Question

2. An American bank expects the euro to appreciate from its present level of $1.02/euro to $1.18/euro in 60 days. They intend to borrow $10 million at a rate of 7.25% annually and they can lend in Europe at 5% annually. What is their total profit/loss from this transaction? Show your work and the flow of funds for full credit.

Answer 1

(2) $ Borrowing = $ 10 million, Current Exchange Rate = $ 1.02/eur, $ Borrowing Rate = 7.25 % and EUR Borrowing Rate = 5 % , Tenure = 60 days

- $ Borrowing of $ 10 million creates a $ repayment liability of 10 x [1+(0.0725) x (60/365)] = $ 10.11918 million

- Converting $ 10 million into EUR at the current rate of $ 1.02/EUR will yield (10 /1 .02) = EUR 9.803922 million

- Lending EUR 9.803922 million at 5 % will produce investment yield of 9.803922 x [1+(0.05) x (60/365)] = EUR 9.884502 million

- Convert the lending proceeds into $ at the 60-day rate of $ 1.18/EUR to yield = 9.884502 x 1.18 = $ 11,66371 million

- Profit = Lending Proceeds in $ - $ Repayment LIability = 11.66371 - 10.11918 = $ 1.544534 million