Question

In: Finance

a) The Evergreen Bank expects that the Peso (P) will depreciate against the     US $ from...

a) The Evergreen Bank expects that the Peso (P) will depreciate against the
    US $ from its spot rate of $0.43 to $0.42 in 90 days. The following interbank
    lending and borrowing rates exist:
                                Currency Lending Rate    Borrowing Rate
                                   US $ 7%                 7.2%
                                      P 22%              24%
The Evergreen Bank considers borrowing$430,000 or its equivalent Peso amount
in the interbank market and investing the proceeds for 90 days. Estimate the
speculative profits (or losses) that could be earned from this strategy.

(b)Describe how market forces will work to bring the speculative profits (or losses)
to long run equilibrium.

Solutions

Expert Solution

If it borrows $430,000
Borrowing rate 7.20%
Future Value after 90 days $437,740 (430000*(1+(0.072/4))
Conversion to Peso at spot rate $0.43
Amount of Peso          1,000,000 Peso (430000/0.43)
Lend Peso at Lending Rate 22%
Future Value after 90 days          1,055,000 Peso (1,000,000*(1+(0.22/4))
Conversion to Dollar at spot rate $0.42
Amount of dollars received $443,100 (1055000*0.42)
Amount tobe paid on borrowing = Future value after 90 days= $437,740
Amount of speculative profit $5,360 (443100-437740)
b Market forces will bring down the spot rate
Peso will further depreciate , since its demand will be high due to speculative reason
The Equilibrium will be achieved at spot Rate=0.43*(1+(0.072/4))/(1+(1+0.22/4)))
Equilibrium Spot rate after 90 days $0.4149

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