AquaSonic, a U.S. company, and a client of your bank, has sold sonar equipment t

Question

AquaSonic, a U.S. company, and a client of your bank, has sold sonar equipment to the Brazilian Navy. Payment from the Brazilian government for the sonar equipment will be made in Brazilian Reals (BRLs). The account receivable is valued at 500M BRLs and will be paid by Brazil in exactly 180 days. AquaSonic is concerned that the BRL will depreciate relative to the USD over the next 180 days and will adversely impact the USD value of the 500M BRLs. The company’s CFO approaches you, as the bank’s relationship manager with AquaSonic, to obtain a forward contract from the bank to exchange 500M BRLs for USDs in 180 days. Since 500M BRLs at the current spot exchange rate of $0.25 per BRL is $125M, which is a lot of money, and 180 days is a long way off, your bank superiors ask you to construct a forward rate quote that is risk-free for the bank. Checking the interbank borrowing interest rates for 180-day loans, you find that: The 180-day interest rate for BRLs 13% and for USDs is 3%. (Annualized rates) Construct a risk-free forward rate position using these interbank rates, showing how many USDs you can exchange for 500M BRLs. Show your work.

Explanation / Answer

Answer:

For construct a risk free forward rate, bank needs to borrow in BRLs. That much of BRLs. needs to be borrowed that will be 500M after 180 days @ 13% p.a.(6.5% for 180 days).

Amount of BRLs needs to be borrowed = 500M/(1 + 6.5%) = 500/1.065 = BRL469.48M

Bank will borrow BRL469.48M and pay BRL500M after 180 days which bank will receive from AquaSonic.

Now bank will convert borrowed money of BRL 469.48M into dollars and deposit those dollars for 180 days @3%p.a.(1.5% for 180 days).

Amount of dollars after 180 days = BRL 469.48M * 0.25 *(1+1.5%)

= 117.38* 1.015 = $119.13M

Bank will certianly have $119.13M after 180 days which can be exchanged with BRL 500 M to be received from AquaSonic.

Risk-free forward rate that can be given to AquaSonic = $119.13M / BRL500M = $0.2382 per BRL(Answer).

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