Question
The finance manager has now been tasked with investing AUD 5 million (or US dollar equivalent) for a period of three (3) months. Facing the
The finance manager has now been tasked with investing AUD 5 million (or US dollar equivalent) for a period of three (3) months. Facing the rates shown in the table below, should the finance manager enter into a covered interest arbitrage (CIA) investment? If yes, show all relevant calculations to support your answer and show which currency the finance manager should invest in. If no, provide an explanation in no more than 4-5 sentences as to the reason why the finance manager should not enter into a covered interest arbitrage (CIA) investment.
Spot exchange rate | S (USD/AUD) | = | 1.036/AUD |
180-day forward rate | F180 (USD/AUD) | = | 1.020/AUD |
AUD discount rate | iAUD | = | 6.00% p.a. |
US dollar Discount rate | iUSD | = | 4.00% p.a. |
In your answer, you should:
i) Demonstrate that a CIA profit is possible due to the relationship between the spot rate and the forward rate; and
ii ) calculate the resulting CIA profit using any relevant calculations. If you wish, you can also use a diagram to show your answer.
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