FX transactions?

Question

Suppose I expect Yen to depreciate by 7 percent against the dollar over the next 3 months. How can I make profit through

(a) spot market transactions only, and

(b) forward market transactions only?

Answer 1

(a) Sell yen and buy dollars and hold it for three months. In three months buy yen and sell the dollars. Aside from the transaction cost, your other cost is financing the dollars for three months and receiving yen interest for three months which are lower than what you pay for financing the US$.

(b) Sell yen and buy dollars in the forward market for three months out. In three months buy yen and sell dollars in the spot market to offset the position. Make sure that the settlement date for both trades is on the same day. When you are quoted the forward rate, the interest differential between yen and dollar is priced in the rate.

Financially speaking there is no difference between using strategy (a) or (b). However, you may not be able to execute one of the two due to credit constraints given to you by the counterpart of this trade.