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Exhange rate problems

1) Speculation. Diamond Bank expects that the Singapore dollar will depreciate against the dollar from its spot rate of $.43 to $.42 in 60 days. The following interbank lending and borrowing rates exist:
Lending Rate Borrowing Rate
U.S. dollar 7.0% 7.2%
Singapore dollar 22.0% 24.0%

Diamond Bank considers borrowing 10 million Singapore dollars in the interbank market and investing the funds in dollars for 60 days. Estimate the profits (or losses) that could be earned from this strategy. Should Diamond Bank pursue this strategy?

2) IRP. The one-year risk-free interest rate in Mexico is 10%. The one-year risk-free rate in the U.S. is 2%. Assume that interest rate parity exists. The spot rate of the Mexican peso is $.14.

a. What is the forward rate premium?
b. What is the one-year forward rate of the peso?
c. Based on the international Fisher effect, what is the expected change in
the spot rate over the next year?
d. If the spot rate changes as expected according to the IFE, what will be
the spot rate in one year?
e. Compare your answers to (b) and (d) and explain the relationship.

Solution Preview

1) We start with 10 million S$. This is borrowed at 24%. Convert S$ to US$ at spot rate of $0.43.
US$ received = 10,000,000 X .43 = $4,300,000
Invest US$ for 60 days at 7% which is the lending rate. The rate for 60 days is 60/360 X 7% = 1.17%
At the end of 60 days, amount received is 4,300,000 X ...

Solution Summary

The solution explains some questions relating to exchange rates