Question

Talent Bank can borrow USD6 million at 6 percent annualised. It can use the proceeds to invest in Pound Sterling at 9 percent annualised over a 6 day period. The Pound Sterling is worth USD1.58 and is expected to be worth USD1.56 in 6 days. Based on this information, should Talent Bank borrow US dollar and invest in Pound Sterling?

Answer 1

To understand if Talent bank should do this, lets track the process step by step:

1. Talent bank borrows 6,000,000$ at 6% per annum

2. Convert to pounds at 1.58 USD / pound:

6,000,000/1.58 = 3,797,468.35443 pounds

3. Investing this amount for 6 days at 9% per annum.

Effective interest rate = 9 * 6 /365 = 0.1479%

Amount at the end of 6 days = 3,797,468.35443 * (1+0.1479/100)^6 [rate and time calculations are converted to days]

= 3,797,468.35443 * 1.001479^6

= 3831291.936 pounds

4. Convert back to dollars at 1.56 USD/pound

3831291.936 * 1.56 = 5976815.42$

As, we can see this final amount is less than the amount borrowed from the bank.

Thus, based on this information, Talent Bank should not borrow USD and invest in Pound Sterling.

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