Question

# Assume the following information. • Interest rate on borrowed euros is 5 percent annualized. • Interest...

Assume the following information. • Interest rate on borrowed euros is 5 percent annualized. • Interest rate on dollars loaned out is 6 percent annualized. • Spot rate is 1.10 euros per dollar (one euro = \$0.909). • Expected spot rate in five days is 1.15 euros per dollar. • Fabrizio Bank can borrow 10 million euros.
If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is

Fabrizio bank will borrow 10 million euros.

From 10 million euros, dollars will be bought at current spot rate of 1 euro = \$0.9090909

Hence, number of dollars bought will be = 10,000,000 x 0.9090909

= 9,090,909

\$9,090,909 will be loaned out @ 6% p.a.

Interest to be received on dollars loaned out = 9,090,909 x 6/100 x 5/365

= \$7,472

Hence, amount to be received after 5 days = 9,090,909 + 7,472

= \$9,098,381

Now, \$9,098,381 will be converted into euros on the spot rate after 5 days i.e 1.15 euros per dollar

Hence, amount in euro will be = 9,098,381 x 1.15

= 10,463,138 euros

Interest to be paid on euro borrowings = 10,000,000 x 5/100 x 5/365

= 6,849 euros

Hence, total amount to be repaid = 10,000,000 + 6,849

= 10,006,849 euros

Hence, profit of Fabrizio Bank after 5 days will be =10,463,138 - 10,006,849

= 456,289 euros

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