Question

A businesswoman in Poland is planning to import CAN $512,500 worth of caviar which she expects to sell for 1,500,000 Polish Zolty. The zolty is currently trading at CAN $.40, and she is afraid the zolty may depreciate between now and the time she receives her shipment (in 3 months). She cannot find someone to write a zloty-dollar forward contract for her, but there is bank in Toronto where she can borrow or lend at 2.5 % interest, and a bank in Kraków offering the same at 7% interest (each based on 3 months).

Describe (carefully) a way in which she can ensure a specific zolty price for her imports. How much can she expect to make on this deal?

Answer 1

At current exchange rate, 512000 CAN is equivalent to

512000/.4= 1280000 Polish Zolty.

She will be selling the Caviar for 1500000 Polis Zolty and that is fixed. What is not fixed is the exchange rate. If Polish Zolty depreciates, her margins will be lesser in 3 months.

Now, it is given that she can borrow or lend in Canda at 2.5% and she can do the same at 7% in Poland.

What she should do is borrow 512000 from Candian bank. This will be 128000 Polish Zolty. She should lend this then to the Polish bank at 7%. The net interest she will get from this investment is

7-2.5=4.5% per annum, or 4.5%/12 per month. Since she needs the money for 3 months, she will earn an interest of

4.5*3/12=1.125%.

Effectively, she has insured herself against the depreciation of at least 1.125% in the coming 3 months. Once the deal goes through, she will repay the Canadian bank.

Assuming that the Zolty doesnt actually depreciate during this time, then she will make

money from the deal+interest money. So,

moeny earned= (1500000-1280000)+1280000*1.125%

=220000+14400

=234400 Polish Zolty.