Question

You have $100 the interest rate in the us is 10% the interest rate in india is 25% the spot exchange rate is 80 rupee/$ the forward exhange rate is 100 rupee/$

If you decide to invest in India to take advantage of the high interest rates (and taking no exchange rate risk by using the forward rate) how much will you have after one year

Answer 1

Ans. To invest in India, first we'll buy rupees from $100. At the spot rate of ₹80/$, $100 will but ₹8000

Then we'll invest ₹8000 in the Indian market at the interest rate of 25% and we'll also buy a forward contract with foreign exchange of ₹100/$ after an year.

After 1 year, ₹8000 must have grown = 8000*(1+0.25) = ₹10000

Then we'll use our forward contract to exchange these ₹8000 into dollars at a rate of ₹100/$.

So, at this rate ₹10000 will buy = $100

Thus, investment in Indian market will leave us with $100 after 1 year.

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