Suppose that California Co., a U.S. based MNC, seeks to capitalize a difference in interest rates between euros and British pounds via the use of a carry trade. In particular, after 1 month, funds invested in euros will yield a 0.50% percent return, while funds invested in pounds will yield a return of 2.00% percent. Currently the spot rate of the British pound is $1.00 while the spot rate of the euro is $0.80. In other words, the pound is worth 1.25 euros. California Co. expects these spot rates to remain constant over the next month. The previous scenario assumed that the spot rates of the pound and the euro remained constant. However, there is a risk that the exchange rates change. Suppose that the euro appreciates over the course of the month, such that the cross exchange rate is now 0.78125 euros per pound. Assume the spot rate for the pound remains constant at $1.00 per pound Under this new cross exchange rate of 0.78125, the 603,000 euros that California Co. needs to repay is equivalent to Thus, after repaying the loan, California Co. will have investments. These pounds are equivalent to -$78,240.00, and represents a profit of $ Co. used from their own funds. pounds from the 693,600 pounds they received from the initial pounds. over the initial $200,000 that California
Suppose that California Co., a U.S. based MNC, seeks to capitalize a difference in interest rates between euros and British pounds via the use of a carry trade. In particular, after 1 month, funds invested in euros will yield a 0.50% percent return, while funds invested in pounds will yield a return of 2.00% percent. Currently the spot rate of the British pound is $1.00 while the spot rate of the euro is $0.80. In other words, the pound is worth 1.25 euros. California Co. expects these spot rates to remain constant over the next month. The previous scenario assumed that the spot rates of the pound and the euro remained constant. However, there is a risk that the exchange rates change. Suppose that the euro appreciates over the course of the month, such that the cross exchange rate is now 0.78125 euros per pound. Assume the spot rate for the pound remains constant at $1.00 per pound Under this new cross exchange rate of 0.78125, the 603,000 euros that California Co. needs to repay is equivalent to Thus, after repaying the loan, California Co. will have investments. These pounds are equivalent to -$78,240.00, and represents a profit of $ Co. used from their own funds. pounds from the 693,600 pounds they received from the initial pounds. over the initial $200,000 that California
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Transcribed Image Text:Suppose that California Co., a U.S. based MNC, seeks to capitalize a difference in interest rates between euros and British pounds via the use of a
carry trade. In particular, after 1 month, funds invested in euros will yield a 0.50% percent return, while funds invested in pounds will yield a return of
2.00% percent.
Currently the spot rate of the British pound is $1.00 while the spot rate of the euro is $0.80. In other words, the pound is worth 1.25 euros. California
Co. expects these spot rates to remain constant over the next month.
The previous scenario assumed that the spot rates of the pound and the euro remained constant. However, there is a risk that the exchange rates
change. Suppose that the euro appreciates over the course of the month, such that the cross exchange rate is now 0.78125 euros per pound. Assume
the spot rate for the pound remains constant at $1.00 per pound
Under this new cross exchange rate of 0.78125, the 603,000 euros that California Co. needs to repay is equivalent to
Thus, after repaying the loan, California Co. will have
investments. These pounds are equivalent to -$78,240.00, and represents a profit of $
Co. used from their own funds.
pounds from the 693,600 pounds they received from the initial
pounds.
over the initial $200,000 that California
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