--%>
Assignment Help - homework help

Magnitude of arbitrage profit and covered arbitrage process

Assume that the current spot exchange rate is FF6.25/$ & three-month forward exchange rate is FF6.28/$. In the U.S. the interest rate of three-month is 5.6% per annum and 8.8% per annum in France. Suppose that you can borrow up to $1,000,000 or FF6,250,000.

a. Estimate how to realize a definite profit by means of covered interest arbitrage, considering that you desire to realize profit in terms of U.S. dollars. Estimate the magnitude of arbitrage profit.

b. Suppose that you desire to realize profit in terms of French francs. Illustrates the covered arbitrage procedure and find out the arbitrage profit in French francs.

The market data is concise as:

   S = FF6.25/$ = $0.16/FF; 

   F = FF6.28/$ = $0.1592/FF; 

   I$ = 1.40%;   iFF = 2.20%

   (1+I­) = 1.014 <  (1+iFF)(F/S) = (1.022)(.1592/.16) = 1.0169 

a. (1) Borrow $1,000,000; repayment $1,014,000.

    (2) Buy FF6, 250,000 spot for $1,000,000.

    (3) Invest in France; maturity value is FF6, 387,500.

    (4) Sell FF6, 387,500 forward for $1,017,118.

    Arbitrage profit $3,118 = $1,017,118 - $1,014,000.

b. (1) Borrow $1,000,000; repayment $1,014,000

    (2) Buy FF6, 250,000 spot for $1,000,000.

    (3) Invest in France; maturity value FF6, 387,500.

    (4) Buy $1,014,000 forward for FF6, 367,920.

    Arbitrage profit will be FF19, 580 = FF6, 387,500-FF6, 367,920.

 

   Related Questions in Financial Management

  • Q : Explain probability of some buses with

    Explain probability of some buses having arrived when the Poisson process is utilized.

    		•
  • Q : Fund Eurodollar loans You are an

    You are an investment banker advising a Eurobank regarding a new international bond offering it is considering.  The proceeds are to be utilized to fund Eurodollar loans to bank clients. What sort of bond instrument would you suggested that the bank consi

    		•
  • Q : Which numerical method should you use

    You need to price an option that is paid for within instalments, and you can stop paying and lose the option. Which numerical method should you use?

    		•
  • Q : Explain sunk cost Explain sunk cost and

    Explain sunk cost and it relevant when evaluating a proposed capital budgeting project?  Explain.

    		•
  • Q : Explain Letters of Credit Letters of

    Letters of Credit: It is a binding document which a buyer can request from his bank in order to pledge that the payment for goods will be moved to the seller. Principally, a letter of credit provides the seller reassurance that he will obtain the paym

    		•
  • Q : Major types of international bond

    In brief define each of the major types of international bond market instruments, noting their distinguishing characteristics.The major kind of international bond instruments & their distinguishing characteristics are as follows:

    		•
  • Q : Resolving a ranking conflict Explain

    Explain how and why to resolve a “ranking conflict” between the internal rate of return and the net present value.

    		•
  • Q : What are different variables and

    What are distinction variables and parameters of Vega Hedging?

    		•
  • Q : Describe construction of special

    Describe how the special drawing rights (SDR) are constructed. Also, discuss the situation under which the SDR was build.SDR was created by the IMF in the year of 1970 as a new reserve asset, partially to alleviate the pressure on the U.S. dolla

    		•
  • Q : Capital rationing Explain in brief

    Explain in brief capital rationing? What are reasons that a firm should practice capital rationing?

    		•