Kurnick Company expects that the pound will depreciate from $1.70 to $1.68 in on

Question

Kurnick Company expects that the pound will depreciate from $1.70 to $1.68 in one year. it has no money to invest, but it could borrow money to invest.It has been approved by a bank to borrow either 1 million dollars or 1 million pounds for one year. It can borrow dollars at 6% or British pounds at 5% for one year. It can invest in a risk-free dollar deposit at 5% for one year or a risk-free British deposit at 4% for one year. Determine the expected profit or loss (in dollars) if Kurnick Company pursues a strategy to capitalize on the expected depreciation of the pound. HINT: Follow these steps: 1. Borrow 1 million pounds and convert to dollars: 2. Total dollar amount at the end of year 1 is: 3. Total owed on pounds borrowed is: 4. Total amount of dollars needed to pay the loan is: 5. Profit or loss is:

Explanation / Answer

1. Borrow 1 million pounds and convert to dollars

= 1 million pound x 1.70 = 1.70 million dollars.

2. Total dollar amount at the end of year 1 is.

The dollar amount invested at the rate of 5% per year

So dollar amount at the year-end is = 1.70 dollar x 105%

= 1.785 million dollars

3. Total owed on pound borrowed is :

The interest rate is 5%

Hence total owed on the pound is = 1 million pound x 105 %

= 1.05 million pounds

4. The total amount of dollars needed to pay the loan is :

= 1.05 million pounds x 1.68 = 1.764 million dollars

5. Profit or loss

Dollars in investment = 1.785 million

Dollars needed to repay loan = 1.764 million

Profit = .021 million dollars

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