Questions 22 through 25 are related

22. A large firm can currently borrow U.S. Dollars for nine months at an interest rate of 0.92%. If exchanging Dollars for Mexican Pesos [buying pesos] the current exchange rate is MXN 18.8725 per U.S. Dollar. Mexican government bonds maturing in nine months yield 5.60%. The firm forecasts in nine months MXN 19.25 will be needed to purchase one USD. If the firm borrows $1 million, converts it into pesos, invests the pesos for nine months, and converts the peso proceeds back into Dollars, what will be the profit? Assume interest is paid and earned at maturity. This is uncovered interest arbitrage, a basic time value of money problem.

$2,431

$14,666

$14,959

$35,100

$46,800

23. As a percentage of the original investment on an annualized basis, the investment in question 21 returned:

Traditional Effective

6.24% 6.29%

4.68% 4.71%

1.99% 2.00%

1.96% 1.96%

0.32% 0.32%%

24. A forward currency contract permit parties to exchange currencies on a future date, say nine months in the future, at an exchange rate agreed at the time the contract is settled. The exchange rate on a nine month forward is currently MXN 19.45 per USD. If the firm in the previous question sells the MXN proceeds at the forward rate, what will be the profit or loss? This is covered interest arbitrage, a basic time value of money problem.

$45,410

$30,600

$7,847

$4,161

$3,715

25. As a percentage of the original investment on an annualized basis, the investment in question 23 returned:

Traditional Effective

0.50% 0.50%

0.55% 0.56%

1.05% 1.05%

4.08% 4.10%

6.05% 6.10%