International Finance Management Chapter 4

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Chapter 4:
Questions and Applications (Page 113): #20, #21, # 29.
20. Speculation (Similar in spirit to the example that we did in class) Blue Demon Bank expects that the Mexican peso will appreciate against the dollar from its spot rate of $.15 to $.17 in 10 days. The following interbank lending and borrowing rates exist: Lending Rate Borrowing Rate

U.S. dollar 8.0% 8.3%
Mexican peso 8.5% 8.7%
Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million peso in the interbank market, depending on which currency it wants to borrow. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy. Because Blue Demon Bank expects that the Mexican peso will appreciate against the dollar, which implies that U.S. dollar will depreciate. So if Blue Demon Bank borrow $, it would earn profits in the end. (1) Borrow $10 million

(2) Convert $ to peso:
$10,000,000 / ($.15/peso) = peso66,666,66.67
(3) Invest the peso at the annual rate of 8.5% annualized for 10 days: peso66,666,666.67 * (1 + 8.5% * 10 / 360) = peso66,824,074.08 (4) Determine $ owed:
$10,000,000 * (1 + (8.3% * 10 / 360) = $10,023,055.56
(5) Determine $ needed to repay peso loan:
$10,023,055.56 / ($.17/peso) = peso58,959,150.33
(6) Profit: peso66,824,074.08 – peso58,959,150.33 = peso7,864,923.75 (or equal: $1,337,037.04 = peso7,864,923.75 * $.17/peso)
Thus, Blue Demon Bank will attempt to capitalize on its expectations is about dollar. And the profits that could be generated from this strategy peso7,864,923.75 (or $1,337,037.04).

21. Speculation. Diamond Bank expects that the Singapore dollar will depreciate against the U.S. dollar from its spot rate of $.43 to $.42 in 60 days. The following interbank lending and borrowing rates exist: Lending Rate Borrowing Rate

U.S. dollar 7.0% 7.2%
Singapore dollar 22.0% 24.0%...
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