Question

5. Today’s 30 day forward rate is $.50 = DM 1. A U.S. speculator (who wants any profits to be in $) expects the spot rate after one month to be

$.45 = DM 1.

a. What actions would the speculators take so as to make expected profits positive at the end of 30 days?                                                      (2 pts)   

b. What would the outcome be if the speculator acted as in (a) above and the actual spot rate in 30 days turned out to be $.53 = DM 1?                   (2 pts)        

Answer 1

Answer)

1. What we are discussing here is an instrument known as futures,what it implies is that after a given time I can buy/sell a security/currency at a predetermined price,in this case that time period is 30 days and US speculator can buy or sell DM1 at $0.50,now s/he believes that after 30 days spot rate will be $0.45=DM1,so DM1 is depreciating in value in terms of US dollar,earlier $0.50 was required,now $0.45 is required for DM1,so DM1 's value is depreciating,so speculator in order to make profit should take an action of short-selling DM1 today at $0.50,that is s/he today is selling DM1 at $0.50 and has to buy it after 30 days at spot price that day which speculator thinks will be at $0.45 for every DM1,now after 30 days s/he will make a profit of 0.50-0.45=$0.05 on every DM1.
2. Now,we are given the condition that speculator acted as above and actual spot rate turned out to be $0.53=DM1 after 30 days,so speculator sold DM1 at $0.50 and now has to buy it at $0.53,so speculator incurs a loss now of 0.50-0.53=$0.03 for every DM1.

Answer is complete.Thank you!