Question

You are looking at the markets for THB (Thai bahts) and EUR. You observe that the bid/ask interest rates in Thailand are 20%/22%, and the bid/ask interest rates on the euro are 2%/4%. The spot exchange rate is 40.1 THB/EUR, and you expect that in the next 3 months (90 days) the exchange rate will not move much, moving to 42 THB/EUR. Your borrowing capacity is 2 million EUR and 50 million THB. Based on this information, you decide to borrow EUR at the relatively low rates, and invest in the higher THB rate. What will be your profit as measured in EUR?

Answer 1

A) The question is about carry trade. Here we borrow in lower interest rates and invest in higher interest rates to get profits.

In the above problem we borrow EUR at 4 percent (Ask price)

We borrow 2 Million * 1.04 EUR (4 percent interest)

2000000*1.04 which equals to 2,080,000 EUR

We convert EUR 2 Million to THB using 40.1 THB/EUR

Which equals 2000000/40.1 THB

that is 49,875.3 THB

we invest this at 20 percent (Bidrate of 20 from the quote 20%/22%)

49,875.3*1.2(20 percent interest) that is 59,850.37 THB

Now convert this to EUR at the rate of 42 THB/EUR

It is 59,850.37*42 EUR that is 2,513,715.5 EUR

Now repay the loan of 2,080,000 EUR taken earlier

Profit is 2,513,715.5 EUR-2,080,000 EUR which equals to 433,715.54 EUR

So profit is 433,715.54 EUR from the carry trade (in 3 months time)