Question

Please answert part b. I believe part a is .0023 and part c is 10.65.

a. Assume the current spot rate is C$1.1103 and the one-year forward rate is C$1.1025. The nominal risk-free rate in Canada is 3.5 percent while it is 4 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

$.0023

$.0006

$.0008

$.0015

$.0018

b. What would the forward rate need to be in the previous problem to eliminate an arbitrage opportunity?

C$1.1103

C$1.1075

C$1.1047

C$1.2722

C$1.0874

c. Assume $1 = CAD 1.1098, $1 = GBP 0.6018, and the cross-rate is CAD 1 = GBP 0.60. How much profit can you earn using triangle arbitrage if you start out with $100?

$10.87

$9.84

$10.65

$9.69

$12.45

Answer 1

a)

Arbitrage profit = [$1 × (C$1.1103 / $1) × 1.035 × ($1 / C$1.1025)] - ($1 × 1.04) = $.0023

b)

Since Arbitrage profit = 0

[$1 × (C$1.1103 / $1) × 1.035 × ($1 / Forward Rate)] = ($1 × 1.04)

C$1.1492 / Forward Rate = 1.04

Hence, Forward rate should be = C$1.1047

C)

If starting amount is $100.

So, CAD: $100 / 1.1098: 90.1063 CAD

Since, CAD 1 = GBP 0.60

Hence, GBP: 90.1063 / 0.60: 150.1772 GBP

Now, as 1$ = GBP 0.6018

Hence, $: 150.1772 * 0.6018: $90.3766

Thus, Profit: $100 - $90.3766: $9.6