1. The current spot exchange rate is €1,40/£ and the three-month forward rate is €1,35/£. Based on your analysis of the exchange rate, you are pretty confident that the spot exchange rate will be €1,37/£ in three months. Assume that you would like to buy or sell £1.000.000. a. What actions do you need to take to speculate in the forward market? What is the expected euro profit from speculation? b. What would be your speculative profit in euro terms if in three months the spot exchange rate actually turns out to be €1,31/£?
If I am pretty confident that the spot exchange rate will be €1,37/£ in three months, I should buy £1.000.000 forward for €1,35/£. My expected euro profit from the speculation would be:
If in three months the spot exchange rate turns out to be €1,31/£, I would have a speculative loss: £1.000.000*(€1,31/£-€1,35/£.)=-€40.000
2. Assume you are a trader with Deutsche Bank. From the quote screen on your computer terminal, you notice that Dresdner Bank is quoting €1,0242/$1 and Credit Suisse is offering CHF 1,5030/$1. You learn that UBS is making a direct market between the Swiss franc and the euro, with a current €/CHF quote of 0,6750. Show how you can make a triangular arbitrage profit by trading at these prices (ignore bid-ask spreads for this problem). Assume you have $5.000.000 with which to conduct the arbitrage. What happens if you initially sell dollars for Swiss francs? What €/CHF price will eliminate triangular arbitrage?
In order to make a triangular arbitrage profit I should sell $5.000.000 to Dresdner Bank, which is quoting €1,0242/$1. In this trade I would make a profit of: $5.000.000*1,0242=€5.121.000
Then I should sell this amount of Euros for Swiss francs to UBS at a price of €0,6750/CHF1. In this trade I would yield: €5.121.000/0,6750=CHF 7.586.666,667
At this point I should resell the Swiss francs to Credit Swiss for the...