Question 3. (20 points) The current spot rate of Canadian dollar is $0.98 and 18
ID: 2652827 • Letter: Q
Question
Question 3. (20 points) The current spot rate of Canadian dollar is $0.98 and 180-day forward rate is $1.12. Interest rates of the two countries are as follows. Assume that borrowing rate and lending rate are the same each other in both countries.
Interest rate (annual)
U.S. dollar 2.5%
Canadian dollar 4.5%
(1) Compute the annualized forward discount or premium for the Canadian dollar. State whether your answer is a discount or a premium.
(2) Suppose that the L.A. bank attempts to make profit by taking advantage of the situation given above. The bank is capable of borrowing either 1 million US dollars or 2 million Canadian dollars. Describe the steps to take to make profit and compute the amount of the profit.
Explanation / Answer
Answer:(1) Forward premium =[ ($1.12 - $0.98)/$0.98]*(360/180)*100= 28.57%
Answer:(2) Borrowing 1 million u.s $
Amount payable at the end of 180 days : Principal borrowed plus interest thereon $1012500
(1000000+12500)
Convert 1 million $ in canadian dollars at spot rate =1000000/0.98=1020408.163
And deposit and earn interest @ 4.5 %= 22959.8366
Total amount =1043367.346
After 180 days this amount is converted into us $ =1043367.346*1.12=1168571.427
Profit=156071.427 (1168571.427-1012500)
Borrwing 2 million canadian $
mount payable at the end of 180 days : Principal borrowed plus interest thereon $2045000
(2000000+45000)
Convert 2 million canadian $ in us dollars at spot rate =2000000*0.98=1960000
And deposit and earn interest @ 2.5 %= 24500
Total amount =1984500
After 180 days this amount is converted into canadian $ =1984500/1.12=1771875
Loss=273125 (1771875-2045000)
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