EECS 1710 Lecture Notes - Lecture 19: New Zealand Dollar, Foreign Exchange Market, United States Dollar
24 Jun 2018
School
Course
Professor
EECS 1710 Lecture 19 Notes
Introduction
Institutional Speculation Based on Expected Depreciation
If the exchange rate on day 30 is $.52 per New Zealand dollar, as anticipated, then the
number of New Zealand dollars necessary to repay the U.S. dollar loan is NZ$38,692,308
(computed as $20,120,000=$.52 per New Zealand dollar).
Given that Chicago Co. accumulated NZ$40,216,000 from lending New Zealand dollars,
it would earn a speculative profit of NZ$1,523,692, which is equivalent to $792,320
(given a spot rate of $.52 per New Zealand dollar on day 30).
The firm could earn this speculative profit without using any funds from deposit
accounts because the funds would be borrowed through the interbank market.
Keep in mind that the computations in the example measure the expected profits from
the speculative strategy.
There is a risk that the actual outcome will be less favorable if the currency appreciates
to a smaller degree (and much less favorable if it depreciates).
If financial institutions believe that a particular currency is presently valued higher than
it should be in the foreign exchange market, they may borrow funds in that currency
now and convert it to their local currency now that is, before the target currency’s value
declines to its proper level.
The plan would be to repay the loan in that currency after it depreciates, so that the
institutions could buy that currency for a lower price than the one at which it was
initially converted to their own currency.
EXAMPLE
After 30 days, Chicago Co. will receive NZ$40,216,000 [computed as NZ$40,000,000 (1 þ
.0054)].
Use the proceeds from the New Zealand dollar investment (on day 30) to repay the U.S.
dollars borrowed.
Document Summary
If the exchange rate on day 30 is $. 52 per new zealand dollar, as anticipated, then the number of new zealand dollars necessary to repay the u. s. dollar loan is nz,692,308 (computed as ,120,000=$. 52 per new zealand dollar). After 30 days, chicago co. will receive nz,216,000 [computed as nz,000,000 (1 . Use the proceeds from the new zealand dollar investment (on day 30) to repay the u. s. dollars borrowed. The annual interest on the u. s. dollars borrowed is 7. 2 percent, or . 6 percent over the. The total u. s. dollar amount necessary to repay the u. s. dollar loan is therefore. Given that chicago co. accumulated nz,216,000 from lending new zealand dollars, it would earn a speculative profit of nz,523,692, which is equivalent to ,320 (given a spot rate of $. 52 per new zealand dollar on day 30). The firm could earn this speculative profit without using any funds from deposit accounts because the funds would be borrowed through the interbank market.
