Problem 6.13 Casper Landsten -- UIA (B) Casper Landsten, using the same values and assumptions as in the previous question, now decides to seek the full 4.800% return available in US dollars by not covering his forward dollar receipts -- an uncovered interest arbitrage (UIA) transaction. Assess this decision. Assumptions Value SFr. Equivalent Arbitrage funds available $1,000,000 SFr. 1,281,000 Spot exchange rate (SFr./S) 1.2810 3-month forward rate (SFr./S) Ble S2 1.2740 Expected spot rate in 90 days (SFr./S) 1.2700 U.S. dollar 3-month interest rate S4 129 1,210 * 4.800% Swiss franc3-month interest rate + 1012,000 3.200% De SH 1.2759367 Since Casper is in the US market (starting point), if he were to undertake uncovered interest arbitrage he would be first exchange dollars for Swiss francs, investing the Swiss francs for 90 days, and then exchanging the Swiss franc proceeds (principle and interest) back into US dollars at whatever the spot rate of exchange is at that time. In this case Casper will have to -- at least in his mind -- make some assumption as to what the exchange rate will be at the end of the 90 day period. START U.S. dollar interest rate (3-month) 4.800% END S 1,000,000 1.0120 S $ $ 1,012,000.00 1,012,029.16 29.16 1 1 #(borrow ) Spot (SFr/S) 1.2810 90 days Expected Spot (SFr/$) 1.2759 su 57 karest) 5 5 SFr. 1,281,000 1.0080 SFr. 1,291,248 3.200% Swiss franc interest rate (3-month) If Casper assumed the spot rate at the end of 90 days were the same as the current spot rate (SFrl.2810/$), the UIA transaction would not make much sense. The lower Swiss franc interest rate would yield final dollar proceeds of only $1,008,000, a full $4,000 less than simply investing in the US (straight across the top of the box). For an UIA transaction to result in higher dollar proceeds at the end of the 90 day period, the ending spot rate of exchange would have to be SF1.2759/$ or less a stronger and stronger Swiss franc resulting in more and more US dollars when exchanged). note 34 Should Casper do it? Well, depends on his bank's policies on uncovered transactions, and his beliefs on the future spot exchange rate. But, given that he is invested in a foreign currency with a lower interest rate, not a higher one, so he is placing all of his 'bets' on the exchange rate, it is not a speculation for the weak of heart. Your position = 3 Problem 6.13 Casper Landsten -- UIA (B) Casper Landsten, using the same values and assumptions as in the previous question, now decides to seek the full 4.800% return available in US dollars by not covering his forward dollar receipts -- an uncovered interest arbitrage (UIA) transaction. Assess this decision. Assumptions Value SFr. Equivalent Arbitrage funds available $1,000,000 SFr. 1,281,000 Spot exchange rate (SFr./S) 1.2810 3-month forward rate (SFr./S) Ble S2 1.2740 Expected spot rate in 90 days (SFr./S) 1.2700 U.S. dollar 3-month interest rate S4 129 1,210 * 4.800% Swiss franc3-month interest rate + 1012,000 3.200% De SH 1.2759367 Since Casper is in the US market (starting point), if he were to undertake uncovered interest arbitrage he would be first exchange dollars for Swiss francs, investing the Swiss francs for 90 days, and then exchanging the Swiss franc proceeds (principle and interest) back into US dollars at whatever the spot rate of exchange is at that time. In this case Casper will have to -- at least in his mind -- make some assumption as to what the exchange rate will be at the end of the 90 day period. START U.S. dollar interest rate (3-month) 4.800% END S 1,000,000 1.0120 S $ $ 1,012,000.00 1,012,029.16 29.16 1 1 #(borrow ) Spot (SFr/S) 1.2810 90 days Expected Spot (SFr/$) 1.2759 su 57 karest) 5 5 SFr. 1,281,000 1.0080 SFr. 1,291,248 3.200% Swiss franc interest rate (3-month) If Casper assumed the spot rate at the end of 90 days were the same as the current spot rate (SFrl.2810/$), the UIA transaction would not make much sense. The lower Swiss franc interest rate would yield final dollar proceeds of only $1,008,000, a full $4,000 less than simply investing in the US (straight across the top of the box). For an UIA transaction to result in higher dollar proceeds at the end of the 90 day period, the ending spot rate of exchange would have to be SF1.2759/$ or less a stronger and stronger Swiss franc resulting in more and more US dollars when exchanged). note 34 Should Casper do it? Well, depends on his bank's policies on uncovered transactions, and his beliefs on the future spot exchange rate. But, given that he is invested in a foreign currency with a lower interest rate, not a higher one, so he is placing all of his 'bets' on the exchange rate, it is not a speculation for the weak of heart. Your position = 3
