Question

You work as a currency trader at the Big Time Bank and specialise in trading the AUD USD. The current spot rate is USD AUD 0.678 and you have forecast a rate of USD AUD 0.6915 in 90 days. The borrowing and lending rates in Australia and the US are:

Currency	Lending rate	Borrowing rate
US dollar	2.3%	2.5%
Australian dollar	1.4%	1.8%

You will speculate on the change in the exchange rate and you have the authority to borrow $10 million of either currency.

a)      Which currency will you borrow and which will you invest in? Explain why.          (1 mark)

b)     What is your profit in AUD? Show all calculations in detail.                                        

Answer 1

a) You will borrow USD at 2.5% interest rate and invest AUD at 1.4% interest rate because USD is forecast to depreciate against AUD.

b) first borrow USD 10,000,000 at 2.5% interest for 90 days.

Interest to be paid on USD 10,000,000 at 2.5% interest for 90 days = USD 10,000,000*2.5%*90/360 = USD 250,000*90/360 = USD 62,500

Total borrowed amount to be paid after 90 days = USD 10,000,000 + USD 62,500 = USD 10,062,500

Now invest USD 10,000,000/0.678 = AUD 14,749,263 for 90 days at interest rate of 1.4%.

Interest to be received on AUD 14,749,263 for 90 days at interest rate of 1.4% = AUD 14,749,263*1.4%*90/360 = AUD 206,490*90/360 = AUD 51,623

Total investment amount to be received after 90 days = AUD 14,749,263 + AUD 51,623 = AUD 14,800,886

profit in AUD = Total investment amount to be received after 90 days in AUD - Total borrowed amount to be paid after 90 days in AUD

profit in AUD = AUD 14,800,886‬  - USD 10,062,500/0.6915 = AUD 14,800,886 - AUD 14,551,699 = AUD 249,187