Question

Consider the following information available in the
Diamond Bank:

Spot Rate for the
British Pound Sterling
$1.60

90 – day forward
rate of the pound
$1.59

90 – day UK
interest rate
4%

90 – day U.S.
interest rate
3%

(a)Given this information, would it be a prudent strategy to engage
in covered interest arbitrage? Explain

(b)If covered interest arbitrage is profitable how much profit
would an investor earn if he/she uses $1,000,000?

(c)Briefly discuss the realignment process that will yield interest
rate parity.

Answer #1

Fair forward rate = Spot rate*(1+Interest rate Dollar)/(1+ Interest Rate Pound)

= 1.60(1+0.03)/(1+0.04)

= $1.5846/Pound

Since actual forward rate is different, Covered interest arbitrage is possible and should be undertaken

b.Convert into pound at spot rate = 1,000,000/1.60 = Pound 625,000

Invest and get 625,000(1+0.04) = Pound 650,000

Convert back into USD at forward rate = 650,000*1.59 = $1,033,500

Dollar cost = 1,000,000(1+0.03) = 1,030,000

Arbitrage Profit = $3,500

c.Realignment Process:

This arbitrage process by market participants will increase the supply of pound and the value of pound would reduce to $1.5846 and will eliminate Covered interest arbitrage

Covered Interest Arbitrage. Assume the following information: •
British pound spot rate = $1.65. • British pound one-year forward
rate = $1.65 • British one-year interest rate = 12 %. • U.S.
one-year interest rate = 10 %. Explain how U.S. investors could use
covered interest arbitrage to lock in a higher yield than 9
percent. What would be their yield? Explain how the spot and
forward rates of the pound would change as covered interest
arbitrage occurs.

Assume the following information:
Spot rate of £ = $1.60
180-day forward rate of £ = $1.59
180-day British interest rate = 4%
180-day U.S. interest rate = 3%
Based on this information, is covered interest arbitrage by U.S.
investors feasible (assuming that U.S. investors use their own
funds ($1 million))? Explain.

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?

Assume the following information:
Quoted Price
Spot rate of Singapore dollar
$.75
90?day forward rate of Singapore dollar
$.74
90?day Singapore interest rate
4.5%
90?day U.S. interest rate
2.5%
Given this information, what would be the yield (percentage
return) to a U.S. investor who used covered interest arbitrage?
(Assume the investor invests $1,000,000.)
What market forces would occur to eliminate any further
possibilities of covered interest arbitrage?

Assume the following information:
Spot rate of £ = $1.60
180-day forward rate of £ =
$1.56
180-day British interest rate =
4%
180-day U.S. interest rate= 3%
(a) Based on this
information, is covered interest arbitrage by U.S. investors
feasible (assuming that U.S. investors use their own funds)?
Explain.
(b) Does interest
rate parity exist? Explain.
(Please provide detailed
answers)

The following is market information:
Current spot rate of pound
=
$1.45
90-day forward rate of pound
=
$1.46
3-month deposit rate in U.S.
=
1.1%
3-month deposit rate in Great Britain
=
1.3%
If you have $250,000 and use covered interest arbitrage for a
90-day investment, what will be the amount of U.S. dollars you will
have after 90 days?

Question 1
(a) Assume the following information:
Spot rate of £ = $1.60
180-day forward rate of £ = $1.59
180-day British interest rate = 4%
180-day U.S. interest rate = 3%
Based on this information, is covered interest arbitrage by U.S.
investors feasible (assuming that U.S. investors use their own
funds ($1 million))? Explain.
(b) Covered Interest Arbitrage in Both Directions. The one-year
interest rate in New Zealand is 6 percent. The one-year U.S.
interest rate is 10 percent....

Covered Interest Arbitrage. Assume the following
information:
Quoted
Price
Spot rate of Canadian dollar
$.90
90‑day forward rate of Canadian
dollar
$.88
90‑day Canadian interest rate
4.4%
90‑day U.S. interest
rate
1.6%
Given this information, what would be the yield
(percentage return) to a U.S. investor who used covered interest
arbitrage? (Assume the investor invests $1,000,000.) What market
forces would occur to eliminate any further possibilities of
covered interest arbitrage?

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...

A) If the British Pound (GBP)
is selling today for $1.272/1GBP (spot rate today) and the 180 day
forward rate on the British Pound is $1.251, what is the annualized
forward premium?
B) If the Euro
(EUR) is selling today for $1.126/1 euro (spot rate today) and the
90 day forward rate on the Euro is $1.131/1 euro, what is the
annualized forward premium or discount on the Euro?

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