Question

The current spot exchange rate is $ 1.93/pound and the three-month futures rate is $1.90/pound. Assume that you would like to buy or sell British Pound for the amount of 1,000,000 pounds.

On the basis of your analysis of the exchange rate, you are pretty confident that the spot exchange rate will be $1.91/pound in three months.

(a) What actions do you need to take to speculate in the futures market? And what is the expected dollar profit from speculation?

(b) What would be your speculative profit in dollar terms if the spot exchange rate actually turns out to $1.86/pound?

Answer 1

[ Solution a ]

Action

The three-month futures rate is $1.90/pound and expected spot exchange rate will be $1.91/pound in three months.

In this case, dealer can purchase the dollar futures today at $1.90/pound and sell it after three months at expected spot rate of $1.91/pound.

Profit Calculation

Expected dollar profit = 1,000,000 pounds * [ 1.91 - 1.90 ]  

                               = $ 10,000 Answer

[ Solution b ]

Expected loss = 1,000,000 pounds * [ 1.86 - 1.90 ]  

                               = $ - 40,000 Answer

The loss will be $ 40000.

Hope you understand the solution.