Question
8. (15 points) A foreign exchange trader at Goldman Sachs (NYSE:GS) can invest $1.2 million, or the foreign currency equivalent (which is 779,221) of the
8. (15 points) A foreign exchange trader at Goldman Sachs (NYSE:GS) can invest $1.2 million, or the foreign currency equivalent (which is 779,221) of the bank's short-term funds, in a covered interest arbitrage with British pound.
(a) Using the following quotes (interests are per year), can the trader make a covered interest arbitrage (CIA) profit? What are the transactions they would make? Calculate the expected profit.
Arbitrage funds available $1,200,000
Spot exchange rate ($/) 1.5400
6-month forward rate ($/) 1.5150
U.S. dollar 6-month interest rate 2.600%
British pound 6-month interest rate 4.600%
(b) If instead, this trader wants to implement an uncovered carry trade strategy, what steps would he or she take? Would this trade be profitable if the realized spot rates in six months would be $1.53/?
(c) Would there still be an arbitrage opportunity if instead of the spot and forward rate above, the quote for the spot rate would be $1.46/ and for the forward rate it would be $1.47/? Explain how you know (no need to describe the transactions or profit).
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