Question

Suppose that the current spot exchange rate is $1.2/£ and the 1-year forward exchange rate is $1.3/£. The U.S. 1-year interest rate is 5 percent and the U.K. 1-year interest rate is 6 percent. Assume that you can borrow up to $1.2M or £1M.

a. Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit in U.S. dollars. Please show your step by step arbitrage strategy and calculation.

b. Assume that you want to realize profit in terms of British pounds. Show the size of covered arbitrage profit in British pounds. Please show your calculation.

Answer #1

(a) Arbitrage Process

A Today's Transaction

1. Borrow $ 1,200,000 at interest rate of 5%

2. Convert $ into £ at spot rate i.e. 1,200,000/1.20 = £1,000,000

3. Invest £ 1,000,000 at interest rate of 6%

4. Take 1 Year forward sale contract of £ 1,060,000@ $1.30/£

B After One Year Transaction

1. Realised £ investment with interest and sale £ under forward contract = (1,000,000 * 1.06) * 1.30

= $ 1,378,000

2. Repay Borrowing of $ with interest = 1,200,000 * 1.05 = $ 1,260,000

3. Net Profit = Investment Proceed - Borrowing Payment

= 1,378,000 - 1,260,000 = $118,000

(b) Calculation of Net profit in £

Net profit = $ 118,000 / 1.30 = £ 90769

To realise such amount directly in pound we will have forward contract for required amount only that use to repay borrowin i.e. $ 1,260,000/1.30 = £969,231 instead of £1,060,000

Suppose that the current exchange
rate is SF1.25/$ and three month forward exchange rate is SF1.30/$.
The three-month interest rate is 4 percent per
annum in United States and 8 percent per
annum in Switzerland. Assume that you can borrow up to
$1,000,000 or SF 1,250,000.
a) Is Interest Rate Parity
holding?
b) If your answer to part a is no,
how would you realize a certain profit via a covered interest
arbitrage? Also determine the size of the arbitrage...

The spot exchange rate is currently $1.31/£ and the six-month
forward exchange rate is $1.25/£. The six-month interest rate is
5.7% per annum in the U.S. and 4.7% per annum in the U.K. Assume
that you can borrow as much as $1,310,000 (in the US) or £1,000,000
(in the U.K.).
a. Determine whether the interest rate parity (IRP) is currently
holding.
b. If the IRP is not holding, how would you carry out covered
interest arbitrage? Show all the steps...

Currently the spot exchange rate is $1.33/£ and the one year
forward exchange rate is $1.32/£. The yearly interest rate is 1% in
US and 3% in U.K. Assume you can borrow as much as $1,330,000.
a. Is interest rate parity
currently (IRP) holding?
b. If IRP is not holding, how
would you execute a covered interest arbitrage? Show all the steps
what you are going to do today and in one year. Also determine the
arbitrage profit.
c. Explain how IRP will...

Currently, the spot exchange rate is $1.50/£ and the
three-month
forward exchange rate is $1.52/£. The three-month interest rate
is
8.0% per annum in the U.S. and 5.8% per annum in the U.K.
Assume that you can borrow as much as $1,500,000 or
£1,000,000.
• Determine whether the interest rate parity is currently
holding.
• If the IRP is not holding, how would you carry out covered
interest arbitrage? Show all the steps and determine the
arbitrage profit.

Currently, the spot exchange rate is $1.50/£ and the six-month
forward exchange rate is $1.52/£. The six-month interest rate is
8.0% per annum in the U.S. and 3% per annum in the U.K. Assume that
you can borrow as much as $1,500,000 or £1,000,000.
Answer The Following:
a. Determine whether the interest rate parity is currently
holding?
b. If the IRP is not holding, how would you carry out covered
interest arbitrage? (Show all the steps and determine the arbitrage...

Suppose that the current spot exchange rate is GBP1= EUR1.50 and
the one-year forward exchange rate is GBP1=EUR1.60.
One-year interest rate is 5.4% in euros and 5.2% in pounds.
If you conduct covered interest arbitrage using EUR 25,000,000
which of the following will happen in the market?
A. EUR will depreciate in spot market
B. GBP will appreciate in forward market
C. Interest rate in EUR will decrease
Please provide supporting evidence and provide any
calculations.

The spot rate between the U.K. and the U.S. is £.7559/$, while
the one-year forward rate is £.7529/$. The risk-free rate in the
U.K. is 4.37 percent and risk-free rate in the United States is
2.63 percent. How much in profit can you earn on $5,500 utilizing
covered interest arbitrage?

Suppose that the current spot exchange rate is GBP1= €1.50 and
the one-year forward exchange rate is GBP1=€1.60.
One-year interest rate is 5.4% in euros and 5.2% in pounds.
If you conduct covered interest arbitrage using EUR 25,000,000,
which of the following will happen in the market?
A. EUR will depreciate in spot market
B. GBP will appreciate in forward market
C. Interest rate in EUR will decrease
D. Interest rate in GBP will increase
E. None of the above...

The spot rate between the U.K. and the U.S. is £.7544/$, while
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2.60 percent. How much in profit can you earn on $6,500 utilizing
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Multiple Choice
$106.84
$127.37
$94.97
$111.45
$101.89

Assume the current spot rate is CAD1.3610 and the 1-year forward
rate is CAD1.3550. The nominal risk-free rate in Canada is 2.23
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$0.0036
$0.0040
$0.0044
$0.0048
$0.0052

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