Question

Jack trades currency for BNP Paribas. He has $1 million to begin with, and he must state all profits at the end of any speculation in U.S. dollars. The spot rate on the euro is $1.3456/£, while the 30-day forward rate is $1.3350/£.

a. Assume that he believes the euro will continue to rise in value against the U.S. dollar, so that he expects the spot rate to be $1.3650/£ at the end of 30 days. Recommend the forward strategy that he should use to make a profit. Estimate his profit.

b. Assume that he believes the euro will depreciate in value against the U.S. dollar, so that he expects the spot rate to be $1.3100/£ at the end of 30 days. Recommend the forward strategy that he should use to make a profit. Estimate his profit.

Answer 1

Solution:

Initial value = $1 million

Spot rate =  $1.3456/£

30-day forward rate = $1.3350/£.

Part A )

The expected exchange rate is $1.3650/£ in 30-days.

£ value = $1 million / $1.3456/£ = 743,162.9013

The forward rate is =  $1.3350/£.

Since the expected rate is higher than the forward rate hence we will buy the forward

We will buy the forward contact at  $1.3350/£.

Profit = 1.3650/£ -  $1.3350/£. = $0.030 / £

Profit = $0.030 / £ * 743,162.9013 = $17,971.0664

Part B )

The expected spot rate = $1.3100/£

The forward rate is =  $1.3350/£.

We will sell the forward contact at  $1.3350/£ as the expected exchange rate is lower than the forward rate.

Profit = 1.3350/£ -  $1.3100/£. = $0.025 / £

Profit = $0.025 / £ * 743,162.9013 = $14,975.89