Question

Takeshi Kamada, a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest $5,000,000 or its yen equivalent, in a covered interest arbitrage between U.S. dollars and Japanese yen. He faced the following exchange rate and interest rate quotes. Arbitrage funds available $5,000,000 or its Yen equivalent Spot rate ¥/$ 118.60 360 day Forward rate ¥/$ 117.80 U.S. dollar annual interest rate 2.4% Japanese yen annual interest rate 1.7% What would be his arbitrage profit in Yen? (round to two decimal places). Also, Calculate the UIA profit potential (in yen). (round to two decimal places).

Answer 1

Amount available for investment= $5,000,000

Yen equivalent of desired investment = $5,000,000 * 118.60 = 593,000,000   (118.60 being spot rate)

Difference in interest rates = 1.7%-2.4% (Yen-Dollar interest rate) = -0.7%

Arbitrage profit in Yen = {(118.60-117.80) / 117.80} * 100 = 0.6791% = 0.68%

Profit in Yen = 0.68% * 593,000,000 = 4,032,400                              

UIA profit potential = -0.7% + 0.68% = -0.02%