Problem
New York Greater Bank is a U.S. investment bank that wants to benefit from the interest rate differential between the euro area and Japan. A euro (€) costs $1.13 today, while a yen (¥) costs $0.0096 today. The fund expects the exchange rates to still be $1.13 per euro and $0.0096 per yen in 7 months. Current annual interest rates are as follows:
|
Currency
|
Borrowing rate
|
Lending rate
|
|
Euro
|
7.5%
|
6.9%
|
|
Yen
|
4.8%
|
4.2%
|
The bank doesn't want to invest any of its own money, but can borrow €10,000,000 or ¥1,000,000,000.
Assume there are 30 days in every month and 360 days per year. Ignore compounding when working with the interest rates.
A. Should the bank borrow euros or yen?
B. What is the value of one euro in yen?
C. What is the value of the borrowed amount in euro?
D. What is the value of the invested amount after 7 months (in euro)?
E. What is the value of loan, including principal and interest, after 7 months (in yen)?
F. What is the expected value of euros required to pay off the yen loan and interest (in euros):
G. What is the expected profit from the transaction (in euros)?
H. What is the expected profit from the transaction (in $)?