Mammouth Mutual Fund of New York has $5 million to invest in certificates of deposit (CDs) for the next six months (180 days). It can buy either a Philadelphia National Bank (PNB) CD with an annual yield of 10 percent or a Zurich (Switzerland) Bank CD with a yield of 12.5 percent. 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 a New York City bank:
Switzerland (CHF)
Spot ............... $0.4200
30-day forward .......... 0.4190
90-day forward .......... 0.4170
180-day forward .......... 0.4155
a. If the Zurich Bank CD is purchased and held to maturity, determine the net gain (loss) in U.S. dollars relative to the PNB CD, assuming that the exchange rate in 180 days equals today's spot rate.
b. Suppose the Swiss CHF declines in value by 5 percent relative to the U.S. dollar over the next 180 days. Determine the net gain (loss) of the Zurich Bank CD in U.S. dollars relative to the PNB CD for an uncovered position.
c. Determine the net gain (loss) from a covered position.
d. What other factor or factors should be considered in the decision to purchase the Zurich Bank CD?