A New York City Bank expects the exchange rate for the euro to appreciate from the spot rate of $0.60 to $0.65 in 90 days. The Bank is able to borrow $15 million or 25 million euros. The short term interest rates (annualized) in the interbank market are as follows:
CURRENCY LENDING RATE BORROWING RATE
U.S Dollars 6.72% 7.2%
Euro 6.48% 6.96%
(a) How will this bank attempt to capitalize on this expected change in exchange rate to make a speculative profit? Estimate the profit
(if any) that could be generated from this strategy.
(b) Assuming the expectation is that the euro will depreciate from $0.60 to $0.55 in 90 days. What change in strategy would be required for the Bank to attempt to earn a speculative profit? Determine the profit (if any) that could be earned.