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Ifm forex markets-01[1].03.07

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Ifm forex markets-01[1].03.07

1. 1. • Suppose the spot rate between Euro and USD is 0.8700 USD per Euro. 90-day forward is 0.8500.Dollars can be lent or borrowed at a rate of 5% p.a while the rate for euro deposits or loans is 8%p.a. Is there an opportunity for arbitrage?
2. 2. Covered Interest Arbitrage• Borrow 100 Euros @ 8%p.a• Convert into USD spot 100x0.87 =\$87• Deposit \$87 for 90 days @ 5%p.a = \$88.0875• Convert it to Euro forward =88.0875/.85=103.63• Repay Euro loan = 102.00• Arbitrage profit = 1.63
3. 3. • Consider the following data:• Gbp/usd: 1.7500/10• 3 month forward: 1.7380/1.7400• 3-month eurodollar:8.00/8.20% p.a• 3-month euro sterling: 10.50/11.005 p.a• Check whether there is a covered interest arbitrage.
4. 4. • Borrow \$1for 3 months at 8.20% p.a., convert to• GBP(1/1.7510) = GBP 0.5711, invest GBP at 10.50% p.a. for three months; maturity value GBP 0.5711[1+(0.1050/4)] = GBP 0.5861, which sold forward at 1.7380 yields \$1.0186. Repayment of dollar loan requires \$1.0205 = 1+(0.0820/4). Net loss.• Borrow GBP 1 at 11%; convert spot to \$1.7500; invest at 8.0% p.a.; maturity value of deposit 1.75(1.02) = \$1.7850; sold forward at \$1.7400 per GBP yield GBP(1.7850/1.7400) = GBP 1.0259; repayment of GBP loan requires GBP [1+(0.11/4)] = GBP 1.0275. Again net loss.• Hence no covered interest arbitrage opportunity.