Question

A currency speculator expects the spot rate of Euros to change from $1.20 to $.80 in one year. Assume the speculator has access to credit lines of USD 12,000,000 in the US and EUR 10,000,000 in Europe. The annual borrowing and lending rates are 6 percent in US and 8 percent in Europe. If his forecast turns out to be true, at the end of the one-year period, the speculator's expected profit will be?

Answer 1

Borrow in EUR 10,000,000

Convert into USD at spot rate and get 10,000,000*1.2 = $12,000,000

Invest for one year and get 12,000,000*(1.06) = $12,720,000

Convert back into EUR and get 12,720,000/0.80 = EUR 15,900,000

Repay loan 10,000,000*(1+8%) = EUR 10,800,000

Expected Profit = EUR 5,100,000 or USD 4,080,000