MOSHI CO-OPERATIVE UNIVERISTY (MoCU)

BAF 305: INTERNATIONAL TRADE FINANCE

BAF III; BCMA III & BAT III 2023/2024
SEMINAR QUESTIONS – INTERNATIONAL PARITY RELATIONSHIP

SECTION A EXCHANGE RATE AND OTHER ECONOMIC VARIABLES

QUESTION 1
Two countries, Tanzania and Kenya produce only one good, wheat. Suppose the price of wheat in Tanzania
is TZS 3,000 and Kenya is KES. 150.
(i) According to the law of one price, what should the TZS/KES spot exchange rate be?
(ii) Suppose the price of wheat over the next year is expected to rise to TZS. 3,500 in Tanzania and KES.
200 in Kenya. What should the one-year TZS/KES exchange rate be?
QUESTION 2
A year back, the exchange rate was TZS. 2,500 per US$. As compared to the last year, TZS has appreciated
by 10%. The inflation rate in Tanzania was 5% while it was 10% in USA.
Required:
(i) What is the exchange rate today?
(ii) If PPP were to hold, what should have the exchange rate?
(iii) Has TZS appreciated or depreciated with respect to dollar and by how much?
QUESTION 3
(a) If expected inflation is 100% and real required return is 5% what will the nominal-interest rate be
according to Fisher effect?
(b) In July the one-year interest rate is 4% on Swiss Fracs and 13% on US dollars.
▪ If the current exchange rate is SFr1=$0.63 what is the expected future exchange rate in one year?
▪ If a change in expectations regarding future US inflation causes the expected future spot rate to
rise to $0.70 what should happen to the U.S. interest rate according to the international fisher
effect?
(c) If the $: ¥ spot rate is $1= ¥ 218 and interest rates in Tokyo and New York are 6% and 12% respectively,
what will be the expected $: ¥ exchange rate one year hence.
QUESTION 4
Given the spot rate between Tanzania and Kenya is TZS. 20 to KES 1 and the respective annual rates of
inflation are 15% and 10%.
i. Assuming that PPP and the expected theory hold, calculate the rate of foreign exchange expected in 12
months’ time and 12 months forward rate.
ii. If the rate of interest in Tanzania is 20%. What is the rate of interest in Kenya?
QUESTION 5
Assume that the one-year interest rate is 12% in the U.K. The expected annual rate of inflation for the coming
year is 10% for the U.K. and 4% for Switzerland. The current spot exchange rate is SFr 3/£. Using the precise
form of the international parity relations, compute the one-year interest rate in Switzerland, the expected
Swiss franc to pound exchange rate in one year, and the one-year forward exchange rate.
QUESTION 6
The following are spot exchange rates.
US$/£1: 1.8000 €/£1: 1.5000 US$/ €1: 1.2000

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The rates of interest for the next three years are 2.5% on the euro, 3.5% on the US dollar and 5% on sterling.
Required:
If the interest rate parity theory applies, what will the spot exchange rates be? (a) after one year (b) after
three years?
QUESTION 7
(a) A selected bundle of goods costs £100 in the UK, and a similar bundle costs 1200 krona (DKR) in
Denmark. People generally expect the rate of inflation to be 5% in the UK and 3% in Denmark.
Required:
(i) Assuming that PPP applies, what is the current exchange rate between GBP and DKR?
(ii) Assuming that PPP will continues to hold, what spot exchange rate would you predict for twelve
months hence?
(b) Due to the integrated nature of their capital markets, investors in both the United States and the U.K.
require the same real interest rate, 2.5 percent, on their lending. There is a consensus in capital markets
that the annual inflation rate is likely to be 3.5 percent in the United States and 1.5 percent in the U.K.
for the next three years. The spot exchange rate is currently $1.50/£.
Required:
(i) Compute the nominal interest rate per annum in both the United States and the U.K., assuming
that the Fisher effect holds.
(ii) What is your expected future spot dollar-pound exchange rate in three years from now?

SECTION B ARBITRAGE AND SPECULATION

QUESTION 8
Suppose that the current spot exchange rate is €0.80/$ and the three-month forward exchange rate is
€0.7813/$. The three-month interest rate is 5.6 percent per annum in the United States and 5.40 percent per
annum in France. Assume that you can borrow up to $1,000,000 or €800,000.
Required:
Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in
terms of U.S. dollars. Also determine the size of your arbitrage profit.

