Question

Dollar Return on Foreign Investments -

(A) Over the past year, the dollar has depreciated by about 10 percent against the euro. A year ago you took out a home equity loan in the U.S. at an interest rate of 8 percent and you invested the money in a German mutual fund that paid a 5 percent euro return. What net return did you earn on all of these transactions over the year? (PLEASE INCLUDE FORMULAS USED TO SOLVE PROBLEM).

(B) You can borrow or invest in the U.S. at an annual rate of 6 percent. Suppose you logon to your favorite financial website and see that you could borrow or invest in Japan at a 5 percent annual rate. The current exchange rate between the dollar and the yen is $0.01/yen. You can use the futures market to lock it in at an exchange rate for one year from now at $0.0095/yen. Is there a profit opportunity here? Prove it by borrowing (either $1 million or $100 yen) in one country and investing in the other? (PLEASE INCLUDE FORMULAS USED TO SOLVE PROBLEM).

Inflation and Exchange Rates -

(C) Suppose gold sells for $1,000 per ounce in the U.S. and it sells for 1,000 Canadian dollars per ounce in Canada. Suppose further, the exchange rate is $1 per Canadian dollar. If U.S. inflation is 6 percent next year, Canadian inflation is 2 percent, and exchange rates do not change, how could you make an arbitrage profit in the gold market? (PLEASE INCLUDE FORMULAS USED TO SOLVE PROBLEM).

Answer 1

B) There is an arbritage opporunity if one borrows money from Japan and Invests in US, the following workings will give us profit of 6.58Yen

Suppose I borrow 100 yen from Japan
I would get (100*0.01)	1
I can invest $1 in US, after one year I would have (1*1.06)	1.06
Yen I would receive = 1.06/0.0095	111.5789474
Loan amount to be paid(100*1.05)	105
Net Profit/Loss	6.578947368

C)

In Gold market we can make arbirtage profit of $60 canadian dollar if we purchase in canada and sell in US market

Suppose we buy one ounce of gold from Canada	1000 Canadian Dollar
Inflation rate in US is 6%, Gold rate would be
(1000*1.06)	1060
So if I sell one ounce of gold purchase from canada in US I would get	$1060
	$1060 canadian dollar
Net profit/loss(1060-1000)	60