4. (FOREX Forward, Synthetic Loan, and Credit Risks) An FBI undercover agent Carey Hopkins dis- covers that a Mexican drug lord Gus is expanding his business to China and needs Chinese Yuan (CNY) to start the operations. Gus does not want to trade CNY on the spot market since such trans- actions might be monitored by the government. He decides to borrow 20 million CNY from Huai Dan, a Chinese criminal, at the simple interest rate of 2.5% per month for two months. Gus's assets are denominated in Mexico Peso (MXN). So Gus needs to convert some of his MXN to CNY in two months to repay his loan. Gus hires Sal, a derivatives expert, to hedge the exchange rate risks. To catch Gus, Carey Hopkins has to figure out Sal's plan. The following rates are observed. MXN 2-month simple interest rate: 2% per month. USD/MXN 2-month forward rate: 13.45. USD/CNY 2-month NDF rate: 6.50.1 (4.1) How much CNY must Gus pay back in two months? (4.2) Gus wants to eliminate the exchange risk of MXN/CNY. The futures/forward contract of MXN/CNY, however, does not exist. How can Sal hedge away the risk by using the forward contracts of US- D/MXN and USD/CNY? Describe his position in each contract. Assume Huai Dan is willing to accept payments in USD and convert USD to the required CNY at the spot rate in two months. (4.3) Two months later, the spot rate of USD/MXN is 13.60 and the spot rate of USD/CNY is 6.7. De- scribe the cash flows resulting from all Gus's contracts. Notice that the USD/CNY NDF contract is settled in USD. Assume Huai Dan is willing to accept USD payment and convert USD to the required CNY payment at the spot rate in two months. 4. (FOREX Forward, Synthetic Loan, and Credit Risks) An FBI undercover agent Carey Hopkins dis- covers that a Mexican drug lord Gus is expanding his business to China and needs Chinese Yuan (CNY) to start the operations. Gus does not want to trade CNY on the spot market since such trans- actions might be monitored by the government. He decides to borrow 20 million CNY from Huai Dan, a Chinese criminal, at the simple interest rate of 2.5% per month for two months. Gus's assets are denominated in Mexico Peso (MXN). So Gus needs to convert some of his MXN to CNY in two months to repay his loan. Gus hires Sal, a derivatives expert, to hedge the exchange rate risks. To catch Gus, Carey Hopkins has to figure out Sal's plan. The following rates are observed. MXN 2-month simple interest rate: 2% per month
