Question

George is a US investor who wants to invest in French stock markets. Consider the following facts about France: Over the course of the next 180 days, there is a 40% chance that the Euro will lose 20% of its value relative to the US dollar and the French stock market will remain unchanged, and there is a 60% chance that the Euro will appreciate by 10% of its value relative to the US dollar and the French stock market will rise by 30%. Assume that James has no current assets or liabilities in France, but he can borrow USD 1 million at 3% p.a. Assuming a 360-day year, how much profits can George earn (or lose) by borrowing USD 1 million and investing in French stock markets for the next 180 days?

Answer 1

George borrowed USD 1 million at the rate of 3% p.a

Expected return will be calculated as R1*r1+R2*r2

R= Risk

r= Return

Where ,

40% risk of 20% loss in currency

60% risk of 10% gain in currency and there will be a gain in 30% in shares.

At the risk of 60% risk, the total risk gain will be 10%+30%

= (x+30%)+10%

=43%

Expected return =0.4(-0.2)+0.6*0.43

=-0.08+0.258=0.178

Expected return =17.8%

Interest to be paid for 180days at the rate of 1.5%

Gain=17.8-1.50=16.30%

On the value of $ 1 million= $163,000