Problem 6.7 Takeshi Kamada -- CIA Japan (A) Takeshi Kamada, a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest $5,000,000 or its yen equivalent, in a covered interest arbitrage between U.S. dollars and Japanese yen. He faced the following exchange rate and interest rate quotes, 3.400% pa Assumptions Value Yen Equivalent Arbitrage funds available $5,000,000 593,000,000 Spot rate (V/S) 118.60 180-day forward rate (V/S) 117.80 180-day U.S. dollar interest rate 4.800% pa 3 steps home 180-day Japanese yen interest rate indirect Formula Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency. Difference in interest rates (i \ - i $) ya -1.400% Forward premium on the yen 1.358% 3 bo CIA profit potential -0.042% FF Too D. ** This tells Takeshi Kamada that he should borrow yen and invest in the higher yielding currency, the U.S. dollar, to lock-in a covered interest arbitrage (CIA) profit. lower cost 47= SEX 360 K180=1-358% U.S. dollar interest rate (180 days) 4.800% $ 1.0240 $ 5,120,000 1 5,000,000 1 1 $ 1 1 invest 180 days Spot (V/S) 118.60 T Forward-180 ($) 117.80 borrow 593,000,000.00 Japanese yen 1.0170 1 603,136,000 603,081,000 55,000 py START 3.400% Japanese yen interest rate (180 days) END Takeshi Kamada generates a CIA profit by investing in the higher interest rate currency, the dollar, and simultaneously selling the dollar proceeds forward into yen at a forward premium which does not completely negate the interest differential. Problem 6.7 Takeshi Kamada -- CIA Japan (A) Takeshi Kamada, a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest $5,000,000 or its yen equivalent, in a covered interest arbitrage between U.S. dollars and Japanese yen. He faced the following exchange rate and interest rate quotes, 3.400% pa Assumptions Value Yen Equivalent Arbitrage funds available $5,000,000 593,000,000 Spot rate (V/S) 118.60 180-day forward rate (V/S) 117.80 180-day U.S. dollar interest rate 4.800% pa 3 steps home 180-day Japanese yen interest rate indirect Formula Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency. Difference in interest rates (i \ - i $) ya -1.400% Forward premium on the yen 1.358% 3 bo CIA profit potential -0.042% FF Too D. ** This tells Takeshi Kamada that he should borrow yen and invest in the higher yielding currency, the U.S. dollar, to lock-in a covered interest arbitrage (CIA) profit. lower cost 47= SEX 360 K180=1-358% U.S. dollar interest rate (180 days) 4.800% $ 1.0240 $ 5,120,000 1 5,000,000 1 1 $ 1 1 invest 180 days Spot (V/S) 118.60 T Forward-180 ($) 117.80 borrow 593,000,000.00 Japanese yen 1.0170 1 603,136,000 603,081,000 55,000 py START 3.400% Japanese yen interest rate (180 days) END Takeshi Kamada generates a CIA profit by investing in the higher interest rate currency, the dollar, and simultaneously selling the dollar proceeds forward into yen at a forward premium which does not completely negate the interest differential