QUESTION 9
Kisukuru Int. Company limited an international firm based in Tanzania has recently observed that a product
called magadi is also obtained in Kenya. A ton of magadi is sold for TZS 2,000 in Meru Tanzania while the
same ton is sold for KZS 125 in Nakuru Kenya. Given that the current average market rate between TZS/KZS
is 17 and that transportation costs between Meru and Nakuru is TZS 500,000 or (KZS 55,000) per trip; and
that the exchange rates are expected to be stable for the foreseeable future.
Required:
(a) Is commodity arbitrage viable given the above information? Why? (Support your answer with necessary
computations).
(b) Calculate total arbitrage profit and profit per tonne (if any) that Kisukuru Int. Company can make, if it can
purchase 100,000 tons of magadi at any given period from either country.
QUESTION 10
James Clark is a currency trader with Wachovia. He notices the following quotes:
Spot exchange rate SFr1.2051/$
Six-month forward exchange rate SFr1.1922/$
Six-month dollar interest rate 2.50% per year

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 Six-month Swiss franc interest rate 2.0% per year
Required:
(a) Is the interest rate parity holding? You may ignore transaction costs.
(b) Is there an arbitrage opportunity? If yes, show what steps need to be taken to make arbitrage profit.
Assuming that James Clark is authorized to work with $1,000,000, compute the arbitrage profit in dollars.

SECTION C NBAA PAST PAPERS

QUESTION 11 MAY 2003
Suppose the interest rate on £ is 15% in London, and the interest rate on a comparable Tanzanian shilling
investment in Dar Es Salaam is 10%. The £ spot rate is TZS1,750 and the one-year forward rate is TZS1,680.
REQUIRED:
1. Are there opportunities for covered interest arbitrage? Show relevant computations. (2 Marks)
2. Is there covered interest differential in favor of London or Dar es Salaam? (2 Marks)
3. Illustrate the profits associated with covered interest arbitrage by showing the steps that a Tanzanian
arbitrageur can take to profit from the discrepancy in rates. Assume that the borrowing and lending rates
are identical and the bid–ask spread in the spot and forward market is zero. (5 Marks)
QUESTION 12 NOVEMBER 2004
(a) Define the Purchasing Power Parity Theory and discuss the problems it faces when applied in practice.
(b) A basket of mangoes in Tanzania sells for TZS 2,400 while in London the price is £1.60. The cost of
shipping a basket of mangoes from Tanzania to London is 10% of the price of basket in Tanzania.
Required:
i. Calculate the exchange rate TZS/£ implied by the law of one price (LOP).
ii. Suppose the actual exchange rate is TZS 1,975/£. Calculate the Net Profit or Loss on a basket of
mangoes bought in Tanzania and sold in London.
iii. What is the principal drawback of the Absolute Version of the Purchasing Power Parity (PPP)?
QUESTION 13 NOVEMBER 2006
(a) It is now the beginning of year 2006. The spot bid rate for the US Dollar is Tshs. 1,240 while the spot
bid-ask spread is Tshs. 15. A forecaster provides the following forecasts for the bid-ask spread and
inflation rates for Tanzania and United States in the next four years:
Year 2007 2008 2009 2010
Bid-Ask Spread (Tshs.) 23 27 30 45
Forecast rate of inflation:
Tanzania 6% 5% 4% 3.5%
United States 3.5% 3% 3% 2.5%
Required:
On the basis of the bid-ask spread forecasts and the theory of Purchasing Power Parity (PPP), determine
the expected exchange rates and the percentage bid ask-spread for the years 2007-2010. [12 marks]
(b) Due to integrated nature of their capital markets, investors in both Tanzania and Kenya require the same
real interest rate 2.5% on their lending. There is a consensus in the Dar es Salaam Stock Exchange
[DSE] and Nairobi Stock Exchange [NSE] that the annual inflation rate is likely to be 4.5% in Tanzania
and 5.5% in Kenya for the next three years. The spot exchange rate is currently Tshs. 10.5/Kshs.
Required:
(i) Compute the nominal interest rate per annum in both Tanzania and Kenya, assuming that the
Fisher Effect holds. [2 marks]

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 (ii) Calculate the expected future spot Tshs. /Kshs. exchange rate in three years from now, assuming
that the International Fisher Effect holds. [2 marks]
(iii) Determine the expected one-year forward discount/premium at which the Tshs. will be trading
against the Kshs. Assume that the Interest Rate Parity holds. [2 marks]
(iv) Assuming that the PPP holds, calculate the expected percentage depreciation/appreciation of the
Tshs. against the Kshs. one year hence. [2 Marks] [Total: 20 Marks]
QUESTION 14 NOVEMBER 2011
The survey of household’s consumption in Tanzania and Kenya for the year 2009 and 2010 revealed the
following consumption patterns for three commodities.
Tanzania
Product 2009 2010
Wheat flour 15 kgs, Tshs. 500 per kg 15 kgs, Tshs. 550 per kg
Maize flour 25 kgs, Tshs. 300 per kg 25 kgs, Tshs. 350 per kg
Potatoes 35 kgs, Tshs. 250 per kg 35 kgs, Tshs. 250per kg

