Question

The treasurer of a major U.S. firm has $34 million to invest for three months. The interest rate in the United States is 1.00 percent per month. The interest rate in Great Britain is 0.8 percent per month. The spot exchange rate is £0.56, and the three-month forward rate is £0.53. Ignore transaction costs.

If the treasurer invested the company's funds in the U.S., what would the value be in three months?

If the treasurer invested the company's funds in Great Britain, what would the value be in three months?

Answer 1

Available Fund with the Treasurer = $ 34 million

Interest Rate in United.States = 1 % per month

Interest Rate in Great Britain. = 0.8 % per month

Spot Exchange Rate   $ 1 = O.56 GBP

3 Month forward Exchange Rate   $ 1 = O.53 GBP  

i. If the Treasurer invested the funds in the U.S. for 3 months:

Amount Invested = $ 34,000,000

Interest Rate in U.S.= 1% per month

Value after 3 months(In US Dollars) = Amount Invested *(1+ Rate)^month

= 34,000,000 * (1+.01)3

  = 34,000,000*1.01*1.01*1.01

= 35,030,234

If the Treasurer invested the funds in the U.S. for 3 months value of the Funds after 3 months will be $ 35,030,234

ii. If the Treasurer invested the funds in the G.B. for 3 months:

Amount Invested = $ 34,000,000

Interest Rate in G.B. = 0.8 % per month

Spot Exchange Rate   $ 1 = O.56 GBP

3 Month forward Exchange Rate   $ 1 = O.53 GBP

Amount Available to Invest in Great Britain = Available funds in Dollar * Exchange Rate

= 34,000,000 * 0.56

= GBP 19,040,000

Amount Available to Invest in Great Britain = GBP 19,040,000

Interest Rate in G.B.= 0.8% per month

Value after 3 months (In GBP) = Amount Invested *(1+ Rate)^month

= 19,040,000 * (1+.008)3

= 19,040,000*1.008*1.008*1.008

  = 19,500,625

3 Month forward Exchange Rate   $ 1 = O.53 GBP

Available Fund in U.S. Dollars = Amount Available in GBP/ Exchange Rate

=19500625/0.53

= 36,793,633

If the Treasurer invested the funds in the G.B. for 3 months value of the Funds after 3 months will be $ 36,793,633