On the eve of its long overdue devaluation (August 31, 1976), the Mexican peso (P) could be purchased or sold 90 days forward at P18 for $1, a considerable discount from the u.S. dollar standpoint. On August 30, 1976, $1

= PI2.5.

a) What was the forward discount on Mexican peso forward contracts?

Compute the yearly implicit rate of interest on 90 days forward pesos.

b) Assuming that on August 31, 1976, you expected the peso to devalue by 25 %, explain how you could speculate through the forward exchange market.

What would be your expected profit? Show how your expected profits would be affected should you be required to put up a margin of 10 % on your forward purchase (sale) contract (the opportunity cost of speculators' funds are supposed to be 9% annually).

c) Would you speculate differently (from the answer to part

b) if you expected the postdevaluation exchange rate to be P26 to $1? Explain.