Problem:
Wang Xiaoming currently has a deposit of HK$ 5 million in a public bank and is planning to convert his HK$ 5 million into the 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 the 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:
1) 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.
2) I you were Wang Xiaoming, which would you choose, one-year fixed deposit in HK dollars, Scheme 1 or Scheme 2? Please elaborate.