A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. Theone-year interest rate in the U.S. is i$= 3.5% and in the euro zone the one-year interest rate is i€ =6.5%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 -€1.00. Show how to realize a certain profit via covered interest arbitrage.O Borrow $1,000,000 at 3.5%. Trade $1,000,000 for €800,000; invest at i€ - 6.5%; translate proceeds back atforward rate of $1.20 - €1.00, gross proceeds - $1,022,400.Both B) and C)Ⓒ Borrow €800,000 at i€ = 6%; translate to dollars at the spot, invest in the U.S. at i$ = 3.5% for one year;translate $1,035,000 back into euro at the forward rate of $1.20 - €1.00. Net profit €10,500.Borrow €800,000 at i€ - 6.5% ; translate to dollars at the spot, invest in the U.S. at i$ - 3.5 % for one year;translate €852,000 back into dollars at the forward rate of $1.20 €1.00. Net profit $12,600.

Arbitrage is risk free opportunity available in market due to incorrect pricing in two markets.

currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. ne-year interest rate in the U.S. is i$ = 3.5% and in the euro zone the one-year interest rate is 5%. The spot exchange rate is $1.25 - €1.00 and the one-year forward exchange rate is $1.20 1.00. Show how to realize a certain profit via covered interest arbitrage. Borrow $1,000,000 at 3.5%. Trade $1,000,000 for €800,000; invest at i€ - 6.5% ; translate proceeds back forward rate of $1.20 - €1.00, gross proceeds - $1,022,400.

currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. ne-year interest rate in the U.S. is i$ = 3.5% and in the euro zone the one-year interest rate is 5%. The spot exchange rate is $1.25 - €1.00 and the one-year forward exchange rate is $1.20 1.00. Show how to realize a certain profit via covered interest arbitrage. Borrow $1,000,000 at 3.5%. Trade $1,000,000 for €800,000; invest at i€ - 6.5% ; translate proceeds back forward rate of $1.20 - €1.00, gross proceeds - $1,022,400.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Similar questions

A European firm borrows MXN from a Mexico bank at a 7% interest rate. Over that same time, the Euro appreciates 2.70% against the MXN. What is the European firm's €-denominated equivalent cost of borrowing?
Newstar Co. expects to pay 500,000 euro in one year. Assume the annual interest rate of borrowing or lending euro is 1% and the annual interest rate of borrowing or lending U.S. dollar is 2%. The spot rate of euro is $1.12 per euro. How much guaranteed amount of U.S. dollar does the company expect to pay after hedging the euro payable transaction in the international money market? (pick the closest answer) A. 565,545 USD. B. 554,510 USD. C. 562,786 USD. D. 576,912 USD.
Suppose a 1-year UK T-bill pays 2.14% and a 1-year Canadian T-bill pays 1.32%. The current spot exchange rate is 1 British pound (GBP) = 1.7244 Canadian dollar (CAD) and the 1-year forward exchange rate is 1 GBP = 1.6837 CAD. What arbitrage profit can an investor earn on an investment value of CAD 1 milion?
Suppose that the interest rate on a US dollar deposit is 3% and the interest rate on a Japanese yen deposit is 1%. Today’s exchange rate is $1/¥ and the expected rate one year in the future is $1.2/¥, so $100 today can be exchanges for ¥100. Which currency deposit yield a higher expected rate of return (which currency investors should be willing to hold)? Why?
Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $ £ A $ 6 % £ 5 % B $ 7 % £ 4 % Explain how firm B could use the forward exchange markets to redenominate a 2-year £30m 4 percent pound sterling loan into a 2-year USD-denominated loan.
A selected bundle of goods costs £100 in the UK, and a similar bundle costs 1,200 krona (DKR) in Denmark. People generally expect the rate of inflation to be 5 per cent in the UK and 3 per cent in Denmark. (a) Assuming that PPP applies, what is the current exchange between GBP and DKR? (b) Assuming that PPP will continue to hold, what spot exchange rate would you predict for 12 months hence? (c) Again assuming PPP, what exchange rate should be quoted for three-month forward transactions?
Given we have 100,000 EUR in an EU bank account we consider the below options: "A" - to deposit the money today in a special savings account in the local bank at the current interest rate at r= 1% for one year. • "B" - to convert the amount into the USD if today's exchange rate is E, is €1/$1, transfer and deposit the money in a USA bank at the going interest rate there at r* = 5% for one year. Make an agreement today to convert and return a specified amount of US $ to € one year from today based on the forward exchange rate (F ) of €1.25/$1. The forward exchange contract can be signed today to eliminate any uncertainty. Which of the two is better?
Foreign exchange investment involves risks and at the same time returns. Considering you will invest your peso @ P50 = $1 foreign exchange with a fixed interest of 5%, when can you say that you are fully maximized the value of your investment upon maturity? a. Interest and proceeds received in full deposit to a bank account b. Interest received in full with current exchange rate @ P52 = $1 but retained the money in USD while waiting for another investment. c. Interest received in full with current exchange rate @ 52 = $1 and converted the full proceeds to peso d. Interest received in full with current exchange rate @ 52 = $1 but converted the interest only while waiting for another investment.
You are an American investor who can borrow $1,000,000 or the equivalent amount in euros today. Suppose the spot rate is $1.18/€, and the one-year forward rate is $1.15/€. The annual interest rate is 4 percent in the U.S. and 2 percent in Germany. Check if IRP holds. If it does not hold, set up a covered interest arbitrage. What will be your profit from this arbitrage opportunity in dollars?
the current spot exchange rate is $1.85/£ and the three-month forward rate is $1.80/£. Based on your analysis of the exchange rate, you are pretty confident that the spot exchange rate will be $1.82/£ in three months, assume that you would like to buy or sell £1,000,000. a) what actions do you need to take to use these rates to earn a profit? what is the expected dollar profit from speculation? b) What would be your speculative profit in dollar terms if the spot exchange rate actually turns out to be $1.76/£
Suppose that you are the CFO of Google with an extra U.S. $20 Million to invest for one year. You are considering the purchase of U.S. T-bills that yield 4% per year. The spot exchange rate is $1.00 = €0.90, and the one-year forward rate is $1.00 = €0.95 . What must the interest rate in the Eurozone (on an investment of comparable risk) be before you are willing to consider investing there instead of the US? a. 9.78% b. 1.56% c. 4.00% d. 5.56%
Suppose the risk free rate in pounds is 5.12% and the risk free rate in US dollars is 7.71%. The current £ to $ exchange is 1.43. You and a broker want to agree an exchange rate now for a £ to $ conversion, but where the money will be exchanged in precisely 36 months time. What exchange rate (£ to $) should you and your broker use to ensure there is no arbitrage? Give your answer to 2 decimal places.

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