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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Transcribed Image Text:A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The
one-year interest rate in the U.S. is i$= 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 at
forward 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.
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