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Activity 6.2 Mr Madzirerusa is a currency arbitrager for Finex and Company, Tokyo. The spot rate this morning is 111.22/$ and early indications are that
Activity 6.2 Mr Madzirerusa is a currency arbitrager for Finex and Company, Tokyo. The spot rate this morning is 111.22/$ and early indications are that short term interest rates in the USA, 90- day rates, are about to rise from their current level of 3.125%. The central bank of USA, the Fed, is worried about rising inflation and has been publicly considering raising interest rates 25 basis points (0.25%). The 90-day forward rate to Madzirerusa by local banks are roughly the same at 111.14/$. The current 90-day yen Eurodeposit rate of interest is 2.156%. Madzirerusa has 250 million at his disposal. a) (1) How can Madzirerusa make a profit through covered interest arbitrage? (ii) How much in yen can he hope to make in profit in 90 days? b) If future spot exchange rates were determined by interest differentials alone (that is, if the forward rate was a very good forecast of future spot exchange rates), what would Madzirerusa expect the spot rate to be in 90 days if the USA Federal Reserve does the expected? c) If Madzirerusa's expectation of the future spot rate is that of part (b), what profit could he expect to make from uncovered interest arbitrage (not signing a forward contract)
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