Question

Let's suppose you have $1.5 million to invest. You are considering to invest in UK first,...

Let's suppose you have $1.5 million to invest. You are considering to invest in UK first, then convert the British Pound back to US$ in the future.

You know the following information:

Annual Interest rate on investment in US: 0.2%

Annual Interest rate on investment in UK: 1.5%

Investment period: 1 year

Current exchange rate: 1.65 $/BP

The forward exchange rate which you can apply when converting BP to US$: 1.63 $/BP In this case, what would be profit through the covered-interest arbitrage?

(The answer is $2053, can you please show me the work to get this answer.)

Business   Finance   
0 0
Add a commentTranscribed image text
Next >

Homework Answers

Answer #1

Investment amount (USD) = 1,500,000

Spot rate (USD/GBP) = 1.65

Investment amount (GBP) = Investment amount (USD)/1.65USD/GBP = 909,090.91 GBP

This is invested at 1.5% p.a., so interest earned in 1 year is 1.5%*909,090.91 = 13,636.36 GBP

Total amount after one year (GBP) = 909,090.91 + 13,636.36 = 922,727.27 GBP

Hedge the exchange rate risk by by selling the total amount earned at the forward rate of 1.63USD/GBP, so the total amount earned (USD) = 922.727.27GBP*1.63USD/GBP = 1,504,045.45 USD

You had invested USD 1.5 million, so your profit is 1,504.045.45 - 1,500,000 = 4,045.45 USD (Answer)

Note: If it is assumed that USD 1.5 million is borrowed then the interest amount will have to be deducted from the profit.

0 0
Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Log In

Sign Up

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Let's suppose you have $1 million to invest. You are considering to invest in UK first,...
Let's suppose you have $1 million to invest. You are considering to invest in UK first, then convert the British Pound back to US$ in the future. You know the following information: The annual Interest rate on investment in UK: 4% Investment period: 1 year Current exchange rate: 1.48 $/BP Forward exchange rate which you can apply when converting BP to US$: 1.47 $/BP What would be profit if you apply the covered-interest arbitrage? A) About $40,542 B) None of...
You are UK company, 400,000 US$ payable to US in one year. Answer in terms of...
You are UK company, 400,000 US$ payable to US in one year. Answer in terms of BP (British Pound). Round at four decimal places Examples: 1.23487 ---> 1.2349; 1.23533 --> 1.2353 Information for Forward Contract: Forward exchange rate (one yr): 0.7124 BP/$ Information for Money Market Instruments (MMI): Current exchange rate: 0.7173 BP/$ Investment return at JP Morgan (in US): 5% annual Interest rate of borrowing from HSBC (UK): 4% annual Information you need for Currency Options Contract: Exercise options...
You are US company, 300,000 BP (British Pound) payable to UK in one year. Answer in...
You are US company, 300,000 BP (British Pound) payable to UK in one year. Answer in terms of US$. Information for Forward Contract: Forward exchange rate (one yr): 1.52 $/BP Information for Money Market Instruments (MMI): Current exchange rate: 1.48 $/BP Investment return at Aerion Fund Management (in UK): 8% annual Interest rate of borrowing from Bank of America (in USA): 3% annual Information you need for Currency Options Contract: Options premium: 0.015 $/BP Interest rate of borrowing from Bank...
You are US company, 500,000 BP (British Pound) payable to UK in one year. Answer in...
You are US company, 500,000 BP (British Pound) payable to UK in one year. Answer in terms of US$. Information for Forward Contract: Forward exchange rate (one yr): 1.54 $/BP Information for Money Market Instruments (MMI): Current exchange rate: 1.50 $/BP Investment return at Aerion Fund Management (in UK): 4% annual Interest rate of borrowing from Bank of America (in USA): 2% annual Information you need for Currency Options Contract: Options premium: 0.015 $/BP Interest rate of borrowing from Bank...
You are US company, 500,000 BP (British Pound) payable to UK in one year. Answer in...
You are US company, 500,000 BP (British Pound) payable to UK in one year. Answer in terms of US$. Information for Forward Contract: Forward exchange rate (one yr): 1.54 $/BP Information for Money Market Instruments (MMI): Current exchange rate: 1.50 $/BP Investment return at Aerion Fund Management (in UK): 6% annual Interest rate of borrowing from Bank of America (in USA): 2% annual Information you need for Currency Options Contract: Options premium: 0.015 $/BP Interest rate of borrowing from Bank...
b) Suppose that the current spot exchange is: 1 BP (British pound) = $1.21. Use the...
b) Suppose that the current spot exchange is: 1 BP (British pound) = $1.21. Use the following interest rates. The interest rate is 8% in the US market (home market). The interest rate is 3% in the UK market (foreign market). i) Find the forward exchange rate when the IRP holds. ii) Assume that the IRP holds (this means you use the IRP forward exchange rate found above). When you invest $10,000 in the UK market and at the same...
Suppose you have $100,000 to place in a bank deposit in either the United States of...
Suppose you have $100,000 to place in a bank deposit in either the United States of Great Britain. The annual interest rate on bank deposits in the United States is = 6% and in Britain is is = 8.5%. The spot US dollar/British pound exchange rate is = 1.9421 and the one-year forward rate is = 1.9933. Answer the following questions using the exact equation for covered interest parity (CIP),    a. if you deposit your money in the US,...
BL lives in the US and has $800,000 surplus funds that he wants to invest for...
BL lives in the US and has $800,000 surplus funds that he wants to invest for one year in any currency. He receives the following quotes from a commercial bank: Spot rate= 1 British Pound: $50-55 One-year forward rate= 1 British Pound: $58-64 One-year US interest rate= 6% One year UK interest rate= 1% (i) With supporting calculations, advise BL whether covered interest arbitrage is worthwhile. (ii) Would your advice differ, if transaction costs in respect of the covered interest...
Alicia Strong is a foreign exchange dealer for a bank in Australia. She wishes to consider...
Alicia Strong is a foreign exchange dealer for a bank in Australia. She wishes to consider whether International Parity Condition (IPC) holds between the British pound and the Australian dollar. Alicia also wonders whether she should invest in AUD or in British pounds (£) to make a covered interest arbitrage (CIA) profit. Depending on the CIA opportunity, she can borrow either A$1,000,000 or £1,000,000 to invest for the next 12 months. Consider Australia as home market and the UK as...
Assume the following information: You have $1,500,000 to invest. Current spot rate of pound = $1.61....
Assume the following information: You have $1,500,000 to invest. Current spot rate of pound = $1.61. 90-day forward rate of pound = $1.57. 3-month deposit rate in U.S. = 2.39%. 3-month deposit rate in U.K. = 5%. Does the covered interest parity hold? If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days?
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT