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Arbitraging between currencies and interest rates Use arbitrage to take advantage of interest rate and spot/forward rate differentials. E.g., using the following table, compute profits
Arbitraging between currencies and interest rates
Use arbitrage to take advantage of interest rate and spot/forward rate differentials. E.g., using the following table, compute profits from arbitrage.
Currency | Annual (90-day) interest rates | e0 | f90 |
7 7/16 5/16 | 240.9696 9912/ | 224.5731 8692/ | |
2 3/8 1/4 |
- Borrow 1,000,000 for 90 days (repayment = [1+ ((7 7/16)/4] = 1,018,594)
- Convert 1,000,000 into yen at spot rate ([1,000,000 (240.9696)] = 240,969,600)
- Invest yen for 90 days (proceeds = [240,969,600 (1 + ((2 1/4)/4)] = 242,325,054)
- Sell proceeds from forward for pounds (242,325,054/ 224.8692 = 1,077,627)
- Profit = 1,077,627 - 1,018,594 = 59,033
Please explain in detail how to calculate number 1 and number 3 from the solution above.
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