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A U.S. firm expects that the British pound will depreciate from $1.70 to $1.68 in one...

  1. A U.S. firm expects that the British pound will depreciate from $1.70 to $1.68 in one year. The firm has no spare cash, but it could borrow either 1 million dollars at 6% or 1 million pounds at 5% for a year. Determine the profit or loss for the firm if they pursue a strategy to capitalize on the expected depreciation of the pound.
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Answer #1

If Pound id going to be depreciated, Borrow in Pound and invest in USD and realize the profit.

Assume Amount borrowed is Pound 1 Million

Convert them into USD using spot Rate

Amount in USD = 1000000 * 1.7

= USD 1700000

Invest amount in USD for 1 Year. And realize the maturity after 1 year.

Amount after 1 Year = 1700000 * 1.06

= USD 1802000

Convert the Maturity proceedings in Pounds using spot Rate avaiable at that time

= 1802000 / 1.68

= Pound 1072619.05

Repay the borrowed loan in Pounds :

Maturity Value = Pound 1000000 * 1.05

= Pound 1050000

Profit = Pound 1072619.05 - Pound 1050000

= Pound 22619.05

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