Question

1. A shirt that retails for $120 in New York sells for £60 in London. The exchange rate between the British pound and the dollar is

£1 = $1.60. You spot a profit-making opportunity and choose to exploit it by buying and selling 5,000 shirts. (35 Points)

• Which country would you purchase the shirts in and for how much (in their currency)?
• Which country would you sell the shirts in and how much would you receive in their currency?

• Converting to dollars at £1 = $1.60, what is the amount of profit you would receive stated in terms of dollars?

2. Assuming the same information as in question 4- however, for your next purchase of 5,000 shirts, the dollar has strengthened against the pound by 25%.

What is the profit you will now make in terms of dollars?

Answer 1

1.

Price of shirt in New york = $120

Price of shirt in London = £60

Exchange rate £1 = $1.60

Price of shirt in London in dollar terms = 60 * exchange rate = 60*1.6 = $96

Number of shirts bought and sold = 5000

You will buy the shirts in London as the price is lower in London

Purchase price in London = 5000 * 60 = £300,000

You will sell the shirts in New York as the price is higher there

Selling price in New York = 5000 * 120 = $600,000

Purchase price in London in dollar terms = 300,000 *1.6 = $480,000

Profit received = Selling price in New York - Purchase price in London in dollar terms = $600,000 - $480,000

Profit received = $120,000

2.

Dollar strengthened against pound by 25%

New exchange rate = Old Exchange rate /(1+25%) = 1.6/1.25 = $1.28

£1 = $1.28

New Purchase price in London in dollar terms = 300,000 *1.28 = $384,000

New Profit received = Selling price in New York - Purchase price in London in dollar terms = $600,000 - $384,000

Profit received = $216,000