Solution 3:
It is clear from the data that 6-months forward US$ is quoting at premium, which is
calculated as below:
35.9010 – 35.0020
Premium = -------------------------- X 12 X 100 = 5.136 percent
35.20 6
Interest rate differential = 12 – 7 = 5 percent
Since the interest rate differential is smaller than the premium, it would be advantageous
to place money in US dollars, the currency whose 6-months interest rate is lower.
An operator would take the following steps:
(i) Borrow Rs.1000 at 12 percent for 6 months.
(ii) Convert this sum at the spot rate to obtain US$ 28.5697 (=1000/35.0020).
(iii) Place the dollars at 7 percent in the money market for 6 months to receive $
28.5697 X (7 X 6/12 X 1/100 + 1) = $ 29.5696.
(iv) Sell US$ at 6-months forward that gives:Rs.29.5696 X 35.9010 = Rs.1061.5782(v) Refund the rupee debt taken at 12 percent; the amount to be refunded is: Rs
1000 (1 + 12 X 6/12 X 1/100) = Rs.1060Net gain = Rs.1061.5782 – Rs.1060 = Rs.1.5782
Gain on transaction turns out to be small/negligible; it will emerge to be significant if the
sum involved is substantial (say Rs.1 million). Accordingly, the gain would be Rs.1,
57,820, i.e.
Rs. 15782
------------ X Rs.10, 00,000
Rs. 1000