Hakan Yorulmaz speculates on the currencies in the foreign currency exchange market. Currently the spot price...

Hakan Yorulmaz speculates on the currencies in the foreign currency exchange market. Currently the spot price for the Danish krona is Dk159.87/$ and the 3-month forward rate is Dk 158.53/$. Hakan thinks the Danish krona will move to Dk 158.00/$ in the next three months.
What should Hakan do? If Hakan has $100.000. explain how much he can earn as profit? Show calculations. Specify the transaction such as buy sell at forward' spot expected future spot rate. (15 pts)

Solutions

Expert Solution

Spot rate = Dk159.87/$

3 month forward rate = Dk158.53/$

3 month expected spot rate = Dk158/$

Amount available = $100,000

Strategy 1: Sell the forward for $

a. Sell the forward contract for $100,000 at the rate of DK 158.53/$

b. At the end of 3 months, he will sell $100,000 at the forward rate of DK 158.53/$ for DK 15,853,000 ($100,000*DK 158.53/$)

c. He will again buy $ by converting DK 15,853,000 at the expected 3 month spot rate of DK158/$ to get $100.335.44 (DK 15,853,000/158)

d. Thus, the profit made is $335.44 ($100,335.44-$100,000)

Strategy 2: Sell $ at the spot rate and buy $ at the expected spot rate after 3 months

a. Sell the $100,000 at the spot rate of DK 159.87/$ to get DK 15,987,000

b. At the end of 3 months, he will sell DK 15,987,000 to buy $ at the expected spot rate of DK 158/$ for $ 101,183.54 (DK 15,987,000/DK 158/$)

c. Thus, the profit made is $1,183.54 ($101,183.54-$100,000)

Strategy 3: Sell $ at the spot rate and buy $ at the forward rate after 3 months

a. Sell the $100,000 at the spot rate of DK 159.87/$ to get DK 15,987,000

b. Buy future contract to buy USD at forward rate of DK158.53/$

c. After 3 months, buy USD by converting DK 15,987,000 at DK158.53/$ for $100,845.27 (DK 15,987,000/DK158.53/$)

d. Thus, the profit made is $845.27 ($100,845.27-$100,000)

Of the 3 strategies, strategy 2 provides the highest profit. Hence he should sell the $ at current spot rate and buy back the $ at the spot rate expected after 3 months.

Note:

a. Assumed buy and sell rates are same

b. Impact of interest on holding the currency not considered

jeff jeffy answered 1 year ago

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