Question

The spot exchange rate is $1.10 per €. One year ahead forward rate is $1.08 per €. If the interest rate in dollars is 4% and the interest rate in euros is 7%. If an investor borrows $100 and invests in a euro denominated bond while locking the one year ahead conversion rate with a forward contract. What is her profit from this strategy?

a)$56,078.43
b)$55,238.22
c)$61,223.59
d)$54,148.33

Answer 1

To calculate the profit from currency exchange and interest rates, one would convert $100 to euros, invest at 7% interest, convert back to dollars at a forward rate, and subtract the initial loan with interest. The correct profit calculation doesn't match any of the provided options, indicating a possible error in the question or answers.

Step-by-step explanation:

The question poses a scenario where an investor borrows $100 and invests in a euro-denominated bond while locking in a one-year ahead conversion rate with a forward contract. The spot exchange rate is $1.10 per € and the one year ahead forward rate is $1.08 per €. The interest rate in dollars is 4% and the interest rate in euros is 7%. To calculate the profit, follow these steps:

1. Borrow $100 and convert to euros at the spot exchange rate: $100 / $1.10 = €90.9091.
2. Invest these €90.9091 at the euro interest rate of 7% for one year: €90.9091 × 1.07 = €97.2737.
3. Use the forward contract to convert €97.2737 back to dollars at the forward rate of $1.08 per €: €97.2737 × $1.08 = $105.0556.
4. Pay back the borrowed amount with interest: $100 × 1.04 = $104.
5. The profit is the final amount minus what you owe: $105.0556 - $104 = $1.0556.

However, none of the provided answer options matches the correct profit calculation ($1.0556), suggesting either a mistake in the initial parameters or the answer choices. Therefore, under the given circumstances and correct arithmetic, none of the provided answer options are correct.