Jack is a foreign exchange trader for a bank in New York. He has $1 million (or Swiss franc equivalent) available to borrow and will then invest it in a short-term money market investment. He is wondering whether he can make a CIA or UIA profit by borrowing in either the U.S. dollar or Swiss franc, and then investing in the other. He has the following data:

• arbitrage funds available $1,000,000
• spot exchange rate (SFr/$) 1.2810
• 3-month forward rate (SFr/$) 1.2740
• the expected spot rate in 90 days 1.2700
• U.S. dollar 3-month interest rate 4.800% per annum
• Swiss franc 3-month interest rate 3.200% per annum

Assess whether UIA profit is possible. Assume that the exchange rate has remained stable over the last few months, and Jack expects if it changes at all in the next 90 days it will maybe SFr1.2700/$. Is there a UIA profit potential; if yes, what is it? Show your work. Which currency should Jack borrow in and which should he invest in? Why?

Given your conclusions for question 1, show how Jack can make a profit (i.e. show how and what numbers you get for how much he would owe on borrowing in the one currency and how much he would make in investing in the other currency).

What is the exchange rate risk that Jack is taking by engaging in UIA?