Free «International Financial Management» Essay Paper

Ability to speculate

The prices of different currencies are subject to a variety of economic and political factors including interest rates, inflation and political stability. To speculate on the belief that the euro will strengthen from the current spot rate of $1.3435 to $1.41 and not the forward rate $1.3705 in 12 months, the leader of the firm will have used both technical factors economic fundamentals affecting the Euro. The technical aspect involves use of charts, trend lines, support and resistance levels alongside numerous patterns and mathematical analyses on how the Euro will trade in the future. Use of economic fundamentals to predict changes in values of different currencies involves interpretation of varied economic information obtained from news, government issued indicators and reports and even rumors concerning the European economies (Stephen, 2006).

Calculations

Amount of profit:

Exchange at spot rate: 1 Euro= $1.3435

                                               $500000 =?

 

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                                               500000/1.3435= 372162.263 Euros

Forward investment at the speculated $1.41 rate:

 1 Euro= $1.41

                                               372162.263 Euros=?

                                               372162.263*1.41= $524748.790

Profit accrued:          

524748.790- 500000= $24748.790

Percentage returns:    

24748.790/500000*100= 4.95%

Recommendations

The projected returns of 4.95% are based on the speculation that the forward exchange rate between the dollar and the Euro will be $1.41 instead of $1.3705. I would recommend that this option based on speculation be dropped in case there is another investment with similar or higher returns at lower risk. This is because the speculation is founded on volatile reasons mainly interest rates, inflation and political stability. For the Euro to strengthen against the dollar as speculated, the European economies have to have low interest rates, low inflation and be politically stable or vice versa. All these factors may or may not occur, or may have a direct opposite effect. Another risk involves the ability of the governments concerned to intervene and check the envisaged interest and inflation rates. Besides that, the 4.95% returns may be realized but at the same time the inflation rate in the USA may have risen and as such diminish the profit margin. An option with similar returns with the leader’s speculation bears fewer risks and should be adopted, while one with better returns is even more attractive.