Question

Assume the following information:

	Quoted Price
Spot rate of Singapore dollar	$.75
90?day forward rate of Singapore dollar	$.74
90?day Singapore interest rate	4.5%
90?day U.S. interest rate	2.5%

Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1,000,000.)

What market forces would occur to eliminate any further possibilities of covered interest arbitrage?

Answer 1

the U.S investor if uses the covered interest arbitrage ,

the $1,000,000 when ocnverted at the spot rate would give us 1333333 singapore dollars. this amount when invested in singapore will provide us with 1333333(1.045) = 1393333 singapore dollars .

now when we convert this amount at the forward rate into US $ we get,

1393333*0.74 = $1031066

so the yield is 1031066 - 1,000,000/1,000,000 = 3.10%

which is greater than the yiled enjoyed by the investor if he had invested all his money in the U.S.then he would get a yield of 2.5%

the market factors that would eliminate the possibilities of covered interest arbitrage is :

• the interest rate falling in SINGAPORE
• U.S interest rates will rise
• singapore dollar spot rate should rise
• and the forward rate for singapore dollars should fall.