Question

You work as a currency trader at the Big Time Bank and specialise in trading the AUD USD. The current spot rate is USD AUD 0.678 and you have forecast a rate of USD AUD 0.6915 in 90 days. The borrowing and lending rates in Australia and the US are:

Currency	Lending rate	Borrowing rate
US dollar	2.3%	2.5%
Australian dollar	1.4%	1.8%

You will speculate on the change in the exchange rate and you have the authority to borrow $10 million of either currency.

a)      Which currency will you borrow and which will you invest in? Explain why.         

b)     What is your profit in AUD? Show all calculations in detail.

Answer 1

a]

I will borrow in USD and invest in AUD. This is because a profit can be earned by doing this.

b]

Amount borrowed in USD = 10,000,000

Amount to be repaid in USD after 90 days = 10,000,000 * (1 + (2.5% * (90/360))) = USD 10,062,500

The amount borrowed in USD is converted into AUD at the spot rate. AUD received = 10,000,000 / 0.678 = AUD 14,749,263

This AUD is invested. The amount received after 90 days = 14,749,26 * (1 + (1.4% * (90/360))) = AUD 14,800,885

This AUD received after 90 days is converted into USD at the exchange rate after 90 days. Amount received in USD after conversion =  14,800,885 * 0.6915 = USD 10,234,812

The amount to be repaid on the original borrowing = USD 10,062,500

Profit in USD = 10,234,812 - 10,062,500 = USD 172,312

Profit in AUD = 172,312 * 0.6915 = AUD 249,186