

The company has the following information available (shown on next page):

• Spot rate (EUR/USD): 1.1000 where EUR is the Base currency and USD is the quote currency
• Forward rate (3 months): 1.0950
• EUR interest rate: 2% p.a.
• USD interest rate: 4% p.a.
• Put option strike price: 1.1000
• Put option premium: 0.0150 USD/EUR
• Projected spot rate in 3 months: 1.0800
• Receivable amount: €10,000,000

Would the company be better off with a forward hedge, money market hedge, option hedge or simply remain unhedged (assuming that the projected spot rate in 3 months is indeed 1.08)? Show workings for each. (5 marks)

QUESTION 5 (6 marks total)

An MNE wishes to calculate its weighted average cost of capital (WACC) for both its domestic operations and its international operations. In other words it wants to work WACC in both traditional domestic form (CAPM) and also in international form (ICAPM). The company has the following information available:

• i) a risk-free rate of 3.40% for CAPM and 2.8% for ICAPM
• ii) expected return of 8.5% on the domestic market portfolio of stocks and 7.25% for its international market portfolio of stocks
• iii) a domestic beta of 1.35 and an international beta of 0.85
• iv) a cost of debt before tax of 7.5% for both domestic CAPM and international CAPM
• v) a corporate income tax rate of 30%
• vi) a capital structure of 45?bt and 55% equity

For both the domestic CAPM and ICAPM, calculate:

1. the company’s cost of equity (2 marks)
2. the company’s cost of debt (2 marks)
3. the company’s weighted average cost of capital (2 marks)

Question 6 (7 marks total)

Two parties, A and B, wish to swap interest rate exposures. Party A can borrow at 6% fixed or LIBOR + 0.5%. Party B can borrow at 7.4% fixed or LIBOR + 1.0%.

Party A prefers fixed whereas party B prefers floating. The two companies agree to undertake an interest rate swap.

a) Calculate the Quality Spread Differential (1 mark)

b) Assume the two parties equally share the QSD under the proposed interest rate swap. Demonstrate how an interest rate swap would benefit both parties and what each party is paying and receiving. You can use a diagram if you wish to answer this question. (3 marks)

c) Assume that instead of the two parties directly undertaking a swap between themselves, they enlist the assistance of a swap bank. In this instance, the swap bank will take 0.2% of the QSD with the remainder split equally between the two parties. Demonstrate how an interest rate swap would benefit both companies and the swap bank and what each party is paying and receiving in the swap. You can use a diagram if you wish to answer this question. (3 marks)

Question 7 (5 marks total)

How do cryptocurrencies differ from traditional fiat currencies? Answer by outlining three differences.

Assessment Summary and Key Pointers

The FIN3106 Take Home Exam is a mandatory, open-book examination with a 24-hour time limit. It consists of seven compulsory questions worth a total of 50 marks. The exam covers various topics in international finance, including currency options and hedging, purchasing power parity (PPP), interest rate parity (IRP), weighted average cost of capital (WACC), and interest rate swaps. No referencing is required, and dot points are an acceptable format for answers. Submissions must be a single document file in a specified format and size.

Key topics and pointers to be covered:

• Currency Options: Calculating intrinsic and time value, and determining profit/loss for a put option writer.

• Exchange Rate Theories: Applying absolute PPP, relative PPP, and the International Fisher Effect (IFE) to calculate exchange rates and evaluate currency valuation.

• Arbitrage and Hedging: Identifying and executing triangular arbitrage and covered interest arbitrage (CIA), as well as comparing different hedging strategies (forward, money market, and options) to manage foreign exchange risk.

• Cost of Capital: Calculating the cost of equity, cost of debt, and WACC using both the traditional Capital Asset Pricing Model (CAPM) and the International CAPM (ICAPM).

• Interest Rate Swaps: Calculating the Quality Spread Differential (QSD) and demonstrating the benefits of an interest rate swap for different parties, with and without a swap bank.

• Cryptocurrencies: Differentiating cryptocurrencies from traditional fiat currencies.

Academic Mentor's Approach to the Assessment

The academic mentor guided the student through the exam in a step-by-step process , ensuring a comprehensive understanding of each section and its underlying learning objectives.

Section-by-Section Breakdown

• Question 1 (Options and Currency Profit/Loss): The mentor began by reviewing the fundamental concepts of options. They guided the student to first calculate the intrinsic value of the call option as the difference between the stock price and the strike price ($150 - $140 = $10). Next, the time value was determined by subtracting the intrinsic value from the option premium ($12 - $10 = $2). The mentor explained that intrinsic value is the immediate profit if the option were exercised, while time value represents the remaining value based on the chance of future price movements. For the put option profit/loss, the mentor helped the student calculate the new spot rate after a 4?preciation of the Euro against the AUD and then compute the total profit/loss by comparing the exercise price to the new spot rate, factoring in the initial premium.

