Assume that annual interest rates are 5 percent in the United States and 4 percent in Turkey. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is $0.6591/Turkish lira (TL). |
a. |
If the forward rate is $0.6735/TL, how could the bank arbitrage using a sum of $4 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 |
Spot Rate = $0.6591/TL
As per IRPT,forward rate = Spot rate*(1+interest rate US)/(1+Interest rate Turkey)
= 0.6591(1.05)/(1.04)
= $0.6654/TL
a.Convert 4 million into TL at spot rate
= 4,000,000/0.6591
= TL 6,068,881.81
Invest and get = TL 6,068,881.81(1.04) = TL 6,311,637.08
Convert into dollar at forward rate = 6,311,637.08*0.6735 = $4,250,887.57
Pay back loan = 4,000,000*(1.05) = $4,200,000
Arbitrage Profit = $50,887.57
Spread Earned = 50,887.57/4,000,000 = 1.27%
b.Forward Rate = $0.6654/TL
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