Question

Kurnick Co. expects that the pound will appreciate from $1.34 to $1.79 per pound in one. It has no money to invest, but it could borrow money to invest. It has been approved by a bank to borrow either 2 million dollars or 2 million pounds for one year. It can borrow dollars at annual rate of 5.82% or British pounds at 6.27%. It can invest in a risk-free dollar deposit at annual rate of 3.81% or a risk-free British deposit at 3.46%. Determine the expected profit (in dollars) if Kurnick Co. pursues a strategy to capitalize on the expected appreciation of the pound (round up to a dollar)

Answer 1

to capitalize on the expected appreciation of the pound, Kurnick Co.shall follow the following strategy:

STEP1. The initial amount borrowed = 2000000 dollar

STEP 2. Pounds received when the dollars are converted to pounds [1 pound =$1.34] =2000000/1.34=1492537.31 pounds.

STEP3. invest 1492537.31 pounds in risk-free British deposit @3.46% for 1 year.Therefore, the total return after 1 year = 1492537.31* 1.0346=1544179.1 Pounds

STEP4. convert total returns received to dollars= 1544179.1 *1.74$= 2686871.64 dollar

STEP 5 total owed on the dollars borrowed =2000000* 1.0582 = 2116400 dollars

STEP6 profits = 2686871.64- 2116400 = 570471.64 Dollars.

ANSWER - expected profit =570471.64 Dollars if kurnick co. persue to capitalise the expected apprecition on pounds.