International Risk Management

The leader of the stated firm seems to believe that she has truly grasped the foreign exchange market over the years and now believes that in the next 12 months the Euro will appreciate against the U.S. dollar from the current spot rate at 1.2622 to 1.33 in 12 months. The firm currently has $150,000 to invest in the spot, forward, and option markets, if the firm chooses to follow their leaders speculations they may enter a very risky investment if her speculation is not right. However, since she has been studying the foreign market for years the firm may choose to go with her knowledge of the speculation appreciation and invest the funds with her speculations.

One of the ways in which this firm could speculate is to do the buy and hold option. Where they would invest the $150,000 and buy the Euro’s at the current spot rate of 1.2622 and holds it for the stated 12 months. If the firm buys the Euro’s today with calculations based on the spot market, it would be as follows:

$ 150,000 x 1.2622 = €118,840.12

The firm can simply hold that for a year or they can opt to buy it back using the forward rate of 1.2905 which would be as follows:

€118,840.12 x 1.2905 = $153,363

Therefore, to the return balance of the forward rate from the twelve month investment would be calculated as follows:

$153,363 – $150,000 = $3,363

On the other hand, the firm could also opt to buy back the Euro’s using speculation rate of exchange. If the firm chooses to follow their leader’s speculation where she believes in 12 months the Euro will appreciation against the U.S. dollar the calculations for buying back the Euro to the U.S. dollar would be as follows:

€118,840.12 x 1.33 = $158,057

Therefore, to the return balance of the speculation rate from the twelve month investment would be calculated as follows:

$158,057 - $150,000 = $8,057

To attain the returns percentage of the forward rate and the speculation rate the firm would calculate them as follows:

Forward rate return: -...