134 Points You dont have money but can borrow from dollar or

13*.[4 Points] You don\'t have money but can borrow from dollar or euro market. Suppose you observe that a Explain your strategies to make certain amount of profit. i.e., explain your positions in all four markets (FX spot, FX forward, Money market (borrowing/lending) in U.S., Money market (borrowing/lending) in EU) at time (0) and (t)), no graphs. b) Calculate your profit in terms of variables (non-numeric-do not use numbers).

Solution

Ans:

Step 1: Let\'s say we borrow some amount $X at rate r in US and get it exchange to Euro at spot price i.e. X/S($/Euro) and put it in bank in Europe for time period t to earn an interest.

Step 2: After time t, the money received is Y (X/S($/Euro) + interest at rate R ) , while getting it converted into $ again at F($/Euro)* (X/S($/Euro) + interest)

Step 3: Payback the loan i.e. Z(X+ interest to be paid)

Net profit = F($/Euro)* (X/S($/Euro) + interest) - Z

So, we can say in case interest rate are same across these countries will always give a profit.

b) Profit = F($/Euro)* (X/S($/Euro)*(1+R)^t) - X(1+r)^t

In case if R is almost same as r , Profit = (1+r)^t*(F($/Euro)* (X/S($/Euro) - X)