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Analysis of foreign currency deposit and local deposits

Wang Xiaoming currently has a deposit of HK$ 5 million in a public bank and is planning to convert his HK$ 5 million into one-year fixed deposit in HK dollar at an annual interest rate of 1.25%. However, Wang Xiaoming has just received a call from Chen Dawen, director of Personal Finance of the public bank, saying that they are promoting two foreign currency deposit/investment schemes as follows:

Scheme 1 (fixed deposit in Australian dollar)
One-year fixed deposit in Australian dollar. The interest rate is 6% and 6.2% respectively for deposit below $A 499,999 (inclusive) and above $A 500,000 (inclusive).

Scheme 2 (Option in Australian dollar)
One-year investment of HK$ 5 million. The accrued interest is used as the premium to buy a one-year European call option in Australian dollar with total contracted value of $A 4 million at the exchange rate of $A 1.00 to HK$ 7.39.

Currently the exchange rate is $A 1.00 to HK$ 7.20. According to your analysis, you estimate the exchange rate in one year's time to be in the range of $A 1.00 to HK$ 6.50 - 7.70. If the trading costs and the difference between the buying and selling prices are excluded:

a. Assuming the exchange rate in one year's time will be $A 1.00 to HK$ 6.50, HK$ 7.40 and HK$ 7.70 respectively, and if Mr. Chen adopted the above schemes, please calculate the compound amounts in HK dollars in one year's time respectively.
b. If you were Wang Xiaoming, which would you choose, one-year fixed deposit in HK dollars, Scheme 1 or Scheme 2? Please elaborate.

Solution Preview

A: One year fixed deposit in HK Dollars
Interest rate = 1.25%
Amount at the end of 1 year = 5*(1+1.25%)=HK$ 5.0625 million

B: Fixed deposit in Australian dollar
First convert the HK$ 5 million into A$ at the rate of A$1.00=HK$7.20 to get A$ 694,444
Since the amount is more than A$500,000, the applicable interest rate is 6.2%.
Amount at the end of 1 year = 694,444*(1+6.2%)=A$ 737,500
Now convert the amount back in HK$

Amount when conversion rate ...

Solution Summary

This post helps students to understand how to compare the investments made in different currencies.