Question

The treasurer of a major US firm has $20 million to invest for six months. Effective

monthly rates are 0.41% in the U.S. and 0.52% in Great Britain. The spot exchange rate

is 0.6543 British pounds per $US and the six month forward rate is 0.644 British pounds

per $US.

Required:

(1)) Ignoring transaction costs, in which country would the treasurer want to

invest the company’s funds? Why?

Answer 1

Answer-

Given

Effective monthly rates in US = 0.41 % (R us)
Effective monthly rates in Great Britan = 0.52 % ( R gb)

spot exchange rate is 0.6543 British pounds per $US (S)
six month forward rate is 0.644 British pounds per $US.(F)

The forward premium or disount = F - S = [( 1 + (R gb x ( days / 360) ) / ( 1 + (R us x ( days/ 360)) - 1 ] x S

The forward premium or disount = [  (1 + ( 0.0052 x ( 180 /360) ) / ( 1 + ( 0.0041 x (180 / 360) ) - 1 ] x 0.6543

The forward premium or disount = [ ( 1 + ( 0.0052 x 0.50) / ( 1 + ( 0.0041 x 0.50) - 1 ] x 0.6543

The forward premium or disount = [ ( 1.0026) / ( 1.00205) - 1 ] x 0.6543

The forward premium or disount = ( 1.0005489 - 1 ) x 0.6543

The forward premium or disount = 0.0005489 x 0.6543

The forward premium = 0.0003591

Therefore one should invest in Britan as there is forward premium.