Question

Casper​ Landsten-CIA (A). Casper Landsten is a foreign exchange trader for a bank in New York. He has ​$0.95 million​ (or its Swiss franc​ equivalent) for a short term money market investment and wonders if he should invest in U.S. dollars for three​ months, or make a CIA investment in the Swiss franc. He faces the following​ quotes:

Arbitrage funds available	$	950,000
Spot exchange rate (SFr/$)		1.2814
3-month forward rate (SFr/$)		1.2742
U.S. Dollar annual interest rate		4.801	%
Swiss franc annual interest rate		3.201	%

1. The CIA profit potential is (​%),

2. which tells Casper Landsten he should borrow (Swiss francs or U.S. dollars)

3. and invest in the (higher or lower)

4. yielding​ currency, the (Swiss franc or U.S. dollar)

​5. in order to earn covered interest arbitrage​ (CIA) profits.  ​(Round to three decimal places and select from the​ drop-down menus.)The CIA profit amount is ​($)

​(Round to the nearest​ cent.)

Answer 1

The arbitrage strategy will be as follows:

Borrow USD 950,000

CONVERT into Sfr at Spot rate = 950,000*1.2814 = Sfr 1,217,330

Invest and get 1,217,330*(1+0.03201*3/12)

= Sfr 1,246,555.05

Convert back into USD at forward rate = 1,246,555.05/1.2742

= USD 978,304.07

Rate of return = (978,304.07-950,000)/950,000

= 2.98%

Return on US deposits = 4.801*3/12 = 1.20025%

CIA profit potential = 1.77975% or 1.78%

CIA profit amount = 978,304.07-950,000(1+0.04801*3/12)

= $16,901.70