Question

Question 8: Blue Demon Bank expects that the Mexican peso will depreciate against the dollar from its spot rate of $.2 to S.16 in 30 days. The following interbank lending and borrowing rates exist: Lending Rate Borrowing Rate U.S. dollar 5.0% 6% Mexican peso 8% 8.5% 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, (12 points)

Answer 1

Blue Demon Bank Expect that the mexican Peso will depreciate against Dollor from its Spot rate of $.2 to $.16 in 30 days.
So, LETS BORROW 70 MILLION PESO AT INTEREST RATE OF 8.5% AND INVEST THAT IN US.DOLLOR.

SPOT RATE = $10MILLION= 70 MILLION MEXICAN PESO.
SO, 1$ = 7 MEXICAN PESO.

USING FOLLOWING RATE CONVERT THE MEXICAN PESO TO US DOLLOR.

70 MILLION MEXICAN PESO /7 = $10 MILLION.

LETS INVEST FOR A MONTH AND RECEIVE INTEREST OF $10 MILLION*5%*30/360 = $41667.67.

TOTAL AMOUNT COLLECT = $ 10MILLION PRINCIPAL AND $41667 INTEREST.

NOW CONVERT USING FORWARD RATE AS MENTIONED : $7.16(I.E.$7 + $0.16)

SO, $10041667*7.16 = MEXICAN PESO = 71898335.7

NOW PAY INTEREST IN MEXICAN PESO ON 70 MILLION MEXICAN PESO.

70 MILLION MEXICAN PESO * 8.5% *30/360 = 495833.33 (INTEREST)

TOTAL PAYOUT = 70 MILLION MEXICAN PESO + 495833.33 = 70495833.33

SO, NET GAIN( IN MEXICAN PESO) = 71898335.7 - 70495833.33 = 1402502.37

USING THE ABOVE STRATEGY WE GAIN ABOVE MENTIONED GAIN IN MEXICAN PESO.