Question

# 1)Use the following information to answer the next two questions. An investment banker in Spain notices...

1)Use the following information to answer the next two questions.

An investment banker in Spain notices that 1 year interest rates in Spain and Mexico are 12% and 8%, respectively. Current spot rates are as follows:

€1.02/\$, \$.15/MP. The one year forward rate is €.18/MP.What should the forward premium be for IRP to hold? a) .037 b) -.0357 c).04 d)-.04

2)Assuming that the banker has access to one million euros, find his covered interest arbitrage profit (in euros). Round intermediate steps to four decimals.

a)197700 b)201600 c)150600 d)0

Spot Rate = 1.02 * 0.15 = Euro 0.153 / MP

1. Forward Premium = (Forward Rate as per IRP - Spot Rate) / Spot Rate

Forward Premium = (0.153 * 1.12/1.08 - 0.153) / 0.153

Forward Premium = 0.037 Option A

2. Convert Euro into MP now at 0.153 / MP = 1000000 / 0.153 = 6535947.71 MP

Invest MP at 8% and realize = 6535947.71 * 1.08 = 7058823.529

Convert MP into Euro at Forward Rate = 7058823.53 * 0.18 = 1270588.235

Profit = 1270588.24 - 1000000 * 112%

Profit = \$150600 Rounded Off Option C