Question

Currently, the spot exchange rate is $0.75/A$ and the one-year forward exchange rate is $0.70/A$. One-year...

Currently, the spot exchange rate is $0.75/A$ and the one-year forward exchange rate is $0.70/A$. One-year interest is 3.5% in the United States and 4.2% in Australia. You may borrow up to $1,000,000 or A$1,333,333, which is equivalent to $1,000,000 at the current spot rate. Explain in detail how you would realize certain profit in US dollar terms.

Homework Answers

Answer #1

As per interest rate parity

(1+i)/(1+h) = F/S

(1+3.5%)/(1+4.2%) = F/0.75

Theoratical Forward Rate is 0.74 where as quoted Forward rate is 0.74 hence there is arbitrage opportunity available by investing in Australian $ (Strong currency)

Flow will be as follow;

Borrow US $ 1,000,000 @ 3.5%

Convert US $ to AU $ @ Spot of $ 0.75/AU % = 1,333,3333

Invest at 4.2%

Enter a forward contral to sell the Australian $ @0.70

After 1 year;

Interest income from Australian Investment is AU $ 1,333,3333 X 4.2% = 56,000

Therefore total value is 1,333,333+56,000 = 1,389,333

Convert at forward rate i.e. $0.70/AU $ = 1,389,333 X 0.70 = 1,042,000

Repay along with interest in US i.e 1,000,000 + 35,000 = 1,035,000

Therefore risk free net profit is $,7,000

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Currently the spot exchange rate is $1.33/£ and the one year forward exchange rate is $1.32/£....
Currently the spot exchange rate is $1.33/£ and the one year forward exchange rate is $1.32/£. The yearly interest rate is 1% in US and 3% in U.K. Assume you can borrow as much as $1,330,000. a.      Is interest rate parity currently (IRP) holding? b.      If IRP is not holding, how would you execute a covered interest arbitrage? Show all the steps what you are going to do today and in one year. Also determine the arbitrage profit. c.      Explain how IRP will...
Suppose that the current spot exchange rate is $1.2/£ and the 1-year forward exchange rate is...
Suppose that the current spot exchange rate is $1.2/£ and the 1-year forward exchange rate is $1.3/£. The U.S. 1-year interest rate is 5 percent and the U.K. 1-year interest rate is 6 percent. Assume that you can borrow up to $1.2M or £1M. a. Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit in U.S. dollars.  Please show...
The spot exchange rate is currently $1.31/£ and the six-month forward exchange rate is $1.25/£. The...
The spot exchange rate is currently $1.31/£ and the six-month forward exchange rate is $1.25/£. The six-month interest rate is 5.7% per annum in the U.S. and 4.7% per annum in the U.K. Assume that you can borrow as much as $1,310,000 (in the US) or £1,000,000 (in the U.K.). a. Determine whether the interest rate parity (IRP) is currently holding. b. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps...
Currently, the spot exchange rate is $1.50/£ and the three-month forward exchange rate is $1.52/£. The...
Currently, the spot exchange rate is $1.50/£ and the three-month forward exchange rate is $1.52/£. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or £1,000,000. • Determine whether the interest rate parity is currently holding. • If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit.
Currently, the spot exchange rate is $1.52/£ and the three-month forward exchange rate is $1.54/£. The...
Currently, the spot exchange rate is $1.52/£ and the three-month forward exchange rate is $1.54/£. The three-month interest rate is 5.84% per annum in the U.S. and 5.84% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or £1,000,000. Is the interest rate parity (IRP) currently holding? Yes NO
A Japanese EXPORTER has a €1,000,000 receivable due in one year. Spot and forward exchange rate...
A Japanese EXPORTER has a €1,000,000 receivable due in one year. Spot and forward exchange rate data is given in the table:    Spot Rate 1-year forward rate Contract Size $1.20 =€1.00 $1.25= €1.00 €62.500 $1.00 =¥100 $1.20= €120 ¥12,500,000 The one-year risk free rates are i$ = 4.03%; i€ = 6.05%; and i¥ = 1%. Detail a strategy using forward contract that will hedge exchange rate risk. Group of answer choices Sell €1m forward using 16 contracts at the...
(Uncovered interest parity) What is the relationship among the forward exchange rate, the spot exchange rate,...
(Uncovered interest parity) What is the relationship among the forward exchange rate, the spot exchange rate, and the interest rate? Suppose the (1-year) interest rate on bank deposits is 2% in Canada and 1.5% in United States. If the (1-year) forward US$–C$ exchange rate is C$1.5 per US$ and the spot rate is C$1.2 per US$, what is the expected US$–C$ exchange rate one year ahead?
Suppose that the current exchange rate is SF1.25/$ and three month forward exchange rate is SF1.30/$....
Suppose that the current exchange rate is SF1.25/$ and three month forward exchange rate is SF1.30/$. The three-month interest rate is 4 percent per annum in United States and 8 percent per annum in Switzerland. Assume that you can borrow up to $1,000,000 or SF 1,250,000. a) Is Interest Rate Parity holding? b) If your answer to part a is no, how would you realize a certain profit via a covered interest arbitrage? Also determine the size of the arbitrage...
Currently, the spot exchange rate is $1.50/£ and the six-month forward exchange rate is $1.52/£. The...
Currently, the spot exchange rate is $1.50/£ and the six-month forward exchange rate is $1.52/£. The six-month interest rate is 8.0% per annum in the U.S. and 3% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or £1,000,000. Answer The Following: a. Determine whether the interest rate parity is currently holding? b. If the IRP is not holding, how would you carry out covered interest arbitrage? (Show all the steps and determine the arbitrage...
Currently, the spot exchange rate is 1.50 USD/GBP and the three-month forward exchange rate is 1.510...
Currently, the spot exchange rate is 1.50 USD/GBP and the three-month forward exchange rate is 1.510 USD/GBP. The three-month interest rate is 5.0% per annum in the U.S. and 2.0% per annum in the UK. Assume that you can borrow as much as $1,500,000 or £1,000,000. a/ What is the implied three-month U.S.per annuminterest rate? (round to 2 decimals in %) b/ Does Interest Rate Parity hold? c/ Determine the arbitrage profit (if any, otherwise type "0") and report it...