1. Pricing ADRs. Today, the stock price of Genevo Company (based in Switzerland)
ID: 2736534 • Letter: 1
Question
1. Pricing ADRs. Today, the stock price of Genevo Company (based in Switzerland) is priced at SF80 per share. The spot rate of the Swiss franc (SF) is $.70. During the next year, you expect that the stock price of Genevo Company will decline by 3%. You also expect that the Swiss franc will depreciate against the U.S. dollar by 8% during the next year. You own American depository receipts (ADRs) that represent Genevo stock. Each share that you own represents one share of the stock traded on the Swiss stock exchange. What is the estimated value of the ADR per share in one year (8 points)?
2. Carry Trade Today British pound’s spot rate is $1.70. Kurnick Co. 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 5.5% or Briitish pounds at 4.5% for one year. It can invest in a risk-free dollar deposit at 5% for one year or a risk-free British pound deposit at 4% for one year. Kurnick uses today’s spot rate as its best guess of the spot rate one year from now. Determine the expected profit or loss (in dollars) if Kurnick Co. executes a carry trade for one year ?
Explanation / Answer
Solution 1:
Value of Swiss stock in one year = current price x (1- decline %)
= SF 80 x (1-0.03)
= SF 77.60
Value of Swiss Franc (SF) in one year would be = current value of Swiss Frank x (1- % decline)
= 0.70 x (1-0.08)
= 0.644 dollars
Value of ADR in one year = Value of Swiss stock in one year x Value of Swiss Franc (SF) in one year
= 77.60 x 0.644 dollars
= 49.97 dollars
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