You expect that the INR will depreciate against the dollar from its spot rate of

Question

You expect that the INR will depreciate against the dollar from its spot rate of $.0.15 to $.0.125 in 60 days. The following interbank lending and borrowing rates exist:

                                           Lending Rate             Borrowing Rate

      U.S. dollar                           1.0%                              2.5%

      INR                                     12.0%                            15.0%

How can you profit from the above given information. Estimate the profits that could be earned given your maximum borrowing limits are either $1,500 or INR 100,000?

Explanation / Answer

Answer: If we borrow $1500 and convert into Rs. and lend in india:

Amount to be borrowed=$1500

Add: Interest paid (1500*2.5%*2/12)=$6.25

Total amount paid=$1506.25

Amount to be converted at spot rate= INR10000 ($1500/0.15)

Add:Interest received (10000*12%*2/12)=INR 200

Total amount received=INR10200

Amount received is converted into $ at forward price=10200*0.125=$1275

So Loss from this transaction is: (1275-1506.25)$231.25

If we borrow INR 100000 and convert into $. and lend in us:

Amount to be borrowed=INR 100000

Add: Interest paid (100000*15%*2/12)=INR2500

Total amount paid after 60 days=INR 102500

Amount to be converted at spot rate= INR100000*0.15=$15000

Add:Interest received (15000*1%*2/12)=$ 25

Total amount received=$15025

Amount received is converted into INR at forward price=$15025/0.125=INR120200

So Profit from this transaction is: (120200-102500) =INR17700

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