Solution: In-Class Excercise # 3: Currency Price Expectations and Trading Strategy
Citibank can borrow/lend dollars at 6%. It can also borrow/lend euros (E) and pounds (BP) at 8%. It has
access to $15,000,000, E20,00,000, or BP10,000,000 for currency speculation
How can Citibank make trading profits:
Scenario 1: If it expects BP to depreciate from $1.50 to $1.40 in 180 days.
Scenario 2: If it expects E to appreciate from $0.75 to $0.80 in 90 days.
Scenario 1
Scenario 2
Which currency should you
borrow in, and how much ?
Depreciating currency: Borrow
BP 10,000,000 @ 8% for 180
days (6 months)
Depreciating currency: Borrow
USD 15,000,000 @ 6% for 90
days (3 months)
Which currency should you invest
in, and how much ?
Appreciating currency: Invest
USD: BP 10,000,000 *1.5 =
$15,000,000 @ 6% for 180 days
(6 months)
Appreciating currency: Invest
E: $15,000,000 / 0.75 =
E 20,000,000 @ 8% for 90 days
(3 months)
What will be your profit in $ or
FC
[15,000,000 (1 + 0.06/2) ]/1.40 10,000,000 (1 + 0.08/2)
11,035,714 - 10,4000,000 =
BP 635,714
[20,000,000 (1 + 0.08/4) ]*0.80 15,000,000 (1 + 0.06/4)
16,320,000 - 15,225,000 =
USD 1,095,000
Which graph best describes what
happens in the FX market
BP Demand No Change + BP
Supply Increase: Graph E
E Demand Increase + E Supply
No Change: Graph G