Exchange rates are: SFR1.8622/$ spot SFR1.8000/$ one year forward Interest rates are: 6 percent per annum in Switzerland 9 percent per annum in the United States You have no money, but your credit is good for a loan of $10,000 or its equivalent in Swiss francs. You can borrow or invest dollars for one year at 9 percent, and you can borrow or invest francs for one year at 6 percent. You notice that U.S. interest rates are above Swiss rates, and you would like to earn excess profits with no risk. What can you do, and how much can you earn?
• Maria Cadiz, a foreign exchange trader in Madrid, sees that the 180-day forward rate for the Japanese yen against the dollar is ¥130/$. She believes that the spot yen in six months will be stronger, at ¥125/$. What would be her expected profit on a 180-day forward speculation with $1 million? What would be her risks?
• Laura Wong would like to speculate that the U.S. dollar is going to weaken compared to the Swiss franc (SFR). She intends to use foreign currency options. She finds an options contract for the SFR62,500 (she can only afford to speculate on one contract). The most recent spot rate is $0.6400/SFR. The three-month forward rate is $0.6500/SFR. The premium for a put option on SFR for three months with a strike price of $0.6400/SFR (“at the money”) is 1.0 cent per SFR. The premium for a three-month call option on SFR is 2.0 cents per SFR for the same strike price. Laura believes that the most likely range for the spot SFR in three months will be a low of $0.6000/SFR and a high of $0.6800/SFR. The most likely value, in her opinion, will be $0.6700/SFR. Ignore brokerage costs.
• Diagram the profit and loss position from Laura Wong’s perspective for both the put and the call options.
• Calculate what she would gain or lose at her expected range of future spot prices and her most likely estimate of $0.6700/SFR.
• Calculate and show on the diagram the breakeven future spot rate for the SFR.
• Which strategy is most likely to lead to a speculative profit for Laura?