Question

Assume that annual interest rates are 6 percent in the United States and 5 percent in...

Assume that annual interest rates are 6 percent in the United States and 5 percent in Turkey. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is $0.6553/Turkish lira (TL).
a.

If the forward rate is $0.6735/TL, how could the bank arbitrage using a sum of $6 million? What is the spread earned? (Do not round intermediate calculations. Round your answer to 4 decimal places. (e.g., 32.1616))
  Spread earned %
b.

At what forward rate is this arbitrage eliminated? (Do not round intermediate calculations. Round your answer to 5 decimal places. (e.g., 32.16161))
  Forward rate /TL  
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Homework Answers

Answer #1

b) At the below price there will be no arbitrage possible,

= 0.6553*1.06/1.05 = $0.66154/TL

a) Since forward rate is higher than than no arbitrage price one must follow the below process:

Borrow in US = 6 million. Pay after 1 year = 6*1.06 = $6.36 million

Convert $ 6 million to TL = 9.1561 million TL. Receive at the end of year TL = 1.05*9.1561 = 9.6139 TL

Convert into US $ at the mentioned forward rate = $6.47497329 million

% return =(6.47497329 - 6.36)/6*100= 1.9162

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