The present spot rate for francs is $0.4000 per SFr. A speculator's expectation of the spot rate for francs in 90 days is $0.4500. If the speculator's expectation proves correct, what would be his dollar profit from speculating $10,000 in the spot market?
With $10,000, the speculator could buy SFr25,000 ($10,000/$0.4000) in the spot market, hold them for 90 days, and resell them at $0.4500 per SFr for a gross of $11,250 (SFr25,000 x $0.4500). As a result, the speculator would earn a net profit of $1,250, or 12.50 percent, on the original $10,000 of capital. But spot speculation is risky. If the spot rate were to decline to $0.3500 during this period, the SFr25,000 would have an ending value of $8,750 (SFr25,000 x $0.3500) for a net loss of $1,250. Theoretically speaking, no limit exists to the potential profit, but the maximum loss would be $10,000.
A speculator is not locked into an absolute 90-day terminal date but may simply hold the currency until a date that seems to be most profitable. This is possible because the speculator could close out the position before 90 days or hold it longer than 90 days if his expectation changes after the spot purchase.
Speculating in the forward market Suppose that a speculator anticipates that the Swiss franc's spot rate in 90 days will exceed its 90-day forward rate as quoted today. The speculator buys francs for 90-day future delivery at today's forward rate, waits for 90 days, and then sells the francs spot to close the position.
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