Question

Clayton Moore is the manager of an international money market fund managed out of London. Unlike many money funds that guarantee their investors a near? risk-free investment with variable interest? earnings, Clayton? Moore's fund is a very aggressive fund that searches out relatively high interest earnings around the? globe, but at some risk. The fund is? pound-denominated. Clayton is currently evaluating a rather interesting opportunity in Malaysia. Since the Asian Crisis of? 1997, the Malaysian government enforced a number of currency and capital restrictions to protect and preserve the value of the Malaysian ringgit. The ringgit was fixed to the U.S. dollar at RM3.80?/$ for seven years. In? 2005, the Malaysian government allowed the currency to float against several major currencies. The current spot rate today is RM 3.13481 divided by $. Local currency time deposits of? 180-day maturities are earning 8.898?% per annum. The London eurocurrency market for pounds is yielding 4.203?% per annum on similar? 180-day maturities. The current spot rate on the British pound is $ 1.5823 divided by pound?, and the? 180-day forward rate is $ 1.5563 divided by pound. The initial investment is pound1,000,000.00.

Answer 1

At initiation, the GBP 1,000,000 is exchanged into USD = 1000000 * 1.5823 = 1,582,300. This is exchanged into ringgit at 3.13481 to receive = (1582300 * 3.13481) = 4,960,209.86 and is invested at 8.898% p.a. rate for 180 days.

After 180 days, the fund should receive = 4960209.86 + 4960209.86 * 8.898% * 180/365 = RM 5,177,866.59.

Now we need to find the rates to convert this back into GBP. We will use the interest rate parity to hold between GBP & USD and USD & RM. Given that the GBP rate is 4.203% p.a. for 180 days or for 180 days = 4.203% * 180/365 = 2.0727%. As per the IRP, we have that the GBP USD forward rate should be given by :

Forward rate = Spot rate * (1+ R_US)/(1+R_GBP) ; hence we have 1.5563 = 1.5823 * (1+R_US) / (1+2.0727%) ; solving for R_US = 0.80% for 180 days.

Using this rate, the forward rate for RM should be = 3.13481 * (1+(8.898%*180/365))/(1+0.80%) = 3.2464. At this rate, after 180 days, we convert RM into USD = 5177866.59/3.2464 = 1594958.4

Using the 1.5563 forward rate to convert to GBP, we get = 1594958.4/1.5563 = 1024839.94 in GBP terms or a return of 4.968% p.a. for the 180 days period which is better than the GBP rate.