Question

Kurnick Co. expects that the pound will appreciate from $1.49 to $1.7 per pound in one. It has no money to invest, but it could borrow money to invest. It has been approved by a bank to borrow either 3 million dollars or 3 million pounds for one year. It can borrow dollars at annual rate of 5.99% or British pounds at 5.56%. It can invest in a risk-free dollar deposit at annual rate of 3.54% or a risk-free British deposit at 2.95%. Determine the expected profit (in dollars) if Kurnick Co. pursues a strategy to capitalize on the expected appreciation of the pound (round up to a dollar)? Please DONOT compute in the intermediate steps.

Answer 1

Expectation is that pound will appreciate from $1.49 to $1.7 per pound in one year. below are the steps to capitalize on the expected appreciation of the pound.

1. Borrow $3 million and convert to ($3,000,000/$1.49 per pound) = £2,013,422.818791946‬

2. Invest the £2,013,422.818791946‬ for one year at 2.95% which will generate (£2,013,422.818791946*2.95%) = £59,395.97315436242‬

3. After one year, convert the (£2,013,422.818791946 + £59,395.97315436242‬) £2,072,818.791946308‬ into dollars at the existing spot rate, which converts to (£2,072,818.791946308*$1.7 per pound) $3,523,791.946308724‬.

4. Pay back the loan of $3 million plus interest of 5.99% , which equals [($3,000,000*5.99%) + $3,000,000] = ($179,700 + $3,000,000) $3,179,700‬.

expected profit (in dollars) = value of investment in dollars - dollar loan + interest = $3,523,791.946308724 - $3,179,700 = $344,092