Introduction
In international finance, every person is assumed to be a rational being. As a result, business people aim to maximize profits and reduce costs. The same principle applies to companies that seek to invest in various projects. As an international finance student, I prefer to invest in the highest profitable business ventures. The best way to tell between high and low profitable ventures is by looking at the interest rate. The higher the interest rate, the better because it implies the returns will be huge as well (Moosa, 2016). In this case, there are two investment options at hand. The first one is to venture in America; whereas, the second one is to invest in South Africa’s rand. This paper seeks to present whether or not a short-term investment in South Africa is better than short-term investment in America.
The US 6 Month Interest Rate
The American 6-month interest rate is 1.83938 %. This implies that investing $100,000,000 in America will garner a profit worth $1,839,380 in six months (I.e., 1.83938 % of $100,000,000).
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The 6 Month Interest Rate of South Africa
The six month ingest rate of South Africa is 7.28 percent. That means investing $100,000,000 in South Africa will garner a profit worth $7,280,000 in six months. (I.e., 7.28 percent of $100,000,000).
Spot Exchange Rate of South Africa
The current spot exchange rate of South African rand and the American dollar is 1 USD=13.1899 South African Rands.
The Six-Month Forward Exchange Rate
The Six-month forward exchange rate of South African rand and the American dollar is 1 USD-12.80 South African Rands.
As shown above, investing in South Africa for 6 months period is more profitable than investing in America. To be precise investing in the former country is about 4 times more profitable than investing in the latter. That is 7.28 percent divided by 1.83938 percent which is 3.958.
Also, in 6 month time, the exchange rate would have fallen from the current 13.1899 to 12.80. That is about 3 percent change ((12.80-13.1899)/ 13.1899 × 100 % = -2.96%). This implies that an extra 2.96 percent of the total amount of money invested in South Africa plus the profit will be generated in the forex process. Simply put, when the domestic currency depreciates against the foreign currency, the domestic, foreign investors venturing into that particular country usually benefit from the forex process (Razmi et al., 2012).
So, firstly let’s calculate the total amount of money that would have accumulated at the end of the 6 month period if you invest in South Africa.
Total amount = principle × period × (interest rate + 100%)/100%
Principle=$100,000,000
Period= 1
Interest rate=7.28 percent
Therefore, total amount= 100,000,000 × 1 × 1.0728%/100%
=$107,280,000
Total gain that will be realized from the foreign exchange process = 2.96 percent of the total amount
That is: total amount × gain rate/100percent
Total amount=$107,280,000
Gain rate=2.96 percent
Therefore total forex gain = 107,280,000 × 2.96%/100%
=$3,175,488
The net amount of money that will be collected back from investing in South Africa is the sum of principal and interest after a six month period plus the total gain from the forex process (Moosa, 2016).
That is; Net amount collected= total amount after six months + total forex gain.
Total amount after six month=$107,280,000
Total forex gain=$3,175,488
Therefore, net amount collected= $107,280,000 + $3,175,488
=$110,455,488
$110,455,488 is net amount of money my company will have in six-month time, if I invest in South Africa.
The next process is to determine the total amount of gain I will get from investing in South Africa. Note that profit = net amount of money after six months – principle.
The net amount of money after six months =$110,455,488
Principle=$100,000,000
Total Profit=$110,455,488 - $100,000,000
=$10,455,488
The following stage is to calculate the Percentage gain of investing in South Africa = profit/principle × 100 percent (Hassan & Mano, 2014)
Profit=$10,455,488
Principle=$100,000,000
Percentage profit= ($10,455,488/$100,000,000) × 100%
=10.46 percent
At the end of six months, I will make a 10.46% profit from my money that is if I invest in South Africa, unlike 1.83938 percent which I will make if I invest in the US. To be precise, I will make 5.69 more profit if I invest in South Africa than America (i.e., 10.46 percent ÷ 1.83938 percent).
Recommendations
As stated in the introduction, it is only rational for a businessman to try and maximize on opportunities that provide the highest profits. There are two investment options in this case. The first one is to invest in America for six months; whereas, the second option is to invest in South Africa for the same period. From the calculations, it turns out that investing in South Africa is more profitable than investing domestically. Therefore, I recommend that my company should invest in the foreign currency, which is South African’s Rand. That is because, after the end of six months, my company will make 10.46 percent of the initial $100,000,000 which is extremely higher than 1.83938 percent I will make if I invest in America.
References
Hassan, T. A., & Mano, R. C. (2014). Forward and spot exchange rates in a multi-currency world (No. w20294). National Bureau of Economic Research.
Moosa, I. (2016). Exchange rate forecasting: techniques and applications . Springer.
Razmi, A., Rapetti, M., & Skott, P. (2012). The real exchange rate and economic development. Structural Change and Economic Dynamics , 23 (2), 151-169.
