Speculation on Expected Exchange Rates
Solve the following problem:
Kurnick Co. expects that the pound will depreciate from $1.70 to $1.68 in one year. It has no money to invest, but it could borrow money to invest. A bank allows it to borrow either 1 million dollars or 1 million pounds for one year. It can borrow dollars at 6 percent or British pounds at 5 percent for 1 year. It can invest in a risk-free dollar deposit at 5 percent for 1 year or a risk-free British deposit at 4 percent for 1 year.
Determine the expected profit or loss (in dollars) if Kurnick Co. pursues a strategy to capitalize on the expected depreciation of the pound.