In: Finance
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.
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 | ||||||||