Question

You are given to following BC (Borrowing Capacity in two different currency; 70 million in USD and 50 million in Euro. the current spot of Euro is 1.20 (EUR/USD) and you are expecting a down swing of EUR against USD, i.e. EUR to be 1.18 in next 10 days. Your borrowing rate for USD is 2% and lending rate for USD is 1.25%. Your Borrowing rate for EUR is 1.5% and lending rate for Euro is .5%.  

Conduct the currency speculation and show me the speculative profit if your expectation is right. Answer in two decimals. Your answer must be in USD. and you are not allowed to use company deposit for this.  

Answer 1

Given the USD is expected to depreciate, we would borrow in USD and lend in EUR. We would follow these steps:

Step 1 - Borrow USD 70 million at 2% for 10 days

Step 2 - Convert this amount into EUR at 1.2 giving us EUR 84 million

Step 3 - Lend EUR 84 million at 0.5% for 10 days (assumption - the limit of EUR 50 million is for borrowing and not for lending)

Step 4 - After 10 days, EUR amount received would be 84 + 84*0.5%*(10/365) = EUR 84.01 million (assuming simple interest rate)

Step 5 - Convert this EUR amount into USD at 1.18 giving USD 71.20 million

Step 6 - USD amount payable after 10 days is 70 + 70*2%*(10/365) = USD 70.04 million (assuming simple interet rate)

Step 7 - Repay USD 70.04 million and keep the rest as speculative profit

Hence, speculative profit = 71.20 - 70.04 = USD 1.16 million