Question

1. (8 pts) Speculation. Blue Demon Bank expects that the Mexican peso will depreciate against the dollar from its spot rate of $0.048 to $0.043 in 30 days. The following interbank lending and borrowing nominal annualized rates exist:

                                                      Lending Rate              Borrowing Rate

                                  U.S. dollar                   1.0% per yr               1.2% per yr

                               Mexican peso                 5.2% per yr              5.6% per yr

Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 200 million pesos in the interbank market, depending on which currency it wants to borrow.

1. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.

2. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to appreciate from its present spot rate of $0.048 to $0.051 in 90 days. How could it attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.

Answer 1

A) Borrow Mexican Peso and buy in dollars

Borrowed amount = 200 million Mexican Peso

$ Bought = 200 million*$0.048

=$9.6 million

After 30 days, sell dollar and receive Mexican peso

Amount received (Peso) = 223.26 million

Profit = Amount received - Interest cost -Amount borrowed

Interest paid = 200 million *5.6%*30/360 =.0.93 million

Amount borrowed = (Peso) = 200 million

=223.26 million - 0.93 million - 200 million =22.33 million

Profit =22.30 million

B) Peso to appreciate from its present spot rate of $0.048 to $0.051 in 90 days:

Borrow dollar and buy Mexican Peso

Borrowed amount =$10 million

Peso bought=$10 million / $0.048= 208.33 million

At the end of 30 days sell Peso

Dollar received = 208.33 *0.051 = $10.625 million

Profit = Amount received - Amount borrowed - Interest cost

=10.625 million - 10 million - (10 million *1.2%*30/360)

=10.625-10-0.01

Profit =$0.615 million