Reference no: EM133043463

Question - From the statement, you are required to:

(a) Suppose that the current spot exchange rate is €1.50/£ and the one-year forward exchange rate is €1.60/£. The one year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, at the current spot exchange rate.

(i) Evaluate how you can realize a guaranteed profit from covered interest arbitrage as a euro investor.

(ii) Calculate the amount of arbitrage profit.

(b) Bamboo Inc sold a super IT equipment to the Plankton Inc in Italy on credit and invoiced €8 million payable in 6 months. Currently the 6 months forward exchange rate is $1.20/€ and the foreign exchange advisor for Bamboo Inc predicts that the spot rate is probably estimated to be $1.15/€ in 6 months.

Based on the statement, you are required to:

(i) Calculate the expected gain or loss from the forward hedging.

(ii) As a financial manager of Bamboo Inc, recommend with reason whether the hedging is appropriate or not.

(iii) Suppose the prediction by foreign exchange advisor shows the future spot rate equal to the spot rate quoted today, recommend with reason whether the hedging is appropriate or not.

(iv) Suppose the forecasted future exchange rate turns to be $1.28/€, recommend with reason whether the hedging is appropriate or not.