Question

Assume a speculator anticipates that the spot rate of the franc in three months will be lower than today’s three-month forward rate of the franc, $0.50 = 1 franc. Complete the following sentence explaining how this speculator can use $1 million to speculate in the forward market. The U.S. speculator should francs today for delivery in three months at today’s forward rate of the franc, which equals $0.50. What occurs if the franc’s spot rate in three months is $0.40? In three months, the speculator can purchase francs at $0.40 and sell them for the previously contracted rate of $0.50 per franc, thus profiting $0.10 on each franc. In three months, the speculator must purchase francs at $0.40 and resell them at $0.50 per franc, thus suffering losses of $0.10 on each franc specified in the forward contract. In three months, the speculator must purchase francs at $0.40 and resell them at $0.50 per franc, thus neither profiting nor losing from the transaction.

Answer 1

Answer:

Assume a speculator anticipates that the spot rate of the franc in three months will be lower than today’s three-month forward rate of the franc, .

a. The speculator can use $1 million to speculate in the forward market by purchasing a forward contract for 2,000,000 francs to be paid out in three months. This helps the speculator avoid losing money as the exchange rate decreases in period of three months.

b. Suppose the franc’s spot rate in three months is $0.40:

This means that the dollar is expected to appreciate in three months because its current rate is. It would take fewer dollars to purchase one franc in three months. The demand for dollars would increase because speculators looking to make a profit would hold as many dollars as possible while waiting for the currency to appreciate, then sell it for more than they purchased it for.

Hence, the speculator could make a profit of $0.10 on each franc.

Suppose the franc’s spot rate in three months is $0.60:

This means that the dollar is expected to depreciate in three months because its current rate is. It would take more dollars to purchase one franc in three months. The demand for dollars would decrease because speculators are expecting the currency’s value to fall in the coming three months.

The speculator would suffer a loss of $0.10 on each franc.

Suppose the franc’s spot rate in three months is $0.50:

This means that the value of the dollar is expected stay the same because its current rate is. It would take the same amount of dollars to purchase one franc in three months. The demand for dollars would remain constant.

The speculator would earn no profit no loss when the Franc’s spot rate in 3 months is $0.50.

Explanation: