Question

In: Finance

MSU Bank believes the New Zealand dollar will depreciate over the next 6 months from NZ$2.20/USD...

MSU Bank believes the New Zealand dollar will depreciate over the next 6 months from NZ$2.20/USD to NZ$2.25/USD. The following 6-month interest rates apply: (the rates are periodic rates so you do not need to adjust them at all – we do not need to multiply by 180/360 or anything like that)

      Currency                                 Lending (deposit) Rate             Borrowing Rate

      Dollars                                                1.25%                                      1.55%

      New Zealand dollar (NZ$)                  1.75%                                      2.05%

MSU Bank has the capacity to borrow either NZ$15 million or $8 million. If MSU Bank’s forecast if correct, what will its U.S. dollar profit be from speculation over the 6-month period?

Solutions

Expert Solution

Option 1st : Lets Borrow from Newzeland and Invest in US

Borrow NZ$ 15,000,000 @ 2.05 % for 6 months and convert the same now into USD using spot rate ie NZ$2.20/ USD and get = NZ$15,000,00 / 2.20

= USD 6,818,181.81

Deposit the same amount into US @ 1.25% for 6 months and get = USD 6,818,181.81 + ( 6,818,181.81*1.25% )

= USD 6,903,409.08

Convert the same using conversion rate after 6 months ie NZ$2.25 / USD and get NZ$ = 6,903,409.08* 2.25

= NZ$ 15,532,670.43

After 6 months we have to pay amount borrowed from Newzeland with interest @ 2.05% ie :

= NZ$ 15,000,000 + (NZ$ 15,000,000 * 2.05%)

= NZ$ 15,307,500

Gain in NZ$ = NZ$ 15,532,670.43 - NZ$ 15,307,500

= NZ$ 225170.43

Since the question is asking profit from speculation in terms of USD therefore convert the same into USD using rate available after 6 months ie NZ$2.25 / USD :

Therefor Gain in USD = NZ$ 225,170.43 / 2.25

= USD 100,075.75

Option 2 : Lets Borrow from US and Invest in Newzwland

Borrow USD 8,000,000 @ 1.55 % for 6 months and convert the same now into NZ$ using spot rate ie NZ$2.20/ USD and get = USD 8,000,00 * 2.20

= NZ$ 17,600,000

Deposit the same amount into Newzeland @ 1.75% for 6 months and get :

= NZ$ 17,600,000 + ( 17,600,000*1.75% )

= NZ$ 17,908,000

Convert the same using conversion rate after 6 months ie NZ$2.25 / USD and get USD = NZ$ 17,908,000/ 2.25

= USD 7959111.11

After 6 months we have to pay amount borrowed from US with interest @ 1.55% ie :

= USD 8,000,000 + ( USD 8,000,000 + 1.55%)

= USD 8,124,000

Loss in USD  = USD 8124000 - 7959111.11

= USD 164888.89

MSu bank should adopt the option one for speculation profir of USD 100,075.75


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