Kenya
Product 2009 2010
Wheat flour 15 kgs, Kshs. 25 per kg 15 kgs, Kshs. 55 per kg
Maize flour 25 kgs, Kshs. 35 per kg 25 kgs, Kshs. 25 per kg
Potatoes 35 kgs, Kshs. 15 per kg 35 kgs, Kshs. 25 per kg
Required: Calculate the PPP exchange rate for the year 2009. (4 marks)
QUESTION 15 NOVEMBER 2013
(a) (i) Explain the “Purchasing Power Parity (PPP)”
(ii) Briefly discuss the circumstances under which the theory holds and some reasons for deviation from it.
(b) Suppose that the current spot exchange rate is TZS. 2,500/£ and the one-year forward exchange rate
is TZS. 2,600/£. The one-year interest rate is 15% in Tanzania and 10% in United Kingdom.
Required:
(i) Calculate the rate of return in Tanzanian shillings terms of one-year deposit of TZS in the United
Kingdom. State any assumption that you have made.
(ii) Assuming you are an investor based in the United Kingdom, illustrate how you can realize a
guaranteed profit from covered interest arbitrage if you can borrow at most TZS. 15,000,000 or
equivalent pound amount at the current spot exchange rate. Also determine the size of the arbitrage
profit you make.
QUESTION 16 FEBRUARY 2020
The price of a Kilo of sugar in TZS. 2,400 in Tanzania. In Uganda the same Kilogram of sugar is sold for UGS
4,000. The current exchange rate between Tanzania Shilling (TZS) and Uganda Shilling (UGS) is TZS.
0.75/UGS.
Required:
(i) Given the above information, does the Purchasing Power Parity (PPP) hold? Are there opportunities for
profit from commodity arbitrage? (Support your answer with relevant calculations)
(ii) If arbitrage opportunity exists, with reference to (i) above, calculate commodity arbitrage profit assuming
that the trader can purchase and sells one (1) tone (1,000 kgs.) of sugar.
QUESTION 17 MAY 2021
b. Briefly discuss the significance of Covered Interest Rate Parity theory in the determination of forward
currency rates

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c. The fund manager at Uko Capital uses the concepts of purchasing power parity (PPP) and the International
Fisher Effect (IFE) to forecast spot exchange rates. He has gathered the following financial information:
Base price level 100
Current Kenyan price level 105
Current Tanzania price level 111
Base TZS spot exchange rate KSH. 0.175
Current TZS spot exchange rate KSH. 0.158
Expected annual Kenya inflation 7%
Expected annual Tanzania inflation 5%
Expected Kenya one-year interest rate 10%
Expected Tanzania one-year interest rate 8%
Required:
Calculate the following exchange rates:
(i) The current TZS. spot rate that could have been forecast by PPP.
(ii) The expected TZS. spot rate one year from now based on the IFE.
(iii) The expected TZS. spot rate in four years from now based on PPP.
QUESTION 18 AUGUST 2021
Critically differentiate between “Currency Arbitrage and Commodity Arbitrage” and discuss the implications
of both on market efficiency. (5 marks)
QUESTION 19 NOVEMBER 2022
Prime point Ltd, needs to borrow TZS 100 million for the next year to support its operations in Tanzania. It
can borrow Tanzania shillings at 7 percent or Kenya shillings at 1 percent. It has no other cash flows in Kenya
shillings. Assume that interest rate parity holds, so the one-year forward rate of the Kenya shillings exhibits
a premium in this case. Prime Point expects that the spot rate of the Kenya shillings will appreciate but not
as much as suggested by one-year forward rate of the Kenya Shillings.
REQUIRED:
(i) Should Prime Point consider financing with Kenya shillings and simultaneously purchasing Kenya
shillings one year forward to cover its position? Explain. (2 marks)
(ii) If Prime Point finances with Kenya shillings without covering this position, what effective financing rate
relative to Kenya interest rate and the Tanzania interest rate? (2 marks)
(iii) Explain the implications of Prime Point financing with Kenya shillings without covering its position and
the future spot rate of the Kenya shillings in one year turns out to be higher than today’s one-year forward
rate on the Kenya shillings. (2 marks)

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