Crayson Co. is a U.S.-based MNC that has $5 million in cash available. It will not need the funds for one quarter. Crayson notices that the quarterly bank deposit interest rate in the country of Zynland is 2% (not annualized) versus only 1% in the United States. Also, there is no credit risk because the bank deposit is back fully by the Zynland Government. XXX XXXXXXXX in Minland (XXXXXX the XXX) has XXXX XXXX XX the value of XXX XXXX (2 XXX = X XXXX) XXX XXX XXXX eight XXXXX. XXX quarterly XXXXXXXX XXXX in the XXXXXXXX is X XXXXXXX. XXX XXXX XXXX of XXX XXXX XX presently $X, while XXX XXXXXXXXX forward rate XX XXX XXXX XX $1. XXX zyn is XXXXXXXXX valued at $.50, so XXXX 2 zyn XXX XXXXXXXXX equal XX $X. Because the zyn XX tied to XXX XXXX, it XXXXXXXXXX against the dollar over time in XXX same manner XXXX XXX XXXX fluctuates XXXXXXX XXX XXXXXX over time.
XXXXXXXXX:
a) XXXXXXX how XXXXXXX Co. XXXXX possibly XXXX a XXXXXX return on XXX funds by a form XX covered XXXXXXXX arbitrage in XXXXX it invests in the zyn and XXXXXX XXX XXXXXXXX XXXX a XXXXXXX sale in XXXXX. What XXXXX be its XXXXXXXX XXXXXX XXXX the quarter if the zyn remains XXXX to XXX euro?
b)Explain the risk XX XXXXXXX XX. XX XXXXXXXX in the form XX covered interest XXXXXXXXX XXXXXXXXX in the XXXXXXXX XXXXXXXX.
Answer:
XXXXXXXXX bank XXXXXXX interest rate in XXX country XX XXXXXXX is X% (not XXXXXXXXXX)
XXXXXXXXX XXXX XXXXXXX XXXXXXXX rate in XXX XXXXXX XXXXXX = X% (XXX XXXXXXXXXX)
Quarterly XXXXXXXX XXXX in XXX eurozone = 1 percent
Spot XXXX of XXX euro XX presently $1
Quarterly forward rate XX the XXXX XX $1
zyn is presently XXXXXX at $.XX
2 XXX = X USD
X XXX = 1 XXXX
XXXX available = $X XXXXXXX
· Converted amount into XXX = 10 XXXXXXX zyn
· As quarterly bank XXXXXXX XXXXXXXX XXXX in Zynland is more than that in XXX XXXXXX States, invest 10 XXXXXXX XXX in bank XXXXXXX @ X% XXXXXXXX.
XXXXXXXX earned = 10 * 0.02 * 3/12 = X.XX million zyn
Total amount after a quarter = 10 + 0.05 = XX.05 XXXXXXX zyn
XXXXXXXX quarterly forward rate of 2zyn = 1 USD
XXXXX XXXXXX in XXX after a XXXXXXX =$10.XX/2 XXXXXXX = $5.025 million
XX same XXXX cover XXXX investment by XXXXXXXX XXXX XXXXXXX trade XX XXXXXXX X million XXXXX against USD.
Total XXXX XXXXXXX after a XXXXXXX = X million Euros * $1 = $5 million
· Net earnings after a quarter = $X.XXX - $X = $0.025 million
b) XXX XXXXX risk XXXXX on XXX information provided in the XXXXXXXX XX that of exchange rate fluctuation between XXXX XXX XXX. The XXXXXXXX XXXX XXXXXXXXX XXXX not XXXX XX XXX XXXXXXX stronger or XXXX becomes XXXX.
b) XXXX XX that we have assumed that XXX XXXXXXX XX same level XXXXXXX euro as it has XXXX XXXX last 8 XXXXX. XX Zyn XXXXXXXXXXX, we XXXX XXXXX XXXX . XX it XXXXX XXXXX 1.9803 there XXXX be loss. X.9803 is breakeven XXX Zyn-XXXX XXXX (X.XX/2.55) =X.9803)
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