Raya Mutual Fund of Kuala Lumpur has RM5 million to invest in certificates of deposit (CDs) for the next six months (180 days). It can buy either a CIMB Bank CD with an annual yield of 10% or a Mumbai (India) Bank CD with a yield of 12.5%. Assume that the CDs are of comparable default risk. The analysts of the mutual fund are concerned about exchange rate risk. They were quoted the following exchange rates by the international department of Kuala Lumpur City bank:
India (INR) Spot RM0.42
30-day forward 0.4190
90-day forward 0.4170
180-day forward 0.4155
(a) If the Mumbai Bank CD is purchased and held to maturity, determine the net gain (loss) in Malaysian ringgit relative to CIMB CD, assuming that the exchange rate in 180 days equals today’s spot.
(b) Suppose INR declines in value by 5% relative to the Malaysian ringgit over the next 180 days. Determine the net gain or loss of the Mumbai Bank CD in Malaysian ringgit relative to the CIMB Bank CD for an uncovered position.
(c) Determine the net gain or loss from a covered position.
(d) What others factors should be considered in decision to purchase the Mumbai Bank CD?