GOPAL AGGARWAL (DOING NOTHING) (1339 Points)
30 March 2012
Hello friends
Today I am revising my SFM from SD Bala Sir Book when going through Chapter International Finance-2, Revision problem -2 I face one problem as under
SD BALA Sir has used the Ask rate in part one to convert the Sterling in to Dollar
and in second part take BId rate to convert the same.
Please help me friends
Whether I have problem or it's a mistake
Mandakini
(CA )
(422 Points)
Replied 30 March 2012
hello gopal...,, I dnt have bala sir book.. if u can provide the question I vl try to help u
GOPAL AGGARWAL
(DOING NOTHING)
(1339 Points)
Replied 30 March 2012
Problem
You are in new York. The Spot $/ £ rate is 1.5865-84. The 12 months forward rate is 1.5443-1.5463. The T-bill rate in US 5% while in UK is 8%
(a) If u Invest £ 25000 in UK, by simultaneously taking a 12 months forward contract how much will you gain or loss
Solution :-
|
Dollar Per Pound |
Bid |
Ask |
|
|
Spot |
1.5865 |
1.5884 |
|
|
Forward |
1.5443 |
1.5463 |
|
Invest in Dollar
|
A |
You have |
25000 |
Pound |
|
B |
Relevant rate We have to sell pound. Hence Spot Ask Relevant |
1.5884[GA1] |
|
|
C |
Dolar Value ( aXb) |
39710 |
Dollar |
|
D |
Dollar Intt Rate |
5% |
|
|
E |
Maturity Value (39710+5% of 39710/-) |
41696 |
Dollar |
Invest in pound
|
A |
You have |
25000 |
Pound |
|
B |
Pound Int rate |
8% |
|
|
C |
Take forward cover (We can sell pound. Hence Forward Bid relevant)
|
1.5443 |
|
|
D |
Maturity Value (25000+8% on 25000) |
27000 |
Pound |
|
E |
Maturity value (cXd) |
41696 |
Dollar |
In part 1 ask rate is used
While in 2 Bid rate is used
[GA1]I THING IT SHOLD BE 1.5865
Back in the Game
(a)
(1273 Points)
Replied 30 March 2012
firstly i don understand why u ve to invest in $ wen its specifically given invest in pound
1)Borrow (to invest 25000 pound *1.5884( cos market maker is gonna sell at high & buy @ low))=39710$
2)For making use of $ u ve to pay for time value of money 39710$*5%+=41695.5$
3)invest in pound simultaneously @ 8% *25000 pounds=27000pound
4)Now boss u r in new york...i think u cant do anything with pound which u gonna recieve after 12 months.
sell it right now @ forward rate(catch hold principle market maker will sell @ high buy @ low),u r selling pound so gotta pick1.5443..
so $ ull be recivng @ the end of 12 months 27000$*1.5443=41696.1
so Arbitage=41696.1$-41695.5$=0.6$
Mandakini
(CA )
(422 Points)
Replied 31 March 2012
| Originally posted by : ashima | ||
 |
in first part u had to invest in dollars so u had to convert pound to dollar so it used ask rate and in second case u hv to invest in pound and u already hv pound so u will convert maturity value of pound to dollar so it used bid rate |
 |
but as per the question and solution in two cases " you have pounds" . i agree with gopal that bid is relevant as we are investing in dollars by converting pounds i.e SELLING POUNDS FOR DOLLARS" so we are selling banker has to buy so bid is relevant as bank buys at lower rate.
C I don’t have an expert way to xplain,but c Let’s take it from the top
U r in new York Where spot rate is 1.5865-1.5884 Forward rate is 1.5443-1.5463
Nw u hv 25000 pounds when u will invest in UK u’ll hv to convert it to $ i.e 25000*1.5884 (spot ask rate)=$39710
Int rate in US is 5 %
So at maturity u’ll receive $(39710+5%)=$41696
II…u’ll take forward cover on 25000 pound ,int rate 8% Maturity value 25000+8%=27000 pounds
Nw to c whether there is any arbitrage gain or not,u got to convert 27000 pound to dollar,so u’ll sell it to bank to get $ at its bid rate i.e 27000*1.5443=41696$
Hence no gain.
I hope I hv made myself clear.hope it helps
CAclubindia
