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A U.S.-based currency dealer has good credit and today can borrow $1,000,000 or its equivalence for up to one year. The 6-month interest rate in
A U.S.-based currency dealer has good credit and today can borrow $1,000,000 or its equivalence for up to one year. The 6-month interest rate in the U.S. is i\$ =2% p.a. and in the euro zone the 6-month interest rate is i=6% p.a.. The spot exchange rate is $1.25=1.00 and the 6-month forward exchange rate is $1.22=1.00. Show how to realize a certain dollar profit via covered interest arbitrage. (I) Borrow $1,000,000 at 2% p.a.. Trade $1,000,000 for 800,000; invest at i = 6% p.a.; translate proceeds back at forward rate of $1.22=1.00, net profit $932,560 (II) Borrow 800,000 at i =6% p.a.; translate to dollars at the spot, invest in the U.S. at i\$ =2% p.a. for one year; translate back to 848,000 at the forward rate of $1.22=1.00. Net profit $2,400. (III) Borrow 800,000 at i =6% p.a.; translate to dollars at the spot, invest in the U.S. at i\$ =2% p.a. for one year; translate back to 850,000 at the forward rate of $1.22=1.00. Net profit 2,000 A U.S.-based currency dealer has good credit and today can borrow $1,000,000 or its equivalence for up to one year. The 6-month interest rate in the U.S. is i\$ =2% p.a. and in the euro zone the 6-month interest rate is i=6% p.a.. The spot exchange rate is $1.25=1.00 and the 6-month forward exchange rate is $1.22=1.00. Show how to realize a certain dollar profit via covered interest arbitrage. (I) Borrow $1,000,000 at 2% p.a.. Trade $1,000,000 for 800,000; invest at i = 6% p.a.; translate proceeds back at forward rate of $1.22=1.00, net profit $932,560 (II) Borrow 800,000 at i =6% p.a.; translate to dollars at the spot, invest in the U.S. at i\$ =2% p.a. for one year; translate back to 848,000 at the forward rate of $1.22=1.00. Net profit $2,400. (III) Borrow 800,000 at i =6% p.a.; translate to dollars at the spot, invest in the U.S. at i\$ =2% p.a. for one year; translate back to 850,000 at the forward rate of $1.22=1.00. Net profit 2,000
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