Chicago Bank expects the exchange rate of the New Zealand dollar (NZ$) to appreciate from its present level of $.50 to $.55 in 30 days.
Chicago Bank is able to borrow $20 million NZD on a short-term basis from other banks. How you can earn profit and how much?
Currency Lending rate Borrowing Rate
U.S Dollar 6.72% 7.20%
New Zealand Dollars(NZ$) 6.48% 6.96%
Step:1 Amount Borrowed = 20Mil NZD
Step 2: Convert the 20 Mil NZD to US $ using Spot Rate
1 NZS = $0.50
20 Mill NZD = $10 Mill
Step 3: Deposit the $10 Mill in Chicago bank for 1 month at 6.72%
Step 4: Withdraw the deposit along with interest
$10Mill(1+0.0672*1/12) = $10.056 Mill
Step 5: Repayment amount of borrowing made in Step 1 = 20millNZD(1+0.0696*1/12) = 20.116Mill NZD
Step 6: AMount required to pay 20.116 mill NZD
1NZD = $0.55
20.116Mill NZD = $11.0638 Mill
Step 7: AMount of outflow = step 6- step 4 = 11.0638-10.056 = 1.0078Mill(Loss)
So it is not feasible to borrow 20Mill NZD at the prevailing interest rates
Note: Least interest rates were considered as Deposit rated and highest interest rates were considered as Borrowing rates accordingly as per general scenario
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