Speculation. You will use the following scenario to fill in the blanks. Blue Dem

Question

Speculation. You will use the following scenario to fill in the blanks. Blue Demon Bank expects that the Mexican peso will depreciate against the dollar from its spot rate of $.15 to $.14 in 10 days. The following interbank lending and borrowing rates exist: U.S. dollar Lending Rate: 8.0%. Borrowing Rate: 8.3%. Mexican peso Lending Rate: 8.5%. Borrowing Rate: 8.7%. Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million pesos in the interbank market, depending on which currency it wants to borrow. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy. Blue Demon Bank can capitalize on its expectations about pesos (MXP) as follows: Note, Steps 1, 2, and 5 have been completed for you: 1: Borrow MXP70 million 2: Convert the MXP70 million to dollars: MXP70,000,000 × $.15 = $10,500,000 3: Lend the dollars through the interbank market at 8.0% annualized over a 10 day period. The amount accumulated in 10 days is:______________ 4: Repay the peso loan. The repayment amount on the peso loan is:_____________ 5: Based on the expected spot rate of $.14, the amount of dollars needed to repay the peso loan is: $9,823,683. 6: After repaying the loan, Blue Demon Bank will have a speculative profit (if its forecasted exchange rate is accurate) of: ________. What are the blanks for questions 3, 4, and 6?

Explanation / Answer

How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.

Ans : Borrow MXP70 million

Convert the MXP70 million to doller : MXP70,000,000 × $.15 = $10,500,000

Ans 3) The amount accumulated in 10 days = $10,500,000 × [1 + (8% × 10/360)] = $10,500,000 × [1.002222] = $10,523,333

Ans 4) The repayment amount on the peso loand = MXP70,000,000 × [1 + (8.7% × 10/360)] = 70,000,000 × [1.002417]=MXP70,169,167

Ans 5) Based on the expected spot rate of $.14, the amount of dollars needed to repay the peso loan = MXP70,169,167 × $.14 = $9,823,683

Ans 6) After repaying the loan, Blue Demon Bank will have a speculative profit (if its forecasted exchange rate is accurate) $10,523,333 – $9,823,683 = $699,650

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