Question

Casper Landsten is a foreign exchange trader for a bank in New York. Using the values and assumptions​ below, he decides to seek the full 4.800​% return available in U.S. dollars by not covering his forward dollar receiptslong dashan uncovered interest arbitrage​ (UIA) transaction. Assess this decision. Arbitrage funds available $ 1,000,000 Spot exchange rate (SFr/$) 1.2810 3-month forward rate (SFr/$) 1.2740 Expected spot rate in 90 days (SFr/$) 1.2700 U.S. Dollar annual interest rate 4.800 % Swiss franc annualinterest rate 3.200 %

The uncovered interest arbitrage​ (UIA) profit amount is ​

Answer 1

Answer :

Here, we have

Arbitrage funds are = $ 1,000,000

He has decided to seek full return, USD is unrecovered, hence money in 3 months shall be:

$ 1,000,000 * 1 + 0.04800 * 3/12 = 1,012,000

Calculating if USD covered:

USD to be converted into SFr at spot = $ 1,000,000 * 1.2810 = 1281000 SFr

SFr to be invested at 3.200% for 3 months = 1281000 SFr * 1 + 0.03200 * 3/12 = 1291248 SFr

Value in USD if transaction was covered = 1291248 / 1.2740 = $ 1013538.46

Value in USD if transaction was not covered = 1291248 / 1.2700 = $ 1016730.71

Arbitrage profit if USD covered = 1013538.46 - 1012000 = $ 1538.46

Arbitrage profit if USD uncovered = 1016730.71 - 1012000 = $ 4730.71