Question

7. The current spot exchange rate is $1.95/£ and the three-month forward rate is $1.90/£. Based on your analysis of the exchange rate, you are pretty confident that the spot exchange rate will be $1.92/£ in three months. Assume that you would like to buy or sell £1,000,000 a. What actions do you need to take to speculate in the forward market? What is the expected dollar profit from speculation? b. What would be your speculative profit in dollar terms if the spot exchange rate actually turns out to be $1.86/£.

Answer 1

solution:- (a) It is expected that the spot rate after three months will be $1.9216. calculate the expected dollar profit from the speculation as follows:- expected dollar probit - Buy amount *(spot exchange rate. - forward rate). = 61,000,000 *[ $1.92.- $1.90) = Ę 1,000,000 * $0.02 = $20,000 Therefore, the expected dollar pustit from the speculation is $20,000 (b) suppose , the spot exchange rate changes to $1.8616 in three months. calculate the expected dollar profit, 108 from the speculation as follows :- Expected dollar profit - Buy amount x( spot exchange rate - forward rate). - € 1000,000 nC #1.86- $1.90) = 61,000,000 *- $0.04 - (- $40,000). Therefore, the expected dollar profit/loss from the speculation is -440,000. The change in spot exchange rate leads to loss of $40,000.