Question
Will an investor facing the following prices be able to make money through a covered interest rate arbitrage by borrowing euros or dollars? Bid Ask
Will an investor facing the following prices be able to make money through a covered interest rate arbitrage by borrowing euros or dollars?
Bid Ask Borrowing Lending
S0 $1.40 - 1.00 $1.43-1.00 i$ 4.20%APR 4.10%APR
F0 $1.44 - 1.00 $1.49-1.00 i 3.65%APR 3.50%APR
a Yes, borrow 1,000,000 at 3.65%, trade for $ at bid price spot rate $1.40 = 1.00; invest at 4.1 percent; hedge this with a long position in a forward contract.
b Yes, borrow at $1,000,000 at 4.2 percent; trade for at the spot exchange rate $1.43=1.00; invest 699,300.70 at 3.5 percent; hedge this by going SHORT in forward (agree to sell @ bid price of $1.44/ in one year.) Cash Flow in 1 year $237.76
c No, the transaction costs are too high
d None of the options
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