• Question 2 (Exchange Rate Theories): This section was approached by breaking down the three key economic theories.

  • Absolute PPP: The mentor explained the concept that the exchange rate should equalize the price of a basket of goods in two countries. The student was guided to set up the ratio of the USD price to the AUD price ($100 / $150 = 0.6667 USD/AUD) and then compare this theoretical rate to the actual rate of 0.70 USD/AUD to determine if the AUD was overvalued or undervalued.

  • Relative PPP and IFE: The mentor explained that these theories predict future exchange rates based on inflation and interest rate differentials, respectively. The student was shown the formulas for each and guided to substitute the given values to calculate the expected future exchange rates. The final part of the question on the unbiased forward rate was straightforward, as it's a direct application of the theory: the forward rate is the best predictor of the future spot rate. The mentor also ensured the student understood how to apply the IFE to find the future spot rate, showing the calculations and workings.

• Question 3 (Arbitrage): The mentor emphasized the "no-free-lunch" principle in finance.

  • Triangular Arbitrage: The student was guided to check for equilibrium by calculating the cross-rate (e.g., Euro-to-Pound rate via the USD) and comparing it to the given market rate. The mentor helped the student identify the disequilibrium and then set up a step-by-step arbitrage strategy (e.g., starting with one currency, converting it to the second, then the third, and finally back to the original) to demonstrate the profit opportunity.

  • Covered Interest Arbitrage (CIA): The mentor explained the principle of investing in the currency with the higher interest rate while simultaneously hedging the exchange rate risk with a forward contract. The student was guided to calculate the future value of investing in both AUD and CNY and compare the outcomes to determine the more profitable investment path. The mentor ensured the student understood why a finance manager would or would not enter into a CIA.

• Question 4 (Hedging): The mentor focused on comparing the outcomes of different hedging strategies.

  • Foreign Currency Payable: The student was guided to calculate the cost in USD for XYZ Corporation under a forward hedge , a money market hedge (borrowing yen, converting to USD, and investing), and an option hedge (calculating the cost including the premium). A simple comparison of the final USD costs for each method was used to identify the best strategy.

  • Foreign Currency Receivable: Similarly, the student was guided to calculate the final USD amount received under a forward hedge , a money market hedge , and an option hedge , and also the amount received if the firm remained unhedged . The mentor helped the student analyze the results to determine the most profitable strategy under the given projected spot rate.

• Question 5 (Cost of Capital): The mentor broke down the WACC calculation into its core components.

  • Cost of Equity: The student was guided to apply the CAPM formula for both domestic and international operations, plugging in the respective risk-free rates, market returns, and betas.

  • Cost of Debt: The after-tax cost of debt was calculated by applying the corporate tax rate to the pre-tax cost of debt.

  • WACC: Finally, the mentor showed the student how to combine the after-tax cost of debt and the cost of equity, weighted by their respective proportions in the capital structure, to arrive at the overall WACC for both domestic and international operations.

• Question 6 (Interest Rate Swaps): The mentor used a practical, visual approach to explain this complex topic.

  • QSD Calculation: The student was first guided to calculate the QSD by finding the difference in fixed-rate borrowing costs and floating-rate borrowing costs between the two parties.

  • Swap with No Bank: The mentor helped the student construct a simple diagram showing the flow of payments to demonstrate how the QSD is shared and how both parties achieve their preferred borrowing rate while saving on their borrowing costs.

  • Swap with a Bank: A more complex diagram was created to illustrate the role of the swap bank, showing the flow of payments from the parties to the bank and from the bank to the parties, ensuring the student understood how the bank takes its spread while still providing a benefit to both parties.

• Question 7 (Cryptocurrencies): The mentor facilitated a discussion on the key differences. The student was encouraged to outline distinctions based on central authority (decentralized vs. central bank), physical form (digital vs. physical), and regulation (unregulated vs. government-backed).

Outcome and Learning Objectives Covered

The academic mentor’s structured approach led to a high-quality outcome, with the student successfully answering all seven questions. This process ensured that the student not only completed the exam but also achieved a deep understanding of the key learning objectives.

The key learning objectives covered included:

• Financial Instrument Valuation: The ability to price and value currency options, understanding the components of intrinsic and time value.

• International Economic Theories: A solid grasp of PPP and IRP and their application in predicting exchange rates and identifying misaligned currencies.

• Risk Management: The ability to analyze and apply various foreign exchange risk hedging strategies.

• Corporate Finance: The skill to calculate a company's cost of capital, a crucial concept for investment decisions, incorporating international factors.

• Financial Engineering: Understanding the mechanics of interest rate swaps and how they can be used to manage interest rate risk and create mutual benefits.

• Emerging Technologies: A foundational understanding of the differences between traditional and new forms of currency, such as cryptocurrencies.

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