Question

Baylor Bank believes the Nee Zealand dollar (NZD) will appreciate over the next one year from USD .50/NZD to USD .80/NZD. The following annual interest rates apply:

currency

USD lending rate 4.00% borrowing rate 5.00%

MZD lending rate 4.50% borrowing rate 5.50%.

Baylor Bank has the capacity to borrow eith NZD 10 million or USD 5 million. If Baylor Bank’s forecast is correct, what will USD profit be from speculation over the one period. ( assuming it does not use any of its existing customer deposits to capitalize on its expectations?

Caluclate for the times befow

Time =O

Time =1

Calculate the proft/loss in USD

Answer 1

At T=0

Current Spot Rate:

USD .50/NZD                          

Borrow 5 million USD at 5%

NZD =5/0.5=10million NZD

Convert to 10 million NZD at current spot rate

Invest 10million NZD at 4.5%

At time T=1,

Amount to be received =10*1.045million=10.45 million NZD

Spot rate at T=1,

USD .80/NZD

Amount of USD received on conversion=10.45*0.8=8.36 USD

Amount to be paid to the bank on borrowing of USD 5 million at 5%,

5*1.05=5.25 million

Profit in USD =(8.36-5.25)=3.11Million USD