Question

# The Green Bank expects the exchange rate for the euro to depreciate from the spot rate...

The Green Bank expects the exchange rate for the euro to depreciate from the spot rate of \$0.15 to \$0.14 in 10 days. Green Bank is able to borrow \$10 million or 70 million euros. The short term interest rates (annualized) in the interbank market are as follows: CURRENCY LENDING RATE BORROWING RATE U.S Dollars 8% 8.3% Euro 8.5% 8.7% (a)How will the Green Bank attempt to capitalize on this expected change in exchange rate to make a speculative profit? Estimate the profit (if any) that could be generated from this strategy. (b)Assuming the expectation is that the euro will appreciate from \$0.15 to \$0.17 in 30 days. What change in strategy would be required for the Bank to earn a speculative profit? Determine the profit that could be earned.

a. Green bank should borrow now 70 million euros @ 8.7% and convert to dollars at spot rate of \$ 0.15, which will give \$ 10.5 million and reconvert after 10 days, \$ 10.5 million @ exchange rate of \$ 0.14, which will give 75 million euros

Interest for 10 days = 70 × 8.7% × 10 ÷ 365

= 0.17 million euros

Amount to be repaid after 10 days is 70 + 0.17 = 70.17 million euros

Profit = 75 - 70.17 = 4.83 million euros

b. Green bank should borrow now \$ 10 mn and convert at spot rate of \$ 0.15 and get 66.67 mn euros and reconvert after 30 days at exchange rate of \$ 0.17 and get back \$ 11.33 mn

Interest to be paid for 30 days is

10 × 8.3% × 30 ÷ 365

= \$ 0.068 mn

Amount to be repaid is 10 + 0.068 = \$ 10.068 mn

Profit = 11.33 - 10.068 = \$ 1.262 mn

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