Blue Demon Bank expects that the Mexican peso will appreciate against the dollar from its spot rate of $.14 to $.15 in 10 days. The following interbank lending and borrowing rates exist:
Lending Rate Borrowing Rate
U.S. dollar 8.0% 8.3%
Mexican peso 8.5% 8.7%
Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million peso in the interbank market, depending on which currency it wants to borrow.
a. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.
b. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to depreciate from its present spot rate of $.17 to $.15 in 30 days. How could it attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.