Suppose the three-month forward rate for the Indian rupees (INR) per Japanese yen (JPY) was INR 0.75/JPY

Suppose the three-month forward rate for the Indian rupees (INR) per Japanese yen (JPY) was INR 0.75/JPY, while the spot rate at the time was INR 0.73/JPY. A scientist located in New York speculates that the spot rate three months later will be INR 0.77/JPY. They decided to devote 500,000 yen in order to try to profit from this speculation, by making a trade in the forward market.

Describe the cash flows and the profit if the prediction comes true (Specify the amounts and currencies).

Solutions

Expert Solution

Spot rate = INR 0.73/JPY

3 month Forward rate = INR0.75/JPY

Expected 3Month Spot rate = INR 0.77/JPY

Speculation Profit can be obtained by doing the following transactions-

Step-1: Enter into forward contract to buy 500000JPY at INR 0.75/JPY after 3 month

Step-2: after 3 months Buy 500000 JPY as per the Forward contract and pay =500000 JPY* INR 0.75/JPY = INR 375000

Step-3:Now sell the JPY 500000 at spot rate @INR 0.77/JPY and receive 500000JPY*INR0.77/JPY = INR 385000

Step-4: Speculation gain after 3 months = (Receive INR 385000-Pay INR 375000) = INR 10000.

jeff jeffy answered 2 years ago

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