QUESTION 3 (25 MARSKS)

1. The Mexican peso (MXN) is expected to decline against the dollar in the next 10 days, according to BBVA Bancomer, from its current spot rate of USD0.1500 to USD0.1400. There are the following rates for interbank lending and borrowing:

Currency	Lending Rate	Borrowing Rate
US Dollar (USD)	8.00%	8.30%
Mexican Peso (MXN)	8.50%	8.70%

Assume BBVA Bancomer has a borrowing capacity of USD10 million or MXN70 million in the interbank market, depending on which currency it wishes to borrow. Determine how BBVA Bancomer might capitalise on its projections without utilising deposited money and earn potential profit from this approach.

(11 marks)

2. In New Zealand, the one-year interest rate is 6%. The one-year interest rate in the United States is 10%. The New Zealand dollar (NZ$) has a spot rate of $.50. The New Zealand dollar has a forward rate of $.54.
   1. Explain if covered interest arbitrage can benefit US or New Zealand investors.

(7 marks)

2. Explain why covered interest arbitrage is or is not conceivable in each situation.

(7 marks